Tag Archives: Japan

Life/Annuity M&A Is Heating Up

As life insurance and annuity carriers pursue greater market share and growth, a potential solution sits before them: M&A activity. This transactional path, leading to deep consolidation in the life insurance and annuity (L&A) sector in the U.S., is stoking much debate and discussion in company boardrooms.

The hunt for elusive growth and profitability for carriers in the U.S. has many players, creating a crowded marketplace for possible consolidation. The multi-headed acquirers come in three dominant forms: large insurance companies, private equity (PE) investors and foreign acquirers, driven largely by the Chinese and Japanese.

Insurance carriers intimately know about their competition and what companies in the sector would mesh well within their operations. Executives have the greatest amount of specific industry expertise and therefore can understand the pros and cons in a specific combination.

See also: How Life Insurance Agents Can Be Ready

Private equity investors have been turning to the life insurance and annuity field for several years to provide consistent returns, as these companies have predictable cash flows. Through these investments, investors can strengthen their returns for assets under management with steady growth. One caveat to this investment approach is the concern of the increasing regulatory state and federal pressures, as navigating through 50 individual state regulatory guidelines can be burdensome and difficult if a company moves out of a state and into a new one.

Foreign countries like China and Japan continue exploring opportunities to increase their presence in the U.S., the world’s largest insurance market. Reasons abound: Japanese insurance companies have found U.S. acquisition targets appealing to offset the aging of Japan’s population and to provide a more attractive interest rate environment. Chinese companies have been snapping up foreign companies, including in the U.S., searching for yield on their capital and economic growth.

Several reasons exist for this trend of M&A activity.

  1. Buyers are motivated by the current low-interest-rate environment and the opportunity to expand their assets and book of business. This has always been an essential piece of the M&A discussion as market conditions must be favorable to make any transaction worth its while.
  2. Sellers are suffering from the low return on their capital. By exiting less profitable lines of business, they can reallocate their capital for use in other capacities. As contemplation of one’s business clarifies, many carriers may conclude that selling, rather than buying, assets is the chosen path. Selling could stabilize or enhance a company’s bottom line as the capital obtained in a sale can be reinvested in its existing operations or be put to use for another potential acquisition.
  3. Increasing regulations are restricting the ability of companies to productively run their businesses; thus, they are looking for exits. Companies are often stymied by the sheer weight of complying with and managing regulations. Exiting businesses can become appealing.

Regardless of which direction is undertaken, one aspect paramount to success is the importance of ensuring that business continues to operate smoothly. In today’s environment, the role of technology, specifically at a time when companies are implementing and managing digital transformations, can be a beacon of light. And as acquirers delve deeper into possible transactions, increasingly they are employing an outsourcing model to extract more value.

See also: This Is Not Your Father’s Life Insurance  

Safeguarding a company’s operations and maintaining its continuity through powerful technology and servicing solutions, or what we call “future proofing,” has additional benefits besides the desired functionality. Companies must first build their vision and plans and then bolster them with end-to-end operational services. This step will then enable rapid expansion into new market segments, faster product launches and seamless servicing of open and closed blocks of business. By future-proofing through technology, carriers can drive greater efficiencies, lower costs and produce higher levels of customer satisfaction.

Insuring What You Want, When You Want

DIAmond Award winner Trōv is one of the most widely referred to cases when speaking about disruption in the insurance sector. But what is Trōv exactly about? What is the business model? How successful is it? Trōv’s founder and CEO Scott Walchek will share his vision in a keynote presentation at DIA Amsterdam, this May. To warm up, I interviewed Scott last week.

Trōv is the world’s first on-demand insurance platform for single items. It is a mobile app that allows users to insure whatever, whenever. It empowers customers to insure “just the things you care about” for whatever period you prefer. Trōv users simply snap a picture of a receipt or the product code of a product. This creates a personal digital repository for all things tangible. For selected items, Trōv offers a quote to insure each individual item. Customers can then simply “swipe to protect” to purchase the insurance. It is equally simple to “swipe to unprotect.” With Trōv, long contracts are not necessary. Even the claims process is automated with the use of chatbots and available on-demand on a smart phone.

Trōv is founded by Scott Walchek. Scott is a successful technology entrepreneur. Over the past 25 years, he built companies such as Macromedia, Sanctuary Woods, C2B Technologies and DebtMarket. He was also a co-lead investor and founding director of Baidu, China’s largest search engine.

