Euro-denominated Run Off and Currency Risk - Commutation Rendez-Vous 11 June 2013 Rory Unsworth Head Contracts Hub Zurich
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Euro-denominated Run Off and Currency Risk Commutation Rendez-Vous ¦ 11 June 2013 Rory Unsworth ¦ Head Contracts Hub Zurich
Context Scenario: Exit (s) from a surviving
Eurozone
• Remains a possible outcome
• Peak risk is within GIIPS…?
• Complete Break-up less likely
Swiss Re, Rory Unsworth, Legacy RV 2013 2
€ Policy View
€ Reinsurance View
€ Transactional View (in-force)
€ Transactional View (future)
Swiss Re, Rory Unsworth, Legacy RV 2013 3
Policy view: reserves kept in Euros
example: GIIPS Motor Policy, with reported claim (injured minor, severe
injuries), reserved in Euro to cover continuing care costs
7
6 Net Annual Costs
5
4 After inflation (new
+ve Development
currency) *
3 Eurozone
After currency
annual cost
exit
2 devaluation
1 Original cost
0 (expected in Euros)
Year 1 2 3 4 5 6 7
Positive impact on net loss burden. * Partly offset by yield increase
Swiss Re, Rory Unsworth, Legacy RV 2013 4
Policy view: reserves converted
same policy
7
6 Net Annual Costs
-ve Development
5
4 After inflation
3 Eurozone
After currency
annual cost
exit
2 devaluation
1 Original cost
0 (expected)
Year 1 2 3 4 5 6 7
Adverse impact on net loss burden.
Swiss Re, Rory Unsworth, Legacy RV 2013 5
Reinsurance view: Reserves kept in Euros,
QS
e.g. GIIPS Motor Book, 10 unsettled claims, reserved in Euro to cover
continuing care costs: Quota Share reinsurance
70
Positive impact on
60 Net Annual losses.
50 Costs
40 Extent depends on
After inflation • Profit Commission
30
• Premium impacts.
annual cost
20 After currency
10 Impact on locally held
devaluation
0 deposits?
Original cost
(expected)
SIMPLIFIED VIEW
Swiss Re, Rory Unsworth, Legacy RV 2013 6Reinsurance view: Reserves kept in Euros,
NP
e.g. GIIPS Motor Book, 10 large unsettled claims, reserved in Euro, coming
43 into the layer at Exit event
60
Positive impact on
50 Net Annual losses.
40 Costs Extent depends on
30 After inflation • layer structure
• whether underlying losses
annual cost
paid or reserved
20
After currency • indexation clause.
10 devaluation Impact on locally held
0 Original cost deposits?
(expected)
SIMPLIFIED VIEW
Swiss Re, Rory Unsworth, Legacy RV 2013 7Q. What happens without new clauses (Exit)?
A. Depends on the new legal framework and the existing wording, but…
Likely Proportional impact: Likely NP impact:
• Contract changes to split-currency • Contract remains in Euro (limits,
contract upon introduction of new payment currency).
currency.
• Currency conversion clause applies to
• Policies issued prior to change payments in new currency.
continue to be accounted/paid in
Euros. • Positive run-off in any exiting GIIPS
countries.
• Policies issued after are
accounted/paid in new currency. • Adverse run-off if new currency
appreciates (but limits unchanged).
• Earned premium before the change
remains in Euros. • Indexation clause applies upon
inflation.
• Reinsurers share impact of inflation.
N.B. ASSUMPTION THAT EURO CONTINUES TO EXIST.
Swiss Re, Rory Unsworth, Legacy RV 2013 8Transactional View (in force)
Like "default" Reinsurance view (see previous slides).
Structure Compares to
ADC NP view
Retrospective QS QS view
Novation Depends on structure(s) being novated
Assuming:
Transaction is Reinsurance in nature (as opposed to novation of original
policies)
No other contrary clauses (e.g. Break option following Change of Law,
Euro clause, MAC clause)
Note: Impact of Commutation depends on where you stand in the commutation, the
currency of the commutation amount, and the structure being commuted.
Swiss Re, Rory Unsworth, Legacy RV 2013 9Transactional View (future)
Like "default" Reinsurance view, unless
– parties want to change it
– parties wish to clear up residual areas of uncertainty (e.g. Break-up of Euro-
zone, change of currency law)
If so, consider benefits of Euro clause.
