Is Grexit threat a damp squib for insurers’ portfolios?
The turmoil witnessed in Greece and the wider Eurozone over the past week has prompted a flurry of coverage in the economic press examining the international markets' reactions.
The crisis intensified after the country defaulted on its EUR1.55bn payment to the International Monetary Fund (IMF) on 30 June and subsequently voted "no" in the referendum on the terms of a bailout.
Most P&C insurers now have no direct exposure to Greek bonds or shares, given they rotated out of any positions they held after the threat of a Greek exit, or "Grexit", first raised its head in 2011.
But questions have been asked about the likely impact on other assets, particularly European sovereign bonds, and any anticipated effect on the euro.
Andreas Gruber, group chief investment officer at Allianz Investment Management, noted that the markets had reacted moderately following Greece's default on 30 June, indicating that the risk of a ripple effect hitting other sectors was relatively low.
"We do not expect the capital markets to drop drastically, even though the volatile development is likely to continue," he continued.
"Allianz has a total exposure to Greek bonds and stocks of around EUR10mn. This is less than 0.002 percent of our EUR665bn insurance assets."
Michael Tripp, partner at Mazars and former CEO of Ecclesiastical, said that most insurers had already unwound any positions they had or taken contingent action. Most had probably also discounted the possibility of Greece leaving the Eurozone, he added.
The remaining risk is one of contagion - i.e. that confidence in peripheral European countries such as Italy, Spain and Portugal falls, causing a knock-on financial crisis. While insurers ran from Greek assets in 2010/2011, some have since moved back into Spanish and Italian debt as the risk return ratio became more attractive.
The contagion scenario, however, seems unlikely given that the fundamentals are much improved compared to five years ago and the European Central Bank (ECB) has now fully embarked on its substantial quantitative easing (QE) programme, which sees it buy huge amounts of European sovereign debt, effectively putting a cap on any widening spreads.
But that's not to say that we won't see some initial reaction, should Greece's exit from the Eurozone become a reality in the coming weeks.
"Contagion is likely to cause an initial spike in [sovereign bond] yields, especially for those economies perceived by the markets as fiscally more vulnerable. The ECB's QE programme would eventually be able to cap the rise in yields, but a currency risk premium is likely to be permanent," noted Standard & Poor's in its recent report, The Credit Impact of a Grexit.
James Peagam, head of insurance advisory at JP Morgan Asset Management, agreed, saying: "Although there will be a widening in the short term, contagion will be much more muted than it was in 2012 because of better fundamentals and the various structural mechanisms in place."
The equity markets have already reacted to the news of Greece's IMF payment default, with the Eurostoxx 50 falling 1.3 percent on 30 June - down more than 9.6 percent from the 52-week high set in April.
But Andrew Harmstone, a portfolio manager at Morgan Stanley Investment Management, believes the negative impact from a potential Grexit may have already been priced in.
"If you look at the market value of a 9.6 percent decline in the market capitalisation of the Eurostoxx 50, it's about EUR266bn," he said.
"Greece's estimated total 2015 GDP is EUR183bn, which suggests that with this one factor alone, the decline in market value of Eurozone equities alone may exceed Greece's GDP by nearly 50 percent.
"It seems reasonable to believe that the impact of Grexit should be proportional to Greek GDP, and therefore it's reasonable to suggest that a large amount of the impact of a Grexit may have already been priced in."
He added that there was little evidence that an extended slide in non-Greek equities would occur, and the overall outlook for Eurozone equities continues to be favourable, thanks to an undervalued currency, cheaper energy prices and signs of a meaningful return to growth.
Looking ahead, the next major milestone that could impact markets will come on 20 July - the day when Greece is due to make a payment to the ECB.
"If we approach 20 July without a resolution, we could see a risk-off event causing a flight to 'safe' assets such as the sovereign debt of the US, Switzerland, and Japan," said John Merante, economist and macro strategist, portfolio strategies at Principal Global Investors (PGI).
"A substantial 'risk-off' move in global risk assets would be a significant shift that would impact a broad range of asset classes."
There is also the wider impact on the currency markets to consider. If Greece returns to the drachma, it would show that the monetary union is reversible, undermining ECB president Mario Draghi's "whatever it takes" strategy.
Globally, investors will also want to take note of what happens to interest rates in the US and Europe, as this will materially impact the performance of credit assets.
"In a Grexit scenario, credit will be a 'follower' market, taking cues from the government bond markets," said Seema Shah, global bond strategist at PGI. "A sharp widening in peripheral spreads and an increase in market volatility would likely have implications for credit spreads and fund flows.
"Importantly, technically driven volatility as a result of developments in Greece may present buying opportunities in credit, provided there is no fundamental deterioration in the peripheral or core European economies."
The ECB's response to a potential tightening in financial conditions or deterioration in liquidity will also be important to investors considering their positioning and the performance of the fixed income market.