European Union: One Or More Countries Leaving The Euro: What Is The Impact For Insurers?

This paper accompanies our more general paper regarding withdrawal from the Eurozone and implications for global markets. As that paper identifies, one of the key risks is that, for the first time since its creation, the possibility of one or more countries leaving the Euro is being widely and seriously debated. In the first of a series of articles, we examine below likely impacts which such a step might have on insurers. Through careful planning, it is possible to mitigate the legal, financial and regulatory risks that such institutions might face in the months ahead.

Direct Insurance

Many insurers will have written policies which are denominated in Euros. Complications could arise where a country leaves the Euro but the currency itself still continues to exist. This is most likely to involve a country in which the economy is under severe pressure.

It is likely that legislation in the country concerned would provide for a new national currency and set an official exchange rate with the Euro, and redenominate contracts and other commercial obligations. It is also likely that the "real" exchange rate of the new currency against the Euro would decline.

What impact would this have on insurers outside that country which issued policies (denominated in Euros) before this development? There are various aspects to consider, each with very real consequences if the new currency does devalue markedly against the Euro:

1. What is the currency in which the local insured "feels" its loss? A purely domestic loss (such as a personal accident claim) could be felt in the new currency; a product liability claim against the insured brought by a third party who is located in another Eurozone country might well be felt in Euros (so the cost to the insured in the new currency would rise as the exchange rate worsens).

2. Would payments have to be converted into the new currency? The lex monetae principle is an internationally recognised legal concept that would apply in this context. It requires that, where a contract refers to a particular national currency, there is an implicit choice of the law of that country to determine the identification of that currency, so that no party may default on a contract if a government alters its national currency, using a particular conversion rate. Amounts specified in the contract will simply be redenominated to the new currency using the specified conversion rate.

The position is more complicated in the context of the Euro, though, because it is the currency for 17 countries. Thus, if the policy covers parties and risks situated in more than one European country, a Euro-denominated payment obligation may not necessarily be redenominated into the currency of the exiting country. The issue will turn on the contractual intention of the parties and this in itself will be a difficult issue to resolve since it is highly unlikely (given the perceived remoteness of the risk when the policy was written) that parties will have inserted wording into their policies to deal with this particular eventuality. It also remains to be seen whether a party could argue that the contract has been frustrated if, for example, it is impossible in practice to obtain a sufficient amount of the local currency to satisfy the obligation.

It certainly seems arguable that claims should still be paid in the currency of the policy in the situation where that currency is still in existence. Furthermore, there is no requirement (at least under English law) that the currency chosen in the policy must have any connection with the parties or the insured risk. Indeed, it is common for policies written to cover risks in countries which are viewed as financially unstable to be denominated in, for example, US dollars or UK sterling.

However, should an insurer deny liability and a claim was litigated in a country which had withdrawn from the Euro (and redenominated), any court judgment against it might be in the new foreign currency (depending on the situation under local law. It was the position at one time under English law that claimants commencing proceedings in England could only claim in sterling, although that position has now been changed). It may also be the case that local law will alter to prohibit the payment in Euros (by virtue of capital or exchange controls).

3. If payments do have to be converted, when should that conversion take place? Possible options are the date the policy incepted, the date of the loss/negligent act etc or the date of payment.

As to what that might mean, consider, for example, that a fire at insured premises located in a country which has exited the Euro occurred at a date when £1 bought you 1 Euro and 2 New National Currency ("NNC"). At the time of the fire, the loss is estimated at 20 million NNC. If the date of conversion is at the time of the fire, it will cost insurers £10 million to pay the claim (assuming a nil deductible). If the NNC then devalues, so that £1 now buys you 1 Euro but 4 NNC, insurers will benefit from this (if the loss is fixed at the date of the loss) because it will only now cost them £5 million to pay the claim. Even if the date of loss is assessed at the date of payment, insurers will not lose out. Say the insured loss doubles to 40 million by the date of payment simply because of the devaluation of the NNC, it will still cost insurers £10 million to pay the claim.

One can appreciate from the above scenario that it will be key to establish the date at which a loss falls to be assessed under the policy. This may be determined by the policy wording or the application of the governing law of the policy (which will usually be local law).

4. Are the premium, excess and limit automatically translated into the new currency and, if so, is this at the official rate? The answer could depend in part on the law that applies to the policy and the venue for disputes to be resolved.

5. Can the parties readily enforce premium and claims obligations? Delays here could make a significant difference to the value of payments in "hard currency" terms and interest is very unlikely to make up for this.

6. The impact of a country leaving the Euro could also have indirect consequences. For example, a drop in value of a country's new currency might leave the purchasers of goods and services unable (because they cannot find the necessary currency) or unwilling to meet their contractual obligations. This was the position in 2001 following the Argentinian crisis when the government removed the peso/dollar peg and converted dollar assets into less valuable pesos.

More generally, insurers which write business in countries that are facing financial crises tend, historically, to see increasing claims costs, a sharp drop in demand (due to an erosion of consumer confidence) and a dramatic rise in the surrender of, for example, life insurance policies. These consequences have played out in Argentina, Mexico and Asia in the past.

Reinsurance

Reinsurance contracts will usually be denominated in one or two currencies. This is, of course, essential with non-proportional contracts, which have to specify a retention and a limit. It is common for the contract to contain a "Currency Conversion Clause" that dictates the date at which premiums and claims received and paid in other currencies are to be translated into one of these specified currencies. The aim will generally be to avoid the reinsured making an exchange gain or loss. This clause will assume great importance if one or more countries leave the Euro and is well worth checking now.

Some reinsurances might be denominated in Euros alone, reflecting the book they cover. In the absence of a Currency Conversion Clause, issues could arise if a country leaves the Euro, particularly if the reinsurance is facultative and designed to operate "back to back" with the policy.

What to do now

As a result of the potential problems highlighted above it is suggested that insurers:

• Review key existing contracts to assess redenomination risk;
• Consider whether any contracts can be terminated or renegotiated;
• Include provisions in new contracts addressing redenomination risks;
• Assess boiler plate and payment obligation clauses including force majeure and default provisions in contracts; and
• Choose "safe" currencies, such as US dollars or UK sterling when writing new policies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.