Euro clause could:
1. put transaction into another currency (e.g. USD)
2. address Break-up or Exit scenarios (Euro disappears – not currently
provided for in contracts)
3. attempt to right any perceived injustice of outcome ("share the gain")
Note higher transactional costs after an Exit or Break-up event.
Swiss Re, Rory Unsworth, Legacy RV 2013 10BEYOND THE SIMPLIFIED VIEW
1. Impact of new currency laws unpredictable.
Can Argentina-style extremes be implemented in countries remaining in the EU?
But…
Will new currency law address Reinsurance?
Will it force re-denomination?
Or will it allow freedom of contract principles to prevail?
Will it be prospective only, or also retroactive? Will it be clear on this point?
2. Exiting country has currency appreciation (as opposed to devaluation).
View would be opposite of devaluing currency scenarios (subject to continued application of
limits and sublimits in Euros) –> currency risk.
3. Dangers of "passive Run-Off" due to unforeseeable risks in development
(operational risk, financial risk, counterparty risk, strikes, riots etc.)
Swiss Re, Rory Unsworth, Legacy RV 2013 11Reserves, deposits, LoCs
State of Issuing/Holding State of Issuing/Holding
Bank Exits Bank remains
Deposits / may be frozen and/or converted to No impact expected
Funds withheld the new currency e.g. Cyprus levy
Letters of Credit capital controls may prevent No impact expected
payment/ enforcement
Pledges Depends on the pledged asset No impact expected
Swiss Re, Rory Unsworth, Legacy RV 2013 12Reserves, deposits, LoCs
• To the extent possible from a legal and regulatory perspective,
consider transferring collaterals out of at risk countries mutual
benefit to protect reserves.
• New risk transfer solutions, with transfer of funds, may hedge
exposure to currency risk.
• Specifically for cash deposits -> consider if possible to convert the
form of collateral (e.g. Trusts, pledges, etc.). This will depend on
whether there is a legal obligation to deposit, and whether the
law/regulation states a specific form of reserve/collateral (e.g.
Greece).
• Note: Collateral accepted by US National Association of Insurance
Commissioners (NAIC) depends on rating of sovereign (domicile of
issuing bank). e.g. LoC from a bank in a country losing AAA (or short
term A1) automatically falls off the approved list, and would have to be
replaced with acceptable LoCs.
Swiss Re, Rory Unsworth, Legacy RV 2013 13Conclusion
Exit(s) may or may not take place
1
• Tail risk, particularly political
2 Euro clauses not very common yet; existing clauses do not
give clarity for EMU Break-up scenarios:
• Novated business – consider other forms of hedging
(match assets to liabilities? portfolio disposition?)
• Reinsurance agreements (ADC/retrospective QS): as
above, or Euro endorsement
3 Future Run-Off Transactions: consider impact of Euro
Exit/Break-up, and advantages of a clause
4 Check your collateral!
5 React to legal and regulatory changes, "as and when"
Swiss Re, Rory Unsworth, Legacy RV 2013 14Back up slide: Swiss Re Euro clauses
Proportional Non-Proportional
Break up Conversion into USD Conversion into USD (incl.
or new local currency limits and deductibles) at
the USD: EUR rate
applying 6 months prior
to break up
Exit Contract continues in Contract continues in
EUR, underlying EUR, as per Proportional
payments in new local
currency are
converted into EUR at
market rates
Subject always to change of law requiring contrary treatment, or
agreement between the parties.
Swiss Re, Rory Unsworth, Legacy RV 2013 15Thank you
Legal notice ©2013 Swiss Re. All rights reserved. You are not permitted to create any modifications or derivatives of this presentation or to use it for commercial or other public purposes without the prior written permission of Swiss Re. Although all the information used was taken from reliable sources, Swiss Re does not accept any responsibility for the accuracy or comprehensiveness of the details given. All liability for the accuracy and completeness thereof or for any damage resulting from the use of the information contained in this presentation is expressly excluded. Under no circumstances shall Swiss Re or its Group companies be liable for any financial and/or consequential loss relating to this presentation. Swiss Re, Rory Unsworth, Legacy RV 2013 17
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