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How will the subprime crisis affect property/casualty insurance? If you ask Standard & Poor's Ratings Services, it won't have much of an impact. But according to other experts, that may not be the case.

S&P surveyed all the insurance and reinsurance companies it rates globally to determine their exposure to U.S. subprime mortgage-related instruments. Based on the results, S&P expects these sectors to navigate the recent deterioration in subprime mortgage-related assets with sufficient liquidity to meet their financial obligations.

The survey, which assessed subprime exposure as of June 30, 2007, revealed that the vast majority of rated insurance companies have negligible subprime exposure. Some companies had more serious subprime exposures.

However, S&P considers these exposures manageable because these companies targeted asset classes rated AA and higher. (Of the $91 billion in estimated total exposure, 93 percent is in AA or AAA tranches.)

However, Michael O'Connell, managing director and practice leader of the financial institutions practice for Aon, says it's not that clear-cut right now.

"Whenever there is a substantial loss in securities value, there is usually an increase in litigation," he says, referring to expected errors-and-omissions claims, which are typically filed by investors. "When investments underperform and can't be sold (for their original value), investors start looking into why they bought them in the first place."

O'Connell cites parallels such as the collapse of hedge fund Long-Term Capital Management in 1998 and the dot-com bubble burst in 2000. "When you have a systemic event with a major devaluation of securities, it leads to increased litigation," he says. "And the greater the overall losses are, the larger the claims."

O'Connell also says it all needs to be figured out, but he expects E&O and directors' and officers' claims fueled by the subprime crisis to reverse a declining trend in that type of litigation.

"We're only in the second or third inning, but insurers are getting concerned," he says. "The underwriting process will become more rigorous, because underwriters are anxious about the impact on their portfolios."

Broker Marsh also is warning several financial services sector companies that they may be exposed to greater D&O and E&O claims in the wake of the subprime crisis.

"Insurance companies, hedge funds, banks and ratings agencies must continually assess the risks raised by the subprime crisis and examine their D&O and E&O exposures," says Jill Sulkes, a managing director in Marsh's Financial Institutions Practice.

According to Marsh, securities class-action lawsuits already have been brought against several bankrupt mortgage originators, alleging violations of the Securities Exchange Act of 1934. Lawsuits have been brought against hedge funds and securities firms for allegedly misleading investors about their exposure to subprime mortgages.

In addition, the potential for regulatory investigations into deceptive lending practices and resulting drops in shareholder value may bring about claims that may be covered by a company's D&O or E&O policy.

"Although the D&O and E&O insurance market has been largely stable, if there are a high number of costly claims under these insurance policies, this trend may reverse and costs may begin to rise," Sulkes adds. "Companies should be prepared to provide to their insurers a detailed description of their subprime exposure when purchasing D&O and E&O coverage."

October 15, 2007

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