Scott is also one of the 75 thought leaders who contributed to our new book “Reinventing Customer Engagement. The next level of digital transformation for banks and insurers.”

What inspired you to create Trōv?

Scott: “At some point I realized there is an enormous latent value in the information related to the things people own. From obvious things such as receipts and warranties to actually having an overview of what you own and what the current replacement value of each item is. We want to curate ways to turn this into value for consumers. From keeping information on items up to date to, for instance, arranging insurance for these items.

We’re a technology company, not an insurance company. We’re new in this space. So I started with testing our first ideas about a proposition and the assumptions behind it with several senior executives of large P&C insurers such as AIG and ACE. What I assumed is that at the end of the day the core metric of success is the ratio of insurance to actual value. The better this ratio, the better the balance sheet.

Of course, this is an oversimplification, but everyone agreed that in essence this is how over the past 200 years value in insurance is created. Now, what is remarkable is that insurers do not really know what consumers own, and what the exact value of these goods is … What if they did know? This would disrupt markets. It would lead to much better risk assessment driven by real knowledge of the true value of what people really own.”

See also: Insurtech: The Approaching Storm  

Trōv’s main target users are millennials, a target segment that most incumbents find very difficult to reach and engage with. Why does Trōv strike the right chord among this generation?

Scott: “We’re in the Australian market for a year now and entered the U.K. market a few months ago. Around 75% of our users are aged between 18 and 24. It appears that we are successful in tapping into the specific needs of this group. We do this by explicitly tapping into four key millennial trends. The first is “on-demand.” We can see that from how millennials consume entertainment, shopping etc. Services need to be now, 24 hours a day, on my device. The second trend is, “Don’t lock me into a lengthy contract.” We enable micro-duration. Customers can turn their insurance on and off as they see fit. In practice, they hardly do. But it is about the psychological benefit of being able to do so. The third is what we call “unbundled convenience”: “Let me choose what to protect, the things I really care about.” The fourth is: “people/agent optional.” Millennials want to engage with their smartphone without having to talk to an actual person.”

Trōv is based in the San Francisco Bay Area. But you decided to launch first in Australia and the U.K. Why there?

Scott: “Ha ha – there’s a linear story and a non-linear story to that! The linear story is that microduration is still new to the industry, so our hypothesis requires testing. The regulatory environment is important if you want to get to market fast. Australia and the U.K. have a single regulatory authority versus the 56 bodies in the U.S. But we’re also in the process of filing in the U.S. The non-linear story is that I just happened to meet Kirsten Dunlop, head of strategic innovation at Suncorp Personal Insurance, at a conference in Meribel in France. She immediately understood the strategic impact of Trōv, and that is when it took off.”

Because the Trōv concept is so new to consumers, it must be extremely interesting to learn what exactly strikes the right chord …

Scott: “Customers just love the experience. Our NPS is +49. However, we’re learning every day. With a completely new concept such as Trōv, it is impossible to know exactly what to expect, honestly. It turns out that Trōv reveals new consumer insights. There is still a significant number of valuables that our audience wants to insure but that we cannot provide a quote for, for instance. Although more than 60% never turn off an insurance, the ability to switch an insurance on and off turns out to be an important psychological benefit. This appears to be category-dependent. Sporting goods are switched on and off more often than smartphones and laptops.

We’re constantly measuring and improving every step of the funnel. From leaving Facebook to downloading the app, to registration, to actual swipes. We will share concrete numbers on uptake and conversion rates at DIA Amsterdam. But to already share two big learnings: We designed Trōv for use on smartphones, but, much to our surprise funnel figures multiplied when we decided to add a web interface. And we are actually even attracting better-quality customers.”

In Australia, you decided to partner with Suncorp, in the U.K. with AXA and in the U.S. with Munich Re. What are the success factors of a partnership between an insurtech and an incumbent?

Scott: “At the end of the day, it is about relationships and people. We understand their internal challenges. Everyone agrees that real knowledge of individual insured goods and the actual value of those goods improves the loss ratio. But we need to figure out how this works exactly through experimentation. This requires internal dedication, throughout the whole organization, starting at the top. It is not about conducting small pilots, but the willingness to experiment while going all the way, invest for several years and learn as we go what insurance will look like in the future and how consumers want to engage.”

