US sub-prime crisis has limited direct impact on European insurers, says Moody’s

The current crisis in the US sub-prime market and the related uncertainty surrounding structured vehicles will not have a direct material impact on European insurers, Moody’s Investors Service said in a new Special Comment issued Friday.

Overall, the absolute level of exposure to sub-prime mortgages and non-investment grade Collateralised Debt Obligations (CDOs) is generally low, and would represent a relatively small percentage of shareholders’ equity, although the rating agency also stressed that it is not appropriate to infer the degree of exposure or to forecast the possible extent of financial loss merely from the size or average credit quality of exposures.

The Moody’s report explains that for many of Europe‘s largest insurers, public disclosures indicate that exposures to sub-prime residential mortgage-backed securities (RMBS) are generally of a high credit quality. Nonetheless, large multinational insurers domiciled in Europe may have a somewhat higher level of exposure than medium- and smaller-sized regional insurers, and the degree of exposure to structured credit assets — as well as the credit quality of those assets — varies greatly in the European insurance industry,” said Timour Boudkeev, author of the report.

Moody’s also observes that second-order effects of the current challenging credit environment may present a greater concern.

“Although the full extent of second-order effects is difficult to ascertain at this stage, a general spreading of weak investor confidence beyond purely sub-prime exposed investments could deepen, leading to a protracted decline in market value of corporate bonds and higher-rated structured credit products along with reduced liquidity, losses in equity markets, as well as a dislocation in capital markets that may reduce insurers’ own access to debt and equity funding and have negative implications on their financial flexibility,” Boudkeev added.

Nonetheless, Moody’s highlights that exposure to the recent turmoil in credit markets has been limited as a result of successful risk management approaches and systems.

Moreover, for most European insurers, non-investment-grade sub-prime exposure represents a negligible proportion of invested assets, largely as a result of their reduced appetite for high levels of credit risk following turbulence in the equity markets in 2000-2002. Stricter guidelines proposed in the forthcoming EU-led Solvency II regime should also mitigate the impact of increased risk, but the agency cautions that it could re-assess the appropriateness of some European insurers’ risk management capabilities in light of recent market developments, particularly if the asset side of insurers’ balance sheet does not prove sufficiently resilient to the recent market volatility.

Overall, Moody’s stressed the importance of taking a holistic view of the investment portfolio when analysing its susceptibility to a deteriorating credit environment, taking into consideration the correlation between assets under exposure and other parts of the investment portfolio, e.g. credit default swaps (CDS) and similar derivatives employed as hedges against credit risk.