George M. Mangion | Wednesday, 24 June 2009

Euro to the rescue

Travelling to Luxembourg last week, I had to fly to Frankfurt and then take a Fokker turbo/prop for the last 40 minutes flight to reach the golden city of banking secrecy. The passenger cabin in the turbo/prop is small and it was raining outside as I landed at the Luxembourg airport. There was a one hour delay waiting for the Lufthansa aircraft to reach Malta. Still I made the connection to Luxemburg and sat tight in this turbo/prop while the hostess gave us the onboard refreshments (ham or cheese sandwiches as Luxair is also feeling the recession). The taxi ride in water-drenched streets of Luxembourg was a pleasant change after leaving sunny Malta sizzling at 32 degrees Celsius (in the shade).The city fit for bankers was grey and overcast, making me feel slightly ominous. Yet, I braced myself as a speaker at the two day conference targeting Captives and PCC’s (among other topics). The venue for the 12th Captive Rendezvous was the ultra modern building within the Luxexp area.
The agenda for the two days was interesting and included titles such as “a sign of the times: trends in insurance and what to expect”. Other topics included how to invest capital in an uncertain environment. The tour d force for me was the discussion on the topic of the EU environmental liability directive. The directive took fifteen years to develop and by now two thirds of EU members have enacted their provisions while infringement procedures have been started against a number of states who failed to implement it. In brief, the directive embraces the concept that the polluter pays and of course places squarely the liability for the damage inflicted on protected habitats and species and other infringements impacting the world’s biodiversity. Thus, the directive expects voluntary financial guarantees or taking up adequate insurance cover for risky or potentially environmentally risky activities. The spirit of the discussion was how to meet the extra insurance and reinsurance costs while the market is hardening and when in the midst of a recession environmental protection does not immediately hit the top priority. Another topic which impressed me was the underwriting problem relating to the risks associated with the volatility of currencies.
This volatility is exacerbating the risks involved in doing global insurance business. Notice the changes in values of sterling and dollar while compared to other currencies especially the euro.
Many expected the Euro to have a modest beginning when it was first launched in 1999 amid much fanfare. One recalls its brief history when during the recession in the early 1990s politicians saw a near-continual series of currency crises within Europe’s exchange-rate mechanism. As an aside, in Malta we officially applied to join the EU in 1992, and our leaders made strenuous efforts, through fiscal tightening, wage restraint and product and labour-market reforms, to finally qualify in 2004. Entry under the Maastricht treaty’s criteria for euro membership took longer as our economy was not ready and we waited until 2008 for our GDP growth to reach its peak at 3.7 per cent mark. Only then the green light was beamed to us. Granted that the test was tough and regrettably this year our fortunes have taken a downturn since growth in the first quarter was negative. Yet our politicians hailed the advent of passing the test in 2008 as a major breakthrough. One hopes that in the midst of the current recession we do not rest on our laurels and relax, beguiled by the notion that membership of the single currency would of itself solve our lack of competitiveness. At the same time, many sectors of our economy shown bouyant traits in the run up to entering the Euro club. Tourism boomed and manufacturing/exports invoiced in the the freshly minted Euro notes rang a triumphant note. Malta for that short period basked in the glow and the benefits of a boom brought on in part by the euro’s lower interest rates. But the honeymoon was short. This year Malta has joined the rest of Eurozone members suffering a steady loss of wage and price competitiveness which is eroding growth. The Eurozone has officially slipped into recession after EU figures showed that the economy shrank by 0.2 per cent in the third quarter. This follows a 0.2 per cent contraction in the 16-nation area.
As they say, one prime motive for creating the euro was precisely to garner strength among members and avert contagion from spreading its evils to a recession. Indeed, in the insurance markets some of those fretting about the troubles of the euro area’s weaker economies are publicly drawing comfort because they have at least been spared pressure from the foreign-exchange market. Euro sceptics lament that currencies are not to be experimented with as they are the means by which wealth is stored, protected and exchanged between countries, organisations and individuals. Yet ten years aback nobody expected the Euro to stand tall next to the Sterling and even less the mighty Greenback. It started at a discount to the dollar but recouped its value over the years as the dollar lost some of its strength. Within the securities and insurance sector the euro is also widely used in third countries and regions neighboring the euro area, for example in South-eastern Europe, while some other countries – Monaco, San Marino and the Vatican City – use the euro as their official currency by virtue of specific monetary agreements with the EU, and may issue their own euro coins within certain quantitative limits.
Thus insurers and brokers have written international risks in Euro. Fortunately, in the run-up to the global credit crunch it acted as a stable currency with low inflation and low interest rates. Insuring your risks in a single European currency was also a logical complement to the single market which other things remaining equal makes it more efficient. Investing in the single currency was amply encouraged due to the additional values of price transparency, while minimising currency volatility. For a while, the experiment was working wonders before the onset of the US sub-prime crisis. Thus it oiled the wheels of the European economy, facilitated international trade and in contrast with the dollar it landed the EU with a more powerful voice in the insurance world. The size and strength of the euro area also protected it from external economic risks, such as unexpected oil price rises or turbulence in the commodity markets.
Naturally the insurance industry in Europe started to use the Euro in a cautious way as it took some years for the currency based on the economy of a select number of central European countries to start becoming attractive beyond its borders. Delegates at the conference were discussing how impressive was the integration of the wonder currency in its trajectory to fame. At the end of 2006, the share of the euro in international debt markets was around one-third, while the US dollar accounted for 44 per cent. The “enfant” has grown up and the euro is the home currency of the 329 million people. The euro is extensively used for general insurance invoicing while covering risks in international trade, not only between the euro area and third countries but also, to a lesser extent, between third countries. But not everything is rosy in the Euro garden even though the number of countries using it now reached 16 in number.
Speakers at the conference opined that the danger signals within the insurance and investment sectors are coming not from the foreign-exchange market but from the bond markets. Spreads on the ten-year government debt of Greece, Ireland, Italy, Portugal and Spain over that of Germany have widened sharply. Rating agencies are paying particularly close attention to the fiscal positions of the so termed the “profligate five”. Standard & Poor’s has downgraded three of them and put another on credit watch. We are witnessing rising unemployment and dwindling demand from major Eurozone members. It is no surprise that insurance rates in these countries is hardening. To a large extent these five countries could be chided for reaping what they have sown. . Yet the logic of their situation argued for exactly the opposite course. Discussions at the workshops during the conference centred around the weakness of the sterling and dollar. But eurozone members are at a disadvantage as exports come dear. They are technically deprived of the chance to devalue and with hindsight some of them should have pursued more vigorous reforms at home to make their economies better able to compete. It is no consolation to say that it is too late to exit since the rules of the single currency expressly forbid any bail-out of one country by the centre or by other countries. To conclude the captive insurance and reinsurance sector is also passing through turbulent times and one prays that the recovery is not far away. We all must endeavour to prepare ourselves to be able to partake fully of the new opportunities when the grass shoots turn into solid plants of plenty.


George Mangion
Partner at PKF – an audit and business advisory firm



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24 June 2009

Malta Today


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