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Impact of Credit Crunch on European Insurance by Delloit
 

Impact of Credit Crunch on European Insurance by Delloit

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Impact of the Credit Crunch on the European Insurance Industry by Delloit

Impact of the Credit Crunch on the European Insurance Industry by Delloit

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    Impact of Credit Crunch on European Insurance by Delloit Impact of Credit Crunch on European Insurance by Delloit Presentation Transcript

    • Impact of the credit crunch on the European Insurance Industry. Insurance Breakfast Tuesday 4 December 2007
    • Agenda • Welcome Prof. Herbert Lüthy • The Credit Crunch and the European Economy Ian Stewart • Impact on the European Insurance Industry Prof. Herbert Lüthy 2 Deloitte © 2007 Deloitte AG. All rights reserved.
    • The Credit Crunch and the European Economy Ian Stewart, Deloitte Research 4th December 2007
    • How it all started Estimates of total US sub-prime losses are increasing Rising US sub-prime mortgage Rising US sub-prime mortgage defaults defaults as banks announce further details of their exposures. Losses and downgrades on related Losses and downgrades on related ABS assets ABS assets Up to $50bn of losses and write-downs announced by investment banks with significantly more expected in Q4 Loss of confidence in ABS globally Loss of confidence in ABS globally due to lack of transparency of due to lack of transparency of [source: FT, various bank analysts] value/losses value/losses Wider flight from risk in credit and Wider flight from risk in credit and other markets other markets Credit conditions have tightened as liquidity has been hoarded to cover. Realised warehousing risk at end of Sept Risks flow back to banks’ balance Risks flow back to banks’ balance sheets estimated at $300bn sheets Money markets tighten as liquidity Money markets tighten as liquidity hoarded Increasing downside risk of global economic impacts hoarded – with recession in the US a growing possibility Continued deterioration in US housing Continued deterioration in US housing market and further downgrades in market and further downgrades in ABS values ABS values Investment banks are now facing unprecedented challenges Investment Banks announce Investment Banks announce substantial Q3 and post Q3 losses and substantial Q3 and post Q3 losses and to the business models that have driven the significant share predict challenging Q4 predict challenging Q4 of profits growth in recent years 4 Deloitte © 2007 Deloitte AG. All rights reserved.
    • August 10th: Europe liquidity Early 2007: Slow down problems Mid November: An economist in US housing market at Goldman Sachs releases a • ECB injected € 94.8 billon into • US housing activity at Mid July: S&P cuts report that suggests losses in the money markets as interbank near recession levels ratings on some top- lending vanishes due to the credit market could reach and mortgage arrears rise rated mortgage bonds concerns about banks’ subprime $400 billion and financial sharply Mid 2007: US Subprime exposure institutions may cut their lending problems by $2 trillion • Overnight Euro money markets • Unprecedented level of were at 4.62% - highest level repayment problems for 6 years Mid Sept: US Fed cuts Federal Mid June: Losses in CDO funds target rate by 50 bp – funds Equity markets rally • Two Bear Stearns CDO hedge • Dow Jones Industrial Average funds suffer heavy losses amid and the S&P 500 touched all time a rapid decline in the market highs for subprime mortgages June July August September October November Mid-June: Banks uncertain European banks September 14th: about value of own assets announce losses Northern Rock • Cut back on other • German rescue: IKB • Northern Rock seeks Fitch says it may commitments require rescue due to emergency financial cut the AAA credit • Exacerbated rising risk subprime exposure support from the ratings of bond aversion • BNP Paribas freezes $2.2 Bank of England insurers, raising concern that such billion worth of funds, action could trigger citing subprime issues a wave of downgrades of some of the $2.5 trillion of bonds they insure Timetable for the credit crisis October: Investment Banks, particularly Citigroup and Merrill Lynch, announce substantial Q3 and post Q3 losses and predict challenging Q4 5 Deloitte © 2007 Deloitte AG. All rights reserved.
