A.M. Best: Subprime Exposure Modest, But Contagion Is Concern

December 14, 2007

As the turmoil from the subprime crisis ripples across the global credit and equity markets and threatens the stability of the U.S. economy, several insurers have announced their exposure to mortgage-linked assets in their third quarter earnings.

Although the majority of property and casualty insurers’ investment portfolios will not be materially affected, A.M. Best believes companies actively writing professional liability coverage are likely to face higher claims activity due to bankruptcies and class-action lawsuits related to the subprime mortgage crisis.

In the life and health sector, given the diversity of insurers’ asset portfolios and their enhanced risk management practices, A.M. Best does not expect, at this time, to take negative rating actions due to the effects of the subprime crisis, with the possible exception of a handful of companies with above average exposure.

Demand for title insurance products has slowed significantly in recent months, as evidenced by the decline in title insurance revenues, which tracks the slowdown in mortgage originations. Some title insurers also face higher claim activity from underwriting exposure on homes financed with subprime mortgages that have defaulted.

In the near term, A.M. Best expects the balance sheets of certain insurers to be affected as more clarity is gained regarding how subprime and Alt-A mortgage-linked securities are valued. Another concern is the potential for heightened default risk for adjustable-rate mortgages expected to reset over the next 18 to 24 months.

A.M. Best also is concerned about the lack of pricing clarity on mortgage-linked securities and its contagion effect on the pricing of other asset classes. Evolving capital market conditions and the potential for increased economic risk and its impact on investment returns will likely remain the dominant investment theme for many U.S. insurers.

Despite these concerns, A.M. Best remains confident in the overall strength and flexibility of U.S. insurance company balance sheets, observing generally modest exposure to subprime investments that seem to be concentrated in the highest credit quality tranches.

A.M. Best has been monitoring the industry exposure in the subprime crisis since August 2007 and will continue to monitor the investment environment and what impact exposure to mortgage-related investments will have on insurers it rates.

Source: A.M. Best, www.ambest.com

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