The continuing debt problems in Greece have served to concentrate attention on the implications of a possible Greek departure from the eurozone. Ongoing discussions betweens between Greece and the "troika" of the European Commission, the International Monetary Fund and the European Central Bank suggest that September is likely to be a critical month in the context of Greece's continued membership of the single currency.
Quite apart from the economic and financial chaos that would follow from a disorderly Greek departure from the single currency, a number of legal questions would arise in the context of contractual arrangements which "straddle" the date of a Greek departure. These questions may arise both on the asset and the liability sides of the balance sheet, and will have an impact upon the insurance sector.
This note examines and highlights the consequences of a Greek eurozone exit for insurers and reinsurers. The subject matter is arranged as follows:
- first of all, we will outline the manner in which a eurozone exit might occur;
- secondly, we will examine the effect of eurozone withdrawal on policies and liabilities that have a relevant nexus with Greece;
- thirdly, we will consider the impact of withdrawal on the assets/reserves of an insurer;
- fourthly, we will outline some wider issues including the impact on ratings and letters of credit issued to cover insurance liabilities;
- fifthly, we will consider the effect on reinsurers of Greek risks concerning ongoing payment of premium and claims and the existence of any currency exchange clauses; and
- finally, we will state our conclusions.
Mode of withdrawal
The EU Treaties do not contain any specific right for a participant Member State to withdraw from the eurozone. Any such withdrawal would thus occur in contravention of those Treaties. Nevertheless, political and economic pressures may override the legal position.
In that event, Greece would introduce new legislation that would create the new drachma. That legislation would also prescribe a legally enforceable substitution rate at which transitional obligations expressed in euro could instead be settled in new drachma. Of course, the difficulty is that the euro will continue to exist, so it will be necessary to identify and separate (i) those financial obligations that are validly converted into the new drachma and (ii) those obligations that remain outstanding in euro. It may be mentioned in passing that Greece would have to take a number of other measures to protect its new currency. These would almost certainly include the imposition of exchange controls in an effort to limit capital flight. However, the present note is concerned primarily with the immediate effects of the currency redenomination. In analysing the relevant issues it is important to bear in mind that a monetary obligation connotes a duty to pay in legal currency as at the time of payment and not as at the time when the contract was originally made (the accepted concept of Lex Monetae). This leaves open the possibility that, in an appropriate case, an obligation expressed in euro may, perfectly legitimately be redenominated into new drachma.
Policies and Liabilities
In recent times, a number of insurers have ceased to issue trade credit, political risk and other types of policies relating to Greece. However, there are likely to be existing policies that remain in force (especially so in the reinsurance market) and both insured and insurer are required to honour their terms.
Where the insured is an entity located in Greece but the policy has been issued by an insurer based in, say London, the policy may be governed by English law or Greek law. The premiums payable by the Greek insured will often be payable in US dollars or euro. If they are payable in euro, the new Greek monetary law should not generally affect the premium obligations of the Greek insured, since the policy has been placed in an international market. The Lex Monetae principle would thus point to a payment that remains denominated in Euro. Inevitably, however, this conclusion becomes more hazardous if the policy is governed by Greek law, since the Greek Courts will naturally feel obliged to apply the new drachma substitution whenever possible. Nevertheless, the Greek insured will face significant problems in the present context. It is widely assumed that the newly-created drachma would rapidly fall in value as against the euro and other external currencies. The effective cost of meeting the premium payments - whether expressed in euro or in US dollars - would rise correspondingly, as would the risk of a payment default. Claims would be more problematic and will probably require payment in the currency indicated in the policy. This could have the effect of paying claims in a higher value currency (such as the euro) rather than the new Greek currency. Eurozone withdrawal may thus have the effect of increasing the risk of policy cancellation (if policy terms permit) by foreign insurers, or by the insured who may have difficulties in meeting premium obligations.
Insurers operating within the domestic Greek markets are likely to also encounter difficulties in this respect. Policies issued to local entities or individuals will be governed by Greek law and all elements relevant to the contract will be effectively connected with Greece. As a result, the premiums payable by the Greek insured will be converted into new drachma at the legally prescribed conversion rate. In terms of a matching of the Greek insurer's assets and liabilities, this may not greatly matter since claims on the policy are likely to be paid out in the new drachma as well at the same legally prescribed conversion rate, although, no doubt, a Greek insured would contest that view on the basis that the policy was originally written in euro and that currency choice should remain valid notwithstanding the introduction of a new currency within Greece itself. It has indeed been the general practice of insurers to pay claims in the currency to which the policy is written. But the euro – as it existed at the time of the issue of the policy – will have been split into two units as a result of the Greek redenomination. The difficult question is – which unit is to prevail in the event that a claim is made? If the concept of Lex Monetae is to apply, as it should, then claims will be paid in the new drachma. Such an issue is likely to be litigated before the Greek Courts and, as noted above, they are in any event to be expected to apply the new drachma substitution wherever possible.
