Godot’s Farewell to the Financial Crisis

“It ain’t over ’til it’s over.”- Yogi Berra, 1973

Industry analysts have often referred to the global financial crisis as ‘the 2008-09′ crisis, as if by putting ’09’ after the 2008 we have closed the door on a miserable chapter of the globe’s financial woes and have moved on.

But one could easily make the argument the global financial crisis isn’t really over. In fact, it’s ongoing, even if it has morphed into a different form. What once was a ‘credit’ crisis, for example, has now been re-branded a ‘sovereign debt’ crisis. Either way, insurers’ investment income remains threatened.

“Sovereign risk is currently the main source of concern for the financial stability of the European Insurance and Occupational Pension Sectors,” according to the European Insurance and Occupational Pensions Authority (EIPOA), which regulates the European Union’s financial and insurance sectors. “The process towards sustainable debt levels for sovereigns, both in Europe and globally, will determine whether, and to which extent, these risks will materialise to adversely impact the financial situation of the sectors.”

A cursory glance at the newspapers these days suggests “the process towards sustainable debt levels for sovereigns” is not going well. Just before press time, Greece, teetering on the edge of a default, received a loan from the International Monetary Fund and eurozone countries. And as these words are being typed, the United States politicians have reached a last-minute agreement to increase the country’s debt limit, thus staving off a looming default situation.

Why is this an issue for insurance companies? Because insurers have lots of money invested in government bonds. Should countries default on their financial obligations, insurers may not receive full value for the amount they have invested in bonds. And thus insurers’ investment portfolios would sustain yet another financial hit. Recall that insurers’ investment income is already suffering as a result of government strategies to lower interest rates (this was intended to stimulate economic growth as a means to overcome the scarcity of global credit in 2008-09).

Throughout the global credit crisis, insurers spoke of their ability to insulate themselves from the worst of the fallout, largely because they chose to invest prudently. This prudence meant avoiding risky, potentially high-yield investments like credit default swaps. Instead, money was parked with supposedly safer, lower-yield investments such as government bonds. Alas, the crisis has exposed the highly leveraged nature of many countries’ economic strategies, and now the dependable investments into bonds aren’t looking very ‘safe’ anymore.

Does the sovereign debt issue have any relevance to Canada, where many of the country’s largest property and casualty insurers have parent companies in Europe?

If anything, the impact of the sovereign debt issue on Canadian branches would be indirect. Ultimately the determination of solvency in Canada is based on whether the local branch has enough capital to support its own risks, as well as the branch’s ability to access capital from the parent company.

A sovereign debt crisis could affect branches or subsidiaries if their parent companies/head offices were materially affected in terms of access to capital should the need arise. “Accessing capital” means having access to full value of investment income tied up in government bonds.

The spectre of U.S. loan defaults is likely of more immediate concern to Canadian insurers. Canadian companies have only moderate U.S. government investment, it’s true. But the ripple effect of U.S. loan defaults would most certainly be felt by Canadian insurers sleeping next to the elephant.

We often say the economic crisis of 2008 stopped in ’09 simply because insurers’ financial results started improving in 2009. But the lingering effects of the global credit contraction now live on in the form of a sovereign debt crisis.

It ain’t over ’til it’s over.