    • A CFO view on the credit crunch: a problem for others? Note: 46% see no impact on their business 60% positive impact 40% Availability of credit for Your business UK corporates The UK economy The UK corporate sector 12% 20% 0% 0% 0% 0% negative impact -20% -40% -42% -60% -80% -82% -92% -100% -98% Survey conducted21st September and 2nd October. “Overall, how do you think recent developments in credit markets will affect the UK Economy, UK Corporate sector, availability of credit for UK corporates and your business?” 6 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Global economy strong…but how quickly will it slow? 5.5 Global GDP growth: % change year on year 5 4.5 4 3.5 3 2.5 2 1.5 1 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: IMF 7 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Transmission channels from financials to the real economy Output of financial services Wealth Financial market development A Bank lending Spending by Prospects firms and for activity & households inflation Non bank lending Uncertainty A The extent of bank lending depends on several factors, such as borrowers’ financial positions, ratio of banks’ capital to their assets, price and availability of bank funding 8 Deloitte © 2007 Deloitte AG. All rights reserved.
    • A key worry: plentiful liquidity + cheap credit = debt boom 2000 T o t a l L ia b ilit ie s a s a % o f N o m in a l G D P 500 Europe’s joined in the debt boom too 2007 400 300 200 100 0 US Japan Germany UK France Italy Spain Netherlands 9 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Spread of 3 month money over ECB repo Rising risk aversion has led to a flight to liquidity and a sharp rise in 3 month interest rates 1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 -0.1 -0.2 -0.3 -0.4 -0.5 99 00 01 02 03 04 05 06 07 19 20 20 20 20 20 20 20 20 10 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Banks’ declared losses Additional announced Q3 Structured credit and estimates of Q4 % of leveraged loans losses losses and write- Market Market and write-downs downs Total Capitalisation Cap Citigroup 6.5 11 17.5 152 11.5% Merrill Lynch 8.4 8.4 45 18.7% Barclays 2.7 2.7 68 4.0% Bank of America 4 3 7 189 3.7% Deutsche 3.4 3.4 62 5.5% UBS 3.6 3.1 6.7 86 7.8% Goldman Sachs 1.5 1.5 85 1.8% JPMorgan 1.3 1.3 139 0.9% Wachovia 1.3 1.3 76 1.7% Bear Stearns 0.7 1.2 1.9 13 14.6% Source: Deloitte Research and press reports 11 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Asset bubbles are followed by a collapse in prices….this takes time…and can be painful 5500 It took more than 2 years for the dot.com bubble to deflate 5000 4500 4000 3500 3000 2500 2000 1500 1000 Nov/97 Nov/98 Nov/99 Nov/00 Nov/01 Nov/02 Nov/03 Nov/04 Nov/05 Nov/06 Nov/07 12 Deloitte © 2007 Deloitte AG. All rights reserved.
    • US banks have become much more unwilling to lend US credit conditions: net % of banks tightening lending terms to corporates 55 45 35 25 15 5 -5 - 15 -25 90 92 94 96 98 00 02 04 06 08 19 19 19 19 19 20 20 20 20 20 13 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Banks tend to under perform when the economy is weak: they are under pressure now UK banks relative to the broad equity market 275 250 225 200 175 150 125 100 75 50 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 14 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Good news… global growth doesn’t just depend on the US anymore Change in oil consumption, % (1996 to 2006) 50 45 40 35 30 % 25 20 15 10 5 0 BRICs The rest of the world G7 15 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Key features of the crisis Sub prime was a result of easy credit and financial innovation. Other asset classes have similar characteristics Financial markets were slow to react to bad news. US housing slowdown started in 2006, sub prime meltdown didn’t start in earnest until Spring 2007 It’s been worse than expected. A financial event has become an economic problem Downside risks have emerging simultaneously. Record oil prices, the lagged effect of past rate hikes, financial stress 16 Deloitte © 2007 Deloitte AG. All rights reserved.