Staying with this scenario, Greek insurers may encounter problems where the risk has been reinsured in an external market such as London. The reinsurance contract is likely to be governed by English law, and in line with the reasoning set out above, the premium will remain payable in euro or other contracted currency. There will therefore be a currency mismatch between the cedants incoming and outgoing premiums, again suggesting that the Greek insurer may struggle to maintain the reinsurance contract.
Matters may be further complicated where liabilities are incurred under, for example, an umbrella policy that covers a group's worldwide business. But even here, the general principles should remain the same. It is common for such policies to provide that cover for risks located in an insured territory are governed by the laws of that territory and, consequently, policies covering risks located within Greece are governed by Greek law. But given the international nature of the policy, global premiums expressed to be payable in euro would remain payable in the single currency, notwithstanding a Greek departure from the zone – i.e. the premium would be payable by the insured from another jurisdiction, or it would simply accept the increased cost resulting from the depreciation of the new drachma.
Assets held by an Insurer
A Greek insurer is likely to hold a significant portion of its assets/reserves within Greece itself, in the form of bonds, shares in Greek companies, deposits in Greek banks and local real estate and other assets. Once again, the effective value of such Greek assets will be redenominated into the new drachma. This will be of limited significance insofar as these assets/reserves are held against risks located in Greece, for those liabilities will likewise be redenominated. But insofar as such assets are held against risks located in other eurozone countries, the depreciation of the new drachma would render them inadequate for their purpose. Considerations of this kind may pose challenges to the continued solvency of Greek insurers.
Although the issues will probably be of a more limited size and scope, non-Greek insurers that hold Greek assets against euro-denominated risks in other countries will be affected by the same difficulties. The redenomination of their assets into new drachma will reduce their value in terms of the euro liabilities that they are intended to cover.
Ratings/Letters of Credit
The above analysis has demonstrated that a Greek withdrawal from the eurozone will result in an asset/liability mismatch which is likely to be seriously detrimental to the insurance sector.
This may have a series of "knock on" consequences that will further prejudice the financial stability of the sector. For example, further rating downgrades of affected insurers may be anticipated. This is likely to have the twin consequences of inhibiting the ability of some insurers both to attract and to write new classes of business and/or to maintain existing market portfolios. A downgrade may also trigger a requirement to provide collateral to banks that have issued letters of credit to cover the insurer's existing obligations, and will obviously have a negative impact on funding costs. Downgrades in rating will have an effect on not only Greek insurers, but also other European insurers with significant Greek investment portfolios.
In a similar vein, a downgrade affecting banks that have issued such letters of credit or have exposure to sovereign debt may trigger an obligation on the part of the insurer to replace them with credits issued by a bank that remains at the required rating level.
As indicated above, the Greek insurer may encounter problems where the risk has been reinsured in an external market such as London. Where the reinsurance contract is governed by English law, the premium will remain payable in euro or other contracted currency. There will therefore be a currency mismatch between the cedents incoming and outgoing premiums, again suggesting that the Greek insurer may be unable to maintain the reinsurance contract with the consequential increase in its uncovered exposure. Reinsurers will be expected to pay claims in the original contracted currency. However, if the reinsurance contract is governed by Greek law then it becomes arguable that the reinsurer must accept premiums in new drachma at the legally prescribed substitution rate. However, we think that this argument is unlikely to succeed because the reinsurance will have been contracted in an international market, and with an agreed contractual currency of payment – but the outcome may depend on whether the litigation takes place in England or in Greece.
Payment of claims that are in the course of being processed when Greece leaves the eurozone may also be problematic. As noted above, reinsurers will presumably want to settle such claims in euro as the currency in which the policy was expressed. But, post-withdrawal, claims may be payable in new drachma, at least if the contracts are governed by Greek law. This is not merely a matter of the currency of payment, for the amount payable would be determined by reference to the legal substitution rate for the new drachma, and not by reference to the market exchange rate between the euro and the new unit.
In view of these difficulties and obscurities, it is perhaps likely that the market will seek to introduce new contractual clauses on the currency of payment in an effort to minimise possible ambiguities.
Whilst this note has considered the relevant issues of a fairly general level, it will be apparent that a Greek withdrawal from the eurozone could have a material impact on the liabilities of both insurers doing business in Greece and on external entities that reinsure them.
In addition, the redenomination of assets held within Greece may render them unsuitable to match liabilities arising elsewhere in the eurozone and may even threaten the solvency of the institution concerned.