The subprime mortgage meltdown: will insurance feel the heat?

The subprime mortgage lending blame game is in full swing — with people arguing about who’s at fault for mortgage defaults, bond losses and lender failures. But it’s only the “very top of the first inning” in terms of assessing the impact on the insurance industry, according to one industry expert.

“Already general litigation in the subprime arena is pointing in about every possible direction. Borrowers have sued lenders. Lenders have sued financial institutions. Financial institutions have sued lenders. Regulators have sued just about everybody,” noted Kevin M. LaCroix, an attorney and a director of OakBridge Insurance Services, a specialized insurance intermediary that focuses on executive liability coverages.

American Home Mortgage Investment Corp. (which filed for bankruptcy), Countrywide Financial Corp. (which has begun laying off staff), Fremont General Corp., IndyMac Financial Group, New Century Financial and Radian Group Inc. are among the financial entities that have been hit with class action lawsuits. (For a more extensive list of filed litigation visit LaCroix’s “D&O Diary” at http://dandodiary.blogspot.com/2007/08/all-subprime-all-time.html.)

If the crisis fosters insurance claims, they will most likely be under financial institutions’ directors and officers (D&O) liability and errors and omissions (E&O). LaCroix says there have already been D&O claims, which could affect underwriting and perhaps even pricing for financial institutions going forward.

“[C]ertainly I think it’s something that the heads of the D&O underwriting facilities can’t ignore, and it’s clearly a concern for them. I think it will lead to conservatism and possibly, if the claims trends continue, the prices will be tightening,” said LaCroix.

Underwriters will be watching to see if claims spread beyond D&O. Some observers have suggested auditors, lawyers and even credit rating agencies should bear some of the burden for investors’ losses. Others have questioned whether corporate gatekeepers sufficiently scrutinized the exposures of some subprime lenders.

Securities rating agencies

Dave Kodama, director of Policy Analysis for the Property Casualty Insurers Association of America, agreed that it’s too early for a complete assessment but noted that with criticisms being leveled against securities rating agencies such as Moody’s and Standard & Poor’s, others will likely be brought into the fray.

“Pension funds are going to have to step back and look at their portfolio and see what is their exposure,” as individuals will want to hold the funds’ directors and officers accountable.

“Definitely insurance companies, including our members, are having to address this with their shareholders — address what is their exposure in their investment portfolio [with] these types of securities,” Kodama said.

Kodama emphasized that the primary purpose of D&O insurance is to protect the corporation and its directors and officers, not the investments of individuals. “The primary loss incurred by that product is mainly for defense costs for protecting the interests of the corporation, as well as its directors and officers,” Kodama said.

D&O coverage is typically negated where intentional acts of fraud, such as defrauding the public, the Securities and Exchange Commission or investors are found. “The defense is not there for intentional acts of criminal activity found through the adjudication process,” Kodama said.

In addition to the claims scenario, companies with both insurance and mortgage affiliations or with subprime-related investments are being watched. Moody’s reported that U.S. P/C insurers’ exposure to subprime mortgage-backed securities is minimal. The ratings agency’s report indicated that P/C carriers tend to invest conservatively and that overall the industry’s exposure to subprime-related investments is less than $15 billion.

The world’s largest insurer, American International Group, has subprime exposure as a lender, investor in mortgage-backed securities and supplier of mortgage insurance. But AIG characterized its exposure as minimal.

Countrywide Financial Corp., which is the largest mortgage lender, is the parent of Balboa Insurance Group, which includes Balboa Insurance Co., Meritplan Insurance Co., Newport E&S Insurance Co., Newport Insurance Co., and life insurers. It also owns Balboa Reinsurance Co., a reinsurer for primary mortgage insurers; and two insurance agencies, Countrywide Insurance Services Inc. and DirectNet Inc.

It remains to be seen if Countrywide’s mortgage troubles will spill over into its other businesses. Earlier this year, Balboa cited aggressive plans to expand its insurance sales nationwide and vowed to develop operating efficiencies between its lending and insurance divisions.

Countrywide insurance

On Aug. 16, Countrywide tapped a $11.5 billion credit line to help it fund loans and began eliminating 500 jobs from the lending division. But it said it would continue its insurance growth.

“Countrywide continues to recruit and hire sales professionals in its pursuit of profitable market share growth. It also is carrying on with its strategic growth initiatives in its banking, insurance, capital markets and global endeavors,” the firm said in a statement.

A.M. Best Co. placed the ratings of Balboa Insurance Group, Newport E&S and the life operations under review with negative implications and warned that any further deterioration in the financial condition at Countrywide would result in a downgrading of all of Balboa’s insurance companies. A.M. Best noted that “due to the volatile and quickly changing market conditions surrounding CFC, that maintenance of the present ratings will be difficult, due to the perceived drag on the insurance operations.”

Countrywide did not respond to several calls from Insurance Journal for comment on the subprime situation. But Countrywide has taken out ads in the Los Angeles Times and Detroit Free Press, attempting to reassure investors and banking customers that the company will not go bankrupt as smaller lenders have. “The future is bright,” the ads say.

IJ’s West editor Patricia-Anne Tom and The Associated Press contributed to this report.