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The British insurance market is hustling to prepare for European Monetary Union, even though the government has ruled out immediate U.K. entry into the system.
London-based insurers and brokers must adapt to dealing with a new currency because of the city's dominant position in the world insurance market, regardless of the British government's position on the matter.
About 11 European Union member countries hope to participate in EMU, to be formed Jan. 1, 1999. E.U. countries will not agree on the membership of the EMU's first phase until the first quarter next year. Britain, Sweden, Denmark and Greece have officially ruled out first phase membership.
U.K. insurers are behind their European counterparts and clients in preparations.
Chris Smith, assistant manager of economic research at the London-based Assn. of British Insurers, explained in an earlier study on the effects of EMU on insurers that main reason for the lack of preparation has been the uncertainty surrounding EMU: whether and when it will start; whether and when the United Kingdom will join; whether and when the "euro" will be widely used before notes and coins are available.
However, multinationals domiciled in countries such as France and Germany, which have declared they will join the first tranche of EMU, already have made preparations.
"We have been told by large European multinational clients and customers that they will deal only in the euro after 1 January 1999," says Nick Stone, group treasurer at London-based broker Lambert Fenchurch.
The costs for the British insurance sector for converting to use of the new single currency, the euro, have been variously estimated at between 1 billion pounds to 1.5 billion pounds ($1.7 billion to $2.5 billion). Costs for the
E.U. insurance sector as a whole have been given by various institutions at 5 billion pounds ($8.36billion).But this total only includes the costs of the transition. There is no estimate for any growing pains that may arise during the euro's early years or of future economic and political problems as the currency either succeeds or ails, according to Mr. Smith.
Costs to industry as a whole from the EMU transition have not been estimated, says Douglas Gooden, head of economic research at the London-based Confederation of British Industry, an industry group with corporate membership. "With banks we found that it could add about 2% to overall costs over three years. In the retail sector the costs would be higher probably, about 4%," Mr. Gooden says.
The chief expense will be changing computer systems to accommodate the euro. The ABI thinks that this could account for 60% to 70% of overall costs of EMU transition. A complicating factor is that the new currency coincides with problems arising from the need to adapt computer systems to deal with the year 2000. "Are there physically enough specialists available to cope with the change?" asks the CBI's Mr. Gooden.
Lambert Fenchurch's Mr. Stone says his company has outsourced most of its information technology work to a service company, which itself may be overloaded with work as the millennium approaches.
Multinational brokers, insurers and businesses are used to dealing with a large number of currencies, so one extra in the form of the euro should not cause many problems.
In fact, insurers may benefit from the euro through reduced currency transaction costs.
However, long-term insurance contracts could be hit if the existence of the EMU led to lower interest rates throughout member countries. Mr. Smith says that if the EMU causes interest rates to be lower than they otherwise would have been, an insurance company may find it cannot meet its liabilities from its invested assets, perhaps forcing it to draw on reserves.
The London-based Institute of Directors, an association of individual company directors, opposes Britain's joining the EMU and thinks the savings for British and European corporations in currency transactions costs will be negligible, if any.
EMU membership does not affect Britain's most important trading partner: the United States.
"Only half of our current account transactions are with European currencies," says Ruth Lea, head of the IOD's Policy Unit.
The United Kingdom conducts 15% of its physical trade and the majority of its currency transactions with North America and the U.S. dollar. "If you are talking about monetary union, then the best union to talk about is joining the U.S. dollar with sterling," Ms. Lea said.
The insurance sector in London also transacts the majority of its business with the dollar.
Mr. Stone of Lambert Fenchurch said about 20% of his company's business is transacted in the European currencies expected to join EMU. The currency union will make a great difference to his company's currency hedging strategy. Nevertheless, the majority of business is transacted in U.S. dollars and sterling.
U.K. Chancellor of the Exchequer Gordon Brown last week ruled out British membership of EMU for the term of the current British Parliament, about the next five years. British membership after that depends on the way EMU progresses and how it fulfills certain economic criteria aimed at converging the U.K. economic cycle with that of EMU members. Mr. Brown said the criteria are:
Whether there is sustainable convergence between Britain and the EMU member countries.
Whether there is enough flexibility to cope with economic change.
The effect on investment.
The impact on the financial service industry.
Whether it is good for employment.
Lambert Fenchurch has adopted three scenarios for its preparations for EMU, Mr. Stone said. They are:
The euro goes ahead without the United Kingdom and is a soft currency as far as transactions are concerned.
Underwriting agencies such as Lloyd's of London and others adopt the euro as a settlement currency, but the United Kingdom stays out.
Sterling goes into EMU, and all of the London underwriting markets adopt the euro as a settlement currency.
London brokers and underwriters have convened working groups to review their trading relationships once the EMU is formed. Lloyd's already has confirmed it will introduce the euro as a settlement currency and is upgrading its system accordingly.
The euro is expected to become legal tender in check and credit form on Jan. 1, 1999, until Jan. 1, 2002.
Throughout the transition period, companies in the EMU zone will have to file reports and accounts in euros and their domestic currencies. All new issues of government debt of participating states will be in euros from the outset.
EMU proponents hope this will result in a critical mass of wholesale financial market transactions being in euros from the start. But it will complicate accounting because of the duplicated reporting requirement during the transition.
"I don't think anyone has invented an accounting procedure to cope with this yet," says a spokesman for Willis Corroon Group P.L.C..
Mr. Smith lists a number of issues insurers must confront with the euro.
During the transition period, insurance buyers will be able to choose to pay premiums or receive payments in euros or domestic currencies. This is called the "no compulsion, no prohibition" principle.
"Potentially, an insured could offer their insurer euros in payment of an insurance premium on 1 January 1999, and if the insurer did not have the capacity to accept and account for this conversion, charges, etc. could fall to the company," Mr. Smith says.
Insurers have a large number of long-term contracts in sterling and other domestic currencies. Some policyholders may be difficult to contact. Problems could arise if insurers are obligated to contact policyholders to report that the terms of the contract have changed.
Mr. Smith said the EMU remains a risky project with collapse a real possibility. The risk may be particularly high during the transition period. As part of their risk management strategy, some insurers, as well as other commercial organizations, are devising both an entry and an exit strategy into EMU.
The IOD's Ms. Lea said that once the euro goes ahead, it is unlikely to be demolished by currency speculators. "This will be a replacement for the deutsche mark. This is not something speculators will tear apart. The real problem is who knows how much pain and economic dislocation will be caused to put it into effect," Ms. Lea added.