set alarm bells ringing in global financial markets and has raised
concerns about possible credit implications for European insurers.
At issue is uncertainty surrounding exposure to structured
investment vehicles that constitute subprime mortgage assets –
collateralised debt obligations (CDOs) and residential
mortgage-backed securities (RMBSs).
Service has published an assessment of the exposure of European
insurers to the ongoing subprime mortgage crisis in which it
concluded that the overall direct risk is low. “The absolute level
of exposure to subprime mortgages and non-investment grade CDOs is
generally low, and would generally represent a relatively small
percentage of shareholders’ equity,” said Timour Boudkeev, a senior
credit officer at Moody’s.
He added that insurers’ risk management approaches and systems
have, in Moody’s view, also “generally held up well” during the
recent turmoil in credit markets.
Boudkeev continued that in recent years European insurers have
generally had limited appetite for high levels of credit risk. He
explained that among factors that have contributed to insurers’
cautious investment stance were turbulent equity markets between
2000 and 2002 that led to a reduction in equity exposure as well as
more generally to a preference for higher quality asset risk
Looking ahead to a Solvency II regulatory environment – Solvency II
is European legislation regarding capital adequacy for the
insurance industry – insurers will have to commit significant
amounts of economic and regulatory capital should they decide to
invest in higher-risk assets, such as equities and non-investment
grade fixed-income securities, said Boudkeev.
Most insurers have also put in place fairly tight internal
investment guidelines for fixed-income instruments – for example,
they can only hold only a certain percentage of assets rated Baa
(non-investment grade) or lower. In addition, said Boudkeev, an
increased focus on maintaining asset liability matching by currency
and domicile of assets and liabilities may make CDOs of US RMBSs an
unattractive investment option for the non-US operations of
However, while Moody’s observation that exposure to subprime
mortgages and non-investment grade CDOs holds true for the overall
European insurance industry, Boudkeev pointed out that the degree
of exposure to structured credit assets, as well as the credit
quality of those assets, varies greatly in the industry.
Nevertheless, he stressed that in Moody’s view, it would not be
appropriate to forecast the possible extent of financial loss
merely from the size or average credit quality of an insurer’s
exposure. He said of critical importance is the correlation of
lower quality assets with other parts of the investment portfolio
such as credit default swaps used as hedges against credit
However, Boudkeev cautioned that while European insurers may have
fairly limited direct exposure to subprime mortgages or the US CDO
market in general, second-order effects of the current credit
environment might be of greater concern.
He explained that second-order exposures could arise from
investments into CDOs of CDOs, hedge funds or liquidity facilities
extended to entities with high levels of exposure to credit
Furthermore, an extension of weak investor confidence beyond purely
subprime 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 and losses
in equity markets. In turn, dislocation in capital markets may
reduce insurers’ access to debt and equity funding and have
negative implications on their financial flexibility.
Second-order effects such as these would, in Moody’s opinion, be
likely to have a far greater impact on the European insurance
industry than the recent events in the US subprime market, said