    • What else could go wrong? • US sub prime defaults are likely to rise further – risk that it spread to other parts of the US housing market • The full impact of recent events on financial institutions may not be fully apparent – risk of further write-offs • Crystallisation of warehousing risk + strain from SIVs/conduits - risk balance sheet damage impedes credit creation hitting leveraged trades • Strains in the commercial real estate sector - risk of further balance sheet damage, confidence effects • Equities are up on the year - risk that weaker growth leads to weaker equity markets • The dollar remains in downtrend - risk of sharp downward correction which hits confidence 17 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Europe – areas of vulnerability • ECB rates have doubled to 4.0% in the last 2 years • 40% appreciation in Euro since 2000 low • Compressed high yield spreads • Surge in low quality bond issuance, credit derivatives • Buoyant real estate and equity prices • Rise in household and corporate exposure to short rates • Household debt/GDP ratio has risen 45% in the last 10 years • Corporate gearing has risen 60% in the last 10 years • Housing valuations stretched in a number of European economies Problems in European covered bond and European Government bonds illustrate risks 18 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Scenarios for the Credit Crunch Scenario 1: Scenario 2: Scenario 3: Consensus (around 12 months) Worse than expected (1-2 years) Large Impact (several years) Comparable 1998 credit crunch 1990-91 recession and Savings & Loans problems Japan in 1990s Event FRB floods market with liquidity FRB provides liquidity FRB liquidity infusion and bail outs are insufficient Key Actions Taken Interest rates are lowered US Government sets up agency to assist ECB lowers interest rates sooner than expected homeowners Confidence returns in credit markets Credit is constricted; spreads stay high Further credit constriction No significant slowdown in credit Increasing defaults prolong the crisis Adequate credit not available for normal operation Market Reaction of economy Sub-prime defaults impact equity prices of some European banks suffer earnings loss and modest financial institutions credit decline Bank balance sheets worsen US GDP growth declines moderately in Q3-Q4 US recession; resumes slow growth in 2008 Prolonged economic stagnation seen in US 2007 Normal growth on hold until at least 2009 Europe experiences medium term decline in growth Economic Outcomes US normal real growth resumes by Q3-Q4 2008 Europe slows more quickly than expected Slower growth in Asia and Latin America No significant effect on growth in Europe or Asia Likelihood EXPECTED POSSIBLE UNLIKELY 19 Deloitte © 2007 Deloitte AG. All rights reserved.
    • US slowdown in ‘07 spreads in ‘08 Evolution of 2007 GDP forecasts Evolution of 2008 GDP forecasts 3.3 2.9 UK 2.8 US US 2.7 2.3 2.5 UK 1.8 2.3 Germany 1.3 Germany 2.1 0.8 1.9 6 7 06 07 6 6 7 7 l/0 l/0 r/0 /0 r/0 /0 7 7 7 07 07 7 7 7 7 n/ n/ ct ct /0 l/0 0 /0 Ju Ju r/0 /0 0 Ap Ap Ja Ja n/ g/ / O O p/ ay ov ar ct Ju Ap Au Ju Se O M M N 20 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Something is changing in the global economy Monsanto Share Price 1050 China Market Price Index 850 Gold Bullion U$/Troy Ounce 650 450 250 50 3 4 5 6 7 03 04 05 06 07 08 00 00 00 00 00 20 20 20 20 20 20 l/2 l/2 l/2 l/2 l/2 n/ n/ n/ n/ n/ n/ Ju Ju Ju Ju Ju Ja Ja Ja Ja Ja Ja 21 Deloitte © 2007 Deloitte AG. All rights reserved.
