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Friday, 14th August 2020
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The implications of the sub prime crisis for insurance Back  
The global insurance industry is the latest casualty of the sub-prime crisis in the US as investors mark down the value of quoted insurance giants amid fears of a rise in genuine claims and indeed the emergence of higher fraudulent claims. Ronan Foley looks at the implications for the sector.
More than £2bn has been wiped off the value of leading UK insurers since 1st January as analysts consider the implications of economic recession.

If a recession takes place, as some analysts fear, insurers can expect an increase in fraudulent claims, in claims relating to directors and officers (D&O) and claims for errors and omissions (E&O). Claims against financial advisers for unsound financial advice often follow in the wake of a recession.

There has been some initial evidence of UK policyholders claiming against their investment advisers. Such claims in the past have heralded the early signs of a recession. In a full recession more and more fraud components tend to appear, particularly in inflating the size of claims for arson and burglary.

It is to be expected however that general insurers may weather the claims storm better than the life side. Life insurers traditionally invest around 50pc in equities, whereas the non-life insurers invest more heavily in corporate and government bonds with as little as 25pc in equities. This means that general insurers are less exposed to current volatility in the stock market, although they can be more exposed to the prospect of falling bond yields.

Globally there are some indicators that the current financial crisis could lead to potential for increased cost of policies. In Germany, for example, a rise in E&O litigation and bond claims will cost the industry and it is expected that the sub-prime crisis will have a major effect on pricing similar to the stock market crashes of 2001 and 2002 (Insurance Day).

This is resulting in a major rush to purchase policies ahead of rate increases which may occur in 2009. The damage caused by the continuing fall-out from the sub-prime crisis will only be seen after a certain amount of time has elapsed. Prices are also likely to go up for Credit & Political risk insurance as they are interlinked and some insurers may suffer significantly.

In the US, rating firm Fitch noted that litigation surrounding the sub-prime mortgage market will result in a rise in D&O and E&O insurance claims. However, it€s still a bit soon to assess the impact of these claims according to Fitch but they are expected to increase in the financial industry sector. This may result in a firming of rates but very little actual claims, Fitch noted. There could be as many as two million foreclosures in the US residential real estate sector as the riskiest of the sub-prime adjustable rate mortgages are reset at higher interest rates.

It is estimated that the US stands to lose $1bn in revenues as property tax assessments drop in value in 2008. However, the deterioration of sub-prime mortgage values in the US will have minimal impact on insurers and reinsurers according to the rating agencies (S&P/Fitch/Moody€s).

This is because insurers and reinsurers have sufficient reserves to meet exposure to the deterioration in sub-prime mortgage-related assets. However, given the recent volatility it is important that more traditional bond and stock portfolios don€t also deteriorate as this would impact underwriting results, ratings and pricing.

A small number of companies had sub-prime exposures that aren€t negligible. But, S&P considers these exposures manageable because these companies targeted asset classes rated €AA€ and higher. As much as 93pc of the $91 billion in estimated total exposure is in €AA€ or €AAA€ tranches, Global players usually acquired sub-prime exposure through their U.S. subsidiaries and thus tend to be involved in the lower risk end of the market.

Since sub-prime mortgage exposure is not a significant direct risk for the property-casualty insurance industry, its primary concern is deterioration in other sectors of the credit market as a result of sub-prime mortgage problems. Although property casualty insurers are not directly at risk, they are concerned about a slowdown in business as banks tighten their credit lines.
While any recession may see an increase in claims and therefore potentially prices to the business consumer, most property-casualty insurers have minimal immediate liquidity needs, and are therefore well positioned to weather the credit crunch in the capital markets.

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