The subprime crisis has resulted from a combination of factors:
High prices in the property sector of the United States along with an aggressive offer of mortgages granted to individuals with modest income, with no consideration of their reimbursement capacity.- Rating agencies that are particularly kind on complex investment products related to the funding of mortgages.
- Investors not mastering the complexity of underlying risks and the leverage of the products in which they invest.
- Financial institutions underestimating the risks and the pledges written.
After banks and assets managers (mainly Americans), it is the insurers who have to suffer the turmoil of the crisis that has spread to their sphere of operations.
Insurers' losses come mainly from three sources:
- Directors & officers' liability insurance,
- Share certificates whose value is defined by the financial products linked to mortgages or to the tools ensuring their performance,
- Investments in companies that are affected by the collapse of the mortgage market.
The insurers covering the third party liability of the Directors and Officers (D & O in insurance slang) are working out their expenses. Indeed, complaints against banks, asset managers and audit firms are piling up, and could lead to indemnifications by the insurers who had offered such policies. The main insurers are: AIG, the Lloyds, XL Capital, Ace, Chubb, Hartford Financial Services. The cost of these indemnifications amounts to 3.6 billion USD.
Even though it is the Bermudan and American insurers who are the hardest-hit, the crisis has sent shock waves across the globe. The Lloyds, particularly, are poised to account for an important share of the overall costs.
According to analysts, the sums of the lawsuits pertaining to the so-called E & O (Errors & Omissions) policies may well be above the losses related to the D & O risks.
Investors in mortgage-related products (trough securitization) have been the hardest-hit. The sums invested by financial institutions is likely to amount to about 400 or 500 billion USD, 5% of which are held by insurers. The latter have now to depreciate the value of those assets in their balance sheets.
Other financial tools such as the credit default swap, ensuring the performance of mortgage-related products have largely affected Swiss Re (1.1 billion USD) and AIG (4.88 billion USD).
Nonetheless, insurers could easily absorb these losses that are mainly linked to the underwriting of third party liability policies of the Directors & Officers or to the Errors & Omissions risks.
The insurance market shall be reporting positive 2007 results. Analysts are forecasting a profitable 2008 year, provided that natural disasters remain moderate.