Indirect effects of bond defaults could be even worse, reinsurer warns

European insurers could face a bill of €143bn (£122bn) if they are forced to write down the valuations of their peripheral eurozone sovereign bonds.

The estimate, from global reinsurance group Swiss Re, equates to around 24.5% of European insurers’ combined shareholders’ funds.

The estimate assumes that insurers would have to halve the value of the government bonds they hold from Greece, Ireland, Portugal, Spain and Italy.

Swiss Re’s estimates also demonstrate the high exposure European insurers have to Italian government bonds. If Italy is excluded, the bill is just €58bn (9.8% of shareholders’ funds).

However, Swiss Re also said that the indirect effects of 50% write-downs on Italian and Spanish bonds in particular could be worse than the direct costs of devaluing the bond holdings. The government bond-writedowns could affect the value of other investments in insurers’ portfolios, and the resulting slowdown in economic activity could make growth and revenue generation difficult

Multiple sovereign defaults could also raise questions about the future of the euro, which would cause financial market volatility and thus reductions in asset values.

“European insurers’ capital buffers appear adequate to cope with direct losses on their sovereign bond holdings, provided any debt restructurings are limited to the smaller peripheral European countries,” Darren Pain, senior economist in Swiss Re’s economic research and consulting division, said at Swiss Re’s annual economic form this morning. “But the direct and indirect implications would be much more serious if write-downs on Spanish and especially Italian bonds were ultimately required.”

Swiss Re predicted a tough outlook for Europe’s non-life insurers, saying profitability would be subdued by low interest rates for the next two years.

However, the reinsurer added that rates are likely to rise in 2012, as reserve releases turn to reserve additions.

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