A wave of defaults by US homeowners with tarnished credit histories cascaded through the global financial markets in 2007 and 2008. Mortgage lenders "imploded," hedge funds were forced to close their doors, investment banks collapsed under the weight of subprime mortgage-related losses, a leading insurer was driven to the brink of bankruptcy, and government sponsored mortgage giants Fannie Mae and Freddie Mac were seized by regulators.
Forced to write down three quarters of a trillion dollars in securities backed by subprime mortgages, and with further writedowns likely, financial institutions around the world became far more cautious in their lending, sparking a global credit crisis unparalleled since the Great Depression. Hundreds of lawsuits have been filed, with almost every participant in the subprime mortgage origination and securitization process a potential target.
Media attention has focused on a surge in securities class action suits arising from the subrpime mortgage market meltdown and the resultant global credit crisis. To date 124 subprime-related securities class action suits have been filed. Advisen estimates these and other lawsuits resulting in D&O claims will cost insurers $5.9 billion. Far less attention has been given to the impact of the crisis on E&O insurers. Settlements resulting in E&O losses will, on average, be much smaller than subprime-related securities class action settlements, but in the aggregate, the impact on the insurance industry will be significant: Advisen estimates total insured E&O losses of $3.7 billion spread across accident years 2007, 2008 and 2009.
An assessment of the impact of the subprime mortgage crisis on the E&O market is more complex than a similar assessment of the D&O market. The broad array of E&O coverages corresponding to the diversity of the entities exposed to liability, differences in insurance buying practices among the classes of insureds, yet-to-be-resolved insurance coverage issues, and uncertainty as to how courts will respond to cases arising from an unprecedented global financial meltdown are among the factors that need to be taken into account. Lawsuits that could trigger coverage under E&O policies are being filed against players in both the mortgage origination process and the securitization process, with defendants ranging from small mortgage brokers to global financial conglomerates. Lawsuits resulting from the subsequent credit crunch also may trigger coverage under E&O policies.
Losses will be largely concentrated in a small number of financial institution E&O insurers: more than 50 percent of the total financial institution E&O volume is written by just three carriers. Losses have sparked rate increases in the FI and real estate E&O sectors, but other parts of the E&O market remain very competitive. Overall soft market conditions throughout the commercial insurance market have been driven by a state of overcapacity, but the combined impact of underwriting losses due to plummeting rate levels, subprime-related losses and higher-than-average natural catastrophe losses, and investment losses resulting from the current global financial crisis has destroyed much of the excess capacity. It now appears that the soft phase of the overall commercial lines market cycle will bottom out by the second quarter of 2009, and a period of rising premiums for all commercial lines including E&O will ensue by the end of the year.
contents
Introduction
The subprime mortgage crisis
The mortgage origination and securitization processes
Sources of E&O claims
Subprime exposures and the E&O insurance market
Expected losses
Impact on pricing
Analysis and conclusion