What are your future plans and ambitions with Trōv? We can imagine that Trōv could also be an interesting partner for retailers and producers of durables. With Trōv, they could seamlessly sell insurance …

Scott: “We have three lines of business. The first is what we call “solid.” This is about expanding the Trōv app geographically, covering more categories and continuously developing the technology. Trōv will be launched in Japan, Germany and Canada shortly. Then there is “liquid”; offering white-label solutions to financial institutions, for instance in relation to connected cars and homes. The third line of business is “gas”; basically Trōv technology embedded in other applications; insurance as a service. This could be attractive for all sorts of merchants, telco operators etc.”

See also: Understanding Insurtech: the ABCs  

This would make Trōv even more part of the context in which consumers makes decisions about the risk they are willing and not willing to incur. And it also taps into the exponential growth of connected devices, similar to how machine-to-machine payments are increasingly taking place …

Scott: “Yes. What we’re now doing with Trōv is really the beginning. Trōv is about providing our customers with exactly the protection they want, exactly when they want it. With more and more connected devices and sensors and new data streams everywhere we can make the whole experience so seamless they don’t have to do anything at all.”

Insurtech Ecosystem Emerging in Asia

Building on T.J. Geelen’s blog post about the thriving fintech ecosystems in Asia, I’d like to share with you some insights relating to the emerging insurtech ecosystem in the region. Although insurtech in Asia is in its infancy, since 2015 we’ve seen a surge of interest. By the way, I’m a big believer that Asia has a real potential to power the next wave of global insurance innovation.

Four flavors of insurtech

First, let’s revisit the definition of insurtech to make sure we are all on the same page. Essentially, there will be three major camps of insurtech: one that enhances existing insurance structures, another one that aims to disrupt by providing alternative digital risk transfer mechanisms and the third type coming from existing insurance firms attempting to defend their existing market positions. The first and third types broadly can be broken into the following sub-types:

  • Product sales/distribution (aggregators, online portals, apps)
  • Risk management (IoT, healthtech, blockchain)
  • Fraud detection/prevention (big data, machine learning)
  • Claims management (big data, machine learning, vendor network management solutions)
  • Service management (chatbots)
  • Investment management (portfolio optimization, asset/liability matching)

The second type attempts to drive an end-to-end structural innovation, either removing part of the structure or fully digitizing it.

Why Asia for insurtech

Asia is attractive from both an insurer and an insurtech perspective due to the size of its significantly underinsured population. The region has traditionally seen a large part of the risks self-insured through family and community networks. As the region experiences rapid growth in the affluence of its population, together with an aging population, the risk exposure is becoming even more apparent, and the need for alternative risk transfer mechanisms, including insurance, increases. Insurtech, alongside traditional insurance, can help.

Further, there are near-perfect locations for the launch of a program. Singapore, for one, allows for sandboxed experimentation, regulatory support and advanced tech infrastructure. Limitations of traditional insurance distribution channels and the rapid increase of 4G mobile penetration mean that insurers are also highly interested in exploring innovative partnerships that help them connect with potential customers.

See also: Matching Game for InsurTech, Insurers

Insurtech in Asia

Asia is a very diverse region and has a mix of developed and emerging countries. So far, the major push for insurtech has come from China, India, and Singapore, while Japan, Korea and emerging Vietnam, Cambodia, Taiwan, Philippines, Thailand, Indonesia, Malaysia and Burma have lagged. (While Australia and New Zealand are geographically close and are very well integrated in the Asian region, the markets are much more ”Westernized” and hence are less applicable to this blog post.)

There’s China, and then there’s everyone else when it comes to insurtech. The first full stack (end-to-end) innovator, Zhong An, is valued at a massive $8 billion and raised $931 million. It accounts for more than a third of the global insurtech funding in 2015. It is also worth mentioning TongJuBao (peer-to-peer) insurer and FWD (Asia’s second-richest family’s insurance venture, which is re-positioning itself from traditional insurer to an agile digital insurance competitor).

India, another vibrant insurance market, has seen its insurtech innovation focus mostly on distribution. Not surprisingly, two of the major aggregators come from India: Policy Bazaar and CoverFox have seen healthy level of customer take-up as well as sources of funding. CoverFox has recently expanded its service proposition, now assisting customers with their insurance claims.

