Subprime and the Insurance Fallout

February 15, 2008

With all of the front page news concerning subprime loan issues and the impact to the national and global economy, do not overlook the potential fallout to the insurance market. When viewing the possible impact, you should be aware that subprime does not just include residential loans, but also includes commercial lending, commercial paper and bonds (structured securities), such as ABS (asset backed security), MBS (mortgage backed security), CMOs (collaterized mortgage obligation) and CDOs (collaterized debt obligation). Most of these structured securities included credit enhancements such as bond insurer wraps and financial guaranties which were supposed to provided a higher level of security and credit rating. Unfortunately, the bond insurers and rating agencies are themselves under attack. MBIA, AMBAC, FGIC and other mono-line insurers (single line of business) are trying to raise capital to support/maintain their own rating. Any downgrade in the rating to a bond insurer could have a disastrous effect not only on the insurer but for those structured securities that they insure. Many laws and regulations are written to require an A or A+ rating on the bond.

State, municipal, university and commercial projects could be placed on hold while the bond insurer issues are addressed. A new entrant to the bond insurer business, Berkshire Hathaway is providing an expedited process to obtain the necessary insurance licenses to help fill the void.

The rating agencies, including S&P, AM Best, and Fitch, are under attack for the high ratings not only on the insurers but on the structured securities as well. New processes are being put into place to periodically review securities for a change in rating.

Accordingly, we expect there will be a major impact on the financial strength rating for a number of insurers, not only with respect to the risks the insurer has underwritten, such as a financial guarantee, but also on the structured securities in their investment portfolio.

The New York Department of Insurance and the National Association of Insurance Commissioners are scrambling to address some of these issues and help avoid the fallout.

With the uncertainty in the marketplace and potential continued fallout to the insurance community, careful review and understanding of your current insurance policies and those of your investments is in order.

Don’t wait until one of your affected insurer’s is downgraded or is placed into insurance receivership to take corrective action and conduct proper planning.