OREANDA-NEWS. European insurers should be able to absorb the potential shocks from a Greek exit from the eurozone, Fitch Ratings says. The main risk would be from contagion to other peripheral eurozone nations, but we believe this type of systemic crisis is unlikely.

European insurers have virtually eliminated their exposure to the Greek sovereign and to Greek banks, so direct losses from a default would be minimal. Exposure to other peripheral sovereigns remains very large. However, in the last three years, the eurozone has developed mechanisms to prevent a run on a sovereign leading to a sovereign default, and to alleviate sovereign-to-sovereign contagion. These measures, including the European Central Banks' Outright Monetary Transactions, mean that Grexit would be unlikely to trigger a systemic crisis like that seen in 2012.

This view is reinforced by the market response. Since Greece announced its plan for a referendum, Portuguese, Spanish and Italian 5-year credit default swap spreads have widened by 20 to 30 basis points, but are only around their level at the start of the year and are far below the levels seen in 2012. Still, the potential market reaction is hard to predict and Grexit could spark a broader sell-off and increased volatility.

Particular features of the insurance industry mitigate the impact of any financial market shock in the wake of a Greek exit. Life insurers can generally pass certain investment losses on to their policyholders. This feature is crucial in falling financial markets because it applies to unit-linked and participating (with-profit) business, which typically accounts for most of the financial market exposure on life insurers' balance sheets. This ability to share losses could be significantly constrained in the event of severe investment losses, however, because of the need to meet certain minimum investment guarantees to policyholders.

Insurance companies can impose significant surrender penalties, which deter surrenders and minimize the risk of a run on eurozone insurers by policyholders in the event of consumer panic triggered by a Greek exit.

Sovereign risks could have an impact on insurers' regulatory capital positions next year when Solvency II comes into force. European sovereigns are still considered risk-free in the standard formula for calculating capital requirements. But regulators have recently said insurers that use an internal model will need to account for material sovereign risks in that model, potentially pushing up capital requirements. We believe this could eventually be extended to insurers using the standard formula.