Being based in Singapore, I have a particularly detailed view of the insurtech landscape in Southeast Asia. So far, I have gathered the following mapping of Asia insurtech startups as they fit within the insurance value stack. There’s a mix of very-early-stage as well as more mature Series A and listed ventures. The list keeps growing.

Please feel free to comment and reach out if you come across any additional startups that I’ve missed out in the list below, and I’ll update it.

Area:

Distribution

Actual Losses

Operating Insurance Co.

Value:

20%

55% Losses + 5% Fraud

20%

Role:

Aggregators

Leads Generation

Customer Transactions

Improving risks

Fraud detection

Rewarding healthy

Risk assessment

Loss adjustment

Operational/Service Efficiency

Start-ups: Policy Bazaar (Aggregator)

CoverFox (Aggregator)

Health/House-front

Latize (Fraud) JustMove (Health)

Uhoo (Health IoT)

Harti (Health)

WaveCell (Comms platform)

Fixir (Finding repair garage)

MyDoc (Health claims)

Stash.ph (Health claims)

GoBear.sg (Aggregator)

Cxa (Employee benefits)

PolicyPal (Policy mgm.)

UEX (Group policies)

Zhong An (General Insurance) CH

TongJuBao (Peer to Peer Insurance) CH

DirectAsia (Direct General Insurance) SG

FWD (General / Life Insurance) HK

Singapore Life (Upcoming Life Insurance Startup) SG

 

Corporate insurtech

Singapore, with its advanced infrastructure and innovation-supportive financial services regulator (MAS), has secured a leadership position for Asia’s corporate insurance innovation as reflected by the high concentration of insurance innovation centers. Eight of 10 Asian insurance innovation centers are based in Singapore. The innovation centers are powerful corporate change catalysts and typically include elements of awareness building and cultural transformation.

Firm Innovation Center Country Focus Status
Aviva Digital Garage Singapore Digital Transformation Active
Manulife Loft Singapore Digital Transformation Active
MetLife LumenLab Singapore New business models Active
Allianz Digital Labs Singapore Digital Transformation Active
AXA Data Innovation Lab Singapore Big data Active
AIA Edge Singapore HealthTech Active
Munich Re Innovation Lab China General Insurance Launched Q1 2016
Swiss Re

India IoT, AI, Big data Planned July 2016
IAG

Singapore

Rumored 2016
NTUC

Singapore

Rumored 2016

 

In summary, Asia is a region to watch when it comes to insurtech. Whether it be the home-grown insurance innovation from China and India, corporate innovation from Singapore or innovation concepts imported from elsewhere and deployed in Asia, the region is likely to deliver a vibrant insurtech ecosystem during the course of the next two to three years. And when the dust and excitement settles down five years down the road, we’ll have a fundamentally stronger set of competitors.

Wanting to accelerate insurance innovation, we’ve created InsurtechAsia, an action-oriented community of insurance practitioners, entrepreneurs and industry stakeholders across Asia. We are aiming to attract the best minds to tackle the challenges and opportunities in insurance, connect entrepreneurs with the best enablers, validate concepts and help business scale rapidly.

See also: New Insurance Models: The View From Asia  

A dedicated and company-agnostic insurtech accelerator, such as Startupbootcamp InsurTech, which was launched in London in late 2015, would go a long way to spur further insurance innovation here in Asia. We eagerly await the day when Startupbootcamp InsurTech will come to Singapore.

Are you passionate about making a change to the insurance industry? If so, join us at www.insurtechasia.com and follow this great team of like-minded people on Twitter: @insurtechasia.

The Defining Issue for Financial Markets

For anyone who has spent time on the open sea, especially in a small craft, you know the sea can be quite the moody mistress. Some days, the gale winds are howling. Some days the sea is as smooth as glass. The financial markets are quite similar.

In late August, the U.S. equity market experienced its first 10% price correction in four years. That ended the third longest period in the history of the market without a 10% correction, so in one sense it was long overdue. But, because the U.S. stock market has been as smooth as glass for years now, it feels as if typhoon winds are blowing.

Cycles define the markets’ very existence. Unfortunately, cycles also define human decision making within the context of financial markets.

Let’s focus on one theme we believe will be enduring and come to characterize financial market outcomes over the next six to 12 months. That theme is currency.

