City View

Many of the major European insurance groups have published their sub-prime asset exposures for the third quarter of 2007 and we eagerly await the full-year results over the coming weeks. Most have also published their exposure to asset-backed and mortgage-backed securities. Fitch expects few rating actions from these exposures, which are generally modest . Direct sub-prime exposure for the major groups averages 0.5% of total invested assets.

We do not expect sub-prime and other structured credit products to have a sizeable impact on the solvency of companies, but writing down any losses may impact earnings. Although sub-prime does not represent a significant direct risk for European insurers, the impact on investment markets and on economic growth is likely to have a bearing on the investment yields that insurers are able to generate, as well as on demand for insurance products.

Another challenge facing insurers in the wake of US sub-prime losses is that of liquidity. Many lenders are taking a much more cautious approach to lending and, in some cases, insurers may not be able to access credit facilities, at least over the short-term. The debt markets have also been affected, with many insurers unable to complete planned debt issuance which could create liquidity problems if they are seeking to refinance maturing debt.

However, the European insurance market has been very fortunate over the past two years as claims experience has been benign relative to historical averages. This has led to strong cash flows and retained earnings, and excellent levels of capitalisation.

We are concerned that the insurance industry’s exposure to sub-prime losses could increase as legal actions commence in the US. The insurance industry could be exposed to directors’ and officers’ liability (D&O) claims. Furthermore, errors and omissions (E&O) insurance may be called upon. Some commentators suggest that E&O exposures may ultimately be greater than D&O claims, although E&O typically take longer to emerge. With some estimates of the potential D&O exposure of the industry at $3bn, and assuming the E&O losses mature to a greater figure, this is still a loss that can be comfortably absorbed by the industry.