    • The Effect on Global Growth What the consensus expects: • The US bears the brunt of the slowdown. • The Euro Area and Japan are expected to “de-couple” from the US • Emerging economies remain buoyant What the Consensus Expects for Global Growth 2006 2007 2008 2007-08 forecast as actual forecast forecast % of average rate* United States 3.3 2.0 2.1 71% Japan 2.2 2.0 1.8 191% Euro area 2.6 2.6 2.0 119% United Kingdom 2.7 2.9 2.1 98% Emerging economies 7.9 7.5 7.1 138% *Average growth rate between 1992 and 2006 Source: The Economist, IMF, Deloitte 22 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry
    • Impact on the European Insurance Industry Overview • The direct impact on insurers – Claims experience – Investment portfolios – Relevance of liquidity – Investment policy and strategy • The indirect impact on insurers – Regulation – Trust – Financial Statements – Consumer demand structure – Economic impact • Conclusion 24 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Direct impact on insurers Claims D&O Insurance Credit Insurance Legal protection insurance Recommendation: Analysis of the insurance contracts 25 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Direct Impact Investments: Market information* Company Total Assets in Structured billion CHF Products in billion CHF** Swiss Re 169 27.2 Zurich FS 186 27.6 Swiss Life 135 0.4 Baloise 52 - Helvetia 30 - * Source: SAL.Oppenheim / www.cashdaily.ch ** Structured products (including Subprime Mortgages, ABS, MBS, CDO) 26 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Direct Impact • Investments: Analysis and Valuation – Analysis of the investment portfolio: Does the company have an end-to-end view of its investment vehicles or are there significant amounts invested in opaque or unregulated investments? • CDO • SIV • real estate • mortgages – Valuation of structured products • Appropriate vetting process regarding the use of counterparty prices • Appropriate vetting process for model parameters (correlations, recovery rates, …) • SST requirement: Quantification of hidden options and hidden guarantees 27 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Direct Impact • Investments: Review – Review of processes to analyse the risk profile of new investments – Review of investment policy – Review of investment strategy • The volatility and turmoil of the capital markets could lead to a change in the investment strategy • Investments: Liquidity – Impact of liquidity • Not usually an important theme for insurers • Some solvency stress scenarios lead to high levels of policyholder lapsation • Important as direct respectively indirect impact – Liquidity management – Monitor the need to adapt liquidity planning • Examine and reconsider existing processes to monitor liquidity 28 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Indirect impact on insurers • Regulation – After the equity market crisis the insurance regulator established risk based systems to quantify risks (esp. risks of structured products). – Can we avoid impairments by following regulatory requirements? – Solvency II is not in place yet / SST is implemented – Principles versus rules based regulation: The credit crunch highlights some advantages of principles based regulation 29 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Indirect impact on insurers • Trust – Impact of information „trickle“ over time – Potential damage to trust of shareholders / policyholders / creditors / … – Important to avoid: new surprises / valuation issues / liquidity problems • Impact on Financial Statements and Annual Reports – Financial Review and Preview – Impairments / Reduction of hidden reserves / Reserving – Widening spread between Government Bonds and Swaps exacerbates debate around „risk free rate“ (IFRS, EEV, SST, Solvency II) – Special focus on valuation because of the public pressure and the sensitivity of the market 30 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Indirect impact on insurers • Change in consumer demand structure – Volatility can lead to more risk averse investing – Potential increase in propensity to save – Increased popularity of insurance products with higher guarantees – Increased demand for credit protection 31 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Indirect impact on insurers • Economic Impact – Liquidity of the market regarding credit instruments • Impact on value • Possible impairments • Solvency – Reduction of the equity markets – Solvency • Impact on value • Solvency – Customer demand reduction • Recession • Impact on growth and value 32 Deloitte © 2007 Deloitte AG. All rights reserved.
    • Impact on the European Insurance Industry Conclusion • Insurers must fully understand the products they‘ve sold • Insurers must fully understand what they`ve invested in • Capital scenarios/stress tests should be designed to reflect all potential risks While the initial impact on the insurance industry has generally been less severe than on some banks, the volatility of capital markets and the time lag in information flowing through the system doesn`t rule out further negative impacts. 33 Deloitte © 2007 Deloitte AG. All rights reserved.
    • “As is common in such situations, one should first focus on the current status, but also immediately prepare for the future.”