In past missives, we have discussed the importance of global currency movements to real world economic and financial market outcomes. The issue of currency lies at the heart of the recent uptick in financial market “swell” activity. Specifically, the recent correction in U.S. equities began as China supposedly “devalued” its currency, the renminbi, relative to the U.S. dollar.

Before we can look at why relative global currency movements are so important, we need to take a step back. It’s simply a fact that individual country economies display different character. They do not grow, or contract, at the same rates. Some have advantages of low-cost labor. Some have the advantage of cheap access to raw materials. Etc. No two are exactly alike.

Historically, when individual countries felt the need to stimulate (not enough growth) or cool down (too much inflation) their economies, they could raise or lower country-specific interest rates. In essence, they could change the cost of money. Interest rates have been the traditional pressure relief valves between various global economies. Hence, decades-long investor obsession with words and actions of central banks such as the U.S. Fed.

Yet we have maintained for some time now that we exist in an economic and financial market cycle unlike any we have seen before. Why? Because there has never been a period in the lifetime of any investor alive today where interest rates in major, developed economies have been set near academic zero for more than half a decade at least. (In Japan, this has been true for multiple decades.) The near-zero rates means that the historical relief valve has broken. It has been replaced by the only relief valve left to individual countries — relative currency movements.

This brings us back to the apparent cause of the present financial market squall — the supposed Chinese currency devaluation that began several weeks ago. Let’s look at the facts and what is to come.

For some time now, China has wanted its renminbi to be recognized as a currency of global importance — a reserve currency much like the dollar, euro and yen. For that to happen in the eyes of the International Monetary Fund (IMF), China would need to de-link its currency from the U.S. dollar and allow it to float freely (level to be determined by the market, not by a government or central bank). The IMF was to make a decision on renminbi inclusion in the recognized basket of important global currencies in September. In mid-August, the IMF announced this decision would be put off for one more year as China had more “work to do with its currency.” Implied message? China would need to allow its currency to float freely. One week later, China took the step that media reports continue to sensationalize, characterizing China’s action as intentionally devaluing its currency.

In linking the renminbi to the dollar for many years now, China has “controlled” its value via outright manipulation, in a very tight band against the dollar. The devaluation Wall Street has recently focused on is nothing more than China allowing the band in which the renminbi trades against the dollar to widen. With any asset whose value has been fixed, or manipulated, for so long, once the fix is broken, price volatility is a virtual guarantee. This is exactly what has occurred.

China loosened the band by about 4% over the last month, which we believe is the very beginning of China allowing its currency to float freely. This will occur in steps. This is the beginning, not the end, of this process. There is more to come, and we believe this will be a very important investment theme over the next six to 12 months.

What most of the media has failed to mention is that, before the loosening, the renminbi was up 10% against most global currencies this year. Now, it’s still up more than 5%, while over the last 12 months the euro has fallen 30% against the U.S. dollar. Not 4%, 30%, and remarkably enough the lights still go on in Europe. Over the last 2 1/2 years, the yen has fallen 35% against the U.S. dollar. Although it may seem hard to believe, the sun still comes up every morning in Japan. What we are looking at in China is economic and financial market evolution. Evolution that will bring change and, we assure you, not the end of the world.

Financial market squalls very often occur when the markets are attempting to “price in” meaningful change, which is where we find ourselves right now.

What heightens current period investor angst is the weight and magnitude of the Chinese economy, second largest on planet Earth behind the U.S. With a devalued currency, China can theoretically buy less of foreign goods. All else being equal, a cheaper currency means less global buying power. This is important in that, at least over the last few decades, China has been the largest purchaser and user of global commodities and industrial materials. Many a commodity price has collapsed over the last year. Although few may realize this, Europe’s largest trading partner is not the U.S., it’s China. European investors are none too happy about recent relative currency movements.

Relative global currency movements are not without consequence, but they do not spell death and destruction.

A final component in the current market volatility is uncertainty about whether the U.S. Fed will raise interest rates for the first time in more than half a decade. Seriously, would a .25% short-term interest rate vaporize the U.S. economy? Of course not, but if the Fed is the only central bank on Earth possibly raising rates again that creates a unique currency situation. Academically, when a country raises its interest rates in isolation, it makes its currency stronger and more attractive globally. A stronger dollar and weaker Chinese renminbi academically means China can buy less U.S.-made goods. Just ask Caterpillar and John Deere how that has been working out for them lately. Similarly, with a recent drop in Apple’s stock price, are investors jumping to the conclusion that Apple’s sales in China will fall off of the proverbial cliff? No more new iPhone sales in China? Really?

The issue of relative global currency movements is real and meaningful. The change has been occurring for some time now, especially with respect to the euro and the yen. Now it’s the Chinese currency that is the provocateur of global investor angst. Make no mistake about it, China is at the beginning of its loosening of the currency band, not the end. This means relative currency movements will continue to be very important to investment outcomes.

We expect a stronger dollar. That’s virtually intuitive. But a stronger dollar is a double-edged sword — not a major positive for the near-term global economic competitiveness of the U.S., but a huge positive for attracting global capital (drawn to strong currencies). We have seen exactly this in real estate and, to a point, in “blue chip” U.S. equities priced in dollars, for years now.

In addition to a higher dollar, we fully expect a lower Chinese renminbi against the dollar. If we had to guess, at least another 10% drop in the renminbi over next 12 months. Again, the price volatility we are seeing right now is the markets attempting to price in this currency development, much as it priced in the falling euro and yen during years gone by. Therefore, sector and asset class selectivity becomes paramount, as does continuing macro risk control.

Much like a sailor away far too long at sea, the shoreline beckons. We simply need to remember that there is a “price” for being free, and for now that “price” is increased volatility. Without question, relative global currency movements will continue to exert meaningful influence over investment outcomes.

These are the global financial market seas in which we find ourselves.

Investor Concerns: Greece Is the Word

Unless you have been living on a desert island, you are aware that Greece is in the midst of trying to resolve its financial difficulties with European authorities. This is just the latest round in a financial drama that has been playing out for a number of years now. Up to this point, the solution by both euro authorities and Greek leaders has been to delay any type of financial resolution. And that is the exact prescription handed down just a few weeks ago as Greece approached a February month-end debt payment of a magnitude it could not meet. Greece has been given another four months to come up with some type of restructuring plan. At this point, we’ve simply stopped counting how many times euro authorities have kicked the Greek can down the road.

Why all the drama regarding Greece? Greece represents only about 2% of Eurozone GDP. Who cares whether Greece is part of the euro? The Greek economy simply isn’t a big enough piece of the entire euro economy to really matter, is it?

The fact is that the key problems in the Greek drama have very little to do with the Greek economy specifically. The issues illuminate the specific flaw in the euro as a currency and the fact that the euro authorities are very much hoping to protect the European banking system. The reason we need to pay attention is that the ultimate resolution of these issues will have an impact on our investment decision making.

A key characteristic of the euro, which was formed in 1998, is that there is no one overall guarantor of euro area government debt. Think about the U.S. If the U.S. borrows money to fund building bridges in five states, the U.S. government (via the taxpayer) is the guarantor of the debt; it is not the individual debt of the five states involved. Yes, individual U.S. states can take on state-specific debt, but states cannot print money, as can large governments, so there are limiting factors. In Japan, the Japanese government guarantees yen-based government debt. In the U.S., the federal government guarantees U.S. dollar-based government debt. In Europe, there is no one singular “European government debt” guarantor of essentially euro currency government debt. The individual countries are their own guarantors.

The Eurozone has the only common currency on planet Earth without a singular guarantor of government debt. All the euro area governments essentially guarantee their own debt, yet have a common currency and interest rate structure. No other currency arrangement like this exists in today’s global economy. Many have called this the key flaw in the design of the euro. Many believe the euro as a currency cannot survive this arrangement. For now, the jury is out on the question of euro viability, but that question is playing out in country-specific dramas, such as Greece is now facing.

One last key point in the euro currency evolution. As the euro was formed, the European Central Bank essentially began setting interest rate policy for all European countries. The bank’s decisions, much like those of the Fed in the U.S., affected interest rates across the Eurozone economies. Profligate borrowers such as Greece enjoyed low interest rates right alongside fiscally prudent countries like Germany. There is no interest rate differentiation for profligate or prudent individual government borrowers in Europe. Moreover, the borrowing and spending of profligate countries such as Greece, Italy, Spain, Portugal, Ireland and, yes, even France, for years benefited the export economies of countries such as Germany — the more these countries borrowed, the better the Germany economy performed.

This set of circumstances almost seemed virtuous over the first decade of the euro’s existence. It is now that the chickens have come home to roost, Greece being just the opening act of a balance sheet drama that is far from over. Even if we assume the Greek debt problem can be fixed, without a single guarantor of euro government debt going forward the flaw in the currency remains. Conceptually, there is only one country in Europe strong enough to back euro area debt, and that’s Germany. Germany’s continuing answer to potentially being a guarantor of the debt of Greece and other Euro area Governments? Nein. We do not expect that answer to change any time soon.

You’ll remember that over the last half year, at least, we have been highlighting the importance of relative currency movements in investment outcomes in our commentaries. The problematic dynamics of the euro has not been lost on our thinking or actions, nor will it be looking ahead.

The current debt problems in Greece also reflect another major issue inside the Eurozone financial sector. Major European banks are meaningful holders of country-specific government debt. Euro area banks have been accounting for the investments at cost basis on their books, as opposed to marking these assets to market value. In early February, Lazard suggested that Greece needs a 50% reduction in its debt load to be financially viable. Germany and the European Central Bank (ECB) want 100% repayment. You can clearly see the tension and just who is being protected. If Greece were to negotiate a 50% reduction in debt, any investor (including banks) holding the debt would have to write off 50% of the value of the investment. At the outset of this commentary, we asked, why is Greece so important when it is only 2% of Eurozone GDP? Is it really Greece the European authorities want to protect, or is it the European banking system?

Greece is a Petri dish. If Greece receives debt forgiveness, the risk to the Eurozone is that Italy, Spain, Portugal, etc. could be right behind it in requesting equal treatment. The Eurozone banking system could afford to take the equity hit in a Greek government debt write-down. But it could not collectively handle Greece, Italy, Spain and other debt write-downs without financial ramifications.

The problem is meaningful. There exist nine countries on planet Earth where debt relative to GDP exceeds 300%. Seven of these are European (the other two are Japan and Singapore):

Debt as % of GDP

IRELAND                                           390 %

PORTUGAL                                       358

BELGIUM                                          327

NETHERLANDS                                325

GREECE                                             317

SPAIN                                                 313

DENMARK                                        302

SWEDEN                                           290

FRANCE                                             280

ITALY                                                 267

As we look at the broad macro landscape and the reality of the issues truly facing the Eurozone in its entirety, what does another four months of forestalling Greek debt payments solve? Absolutely nothing.

How is the Greek drama/tragedy important to our investment strategy and implementation? As we have been discussing for some time now, relative global currency movements are key in influencing investment outcomes. Investment assets priced in ascending currencies will be beneficiaries of global capital seeking both return and principal safety. The reverse is also true. While the Greek debt crisis has resurfaced over the last six months, so, too, has the euro lost 15% of its value relative to the dollar. Dollar-denominated assets were strong performers last year as a result.

The second important issue to investment outcomes, as we have also discussed many a time, is the importance of capital flows, whether they be global or domestic. What has happened in Europe since the Greek debt crisis has resurfaced is instructive. The following combo chart shows us the leading 350 European stock index in the top clip of the chart and the German-only stock market in the bottom.

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Broadly, euro area equities have not yet attained the highs seen in 2014. But German stocks are close to 15% ahead of their 2014 highs. Why? Germany is seen as the most fiscally prudent and financially strong of the euro members. What we are seeing is capital gravitating toward the perception of safety that is Germany, relative to the euro area as a whole. This is the type of capital flow analysis that is so important in the current environment.

The headline media portray the Greek problem as just another country living beyond its means and unable to repay the debts it has accumulated. But the real issues involved are so much more meaningful. They cut to the core of euro viability as a currency and stability in the broad euro banking system. The Greek problem’s resurfacing in the last six months has necessarily pressured the euro as a currency and triggered an internal move of equity capital from the broad euro equity markets to individual countries perceived as strong, such as Germany. This is exactly the theme we have been discussing for months. Global capital is seeking refuge from currency debasement and principal safety in the financial markets of countries with strong balance sheets. For now, the weight and movement of global capital remains an important element of our analytical framework.

Watching outcomes ahead for Greece within the context of the greater Eurozone will be important. Greece truly is a Petri dish for what may be to come for greater Europe. Outcomes will affect the euro as a currency, the reality of the Greek economy, the perceived integrity of the European banking system and both domestic and global euro-driven capital flows. For now, Greece is the word.