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Insurance Industry Ponders Mortgage Market Exposure

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A rating agency and a life reinsurer have been talking about the effects of the recent downturn in the mortgage market.

Fitch Ratings, New York, says life insurers have invested only a small percentage of their investment portfolios in subprime mortgages and have concentrated most of their mortgage holdings in high investment-grade securities with significant structural protection.

Scottish Re Group Ltd., Hamilton, Bermuda, the reinsurer, has invested about 19% of its portfolio in subprime mortgages, but most of the $2.1 billion invested in securities backed by subprime mortgages and the $1 billion in securities backed by Alt-A residential mortgages are in highly rated tranches of offerings put out by highly rated issuers, according to Duncan Hayward, Scottish Re’s chief accounting officer.

Fitch analysts conclude in a discussion of U.S. life insurers that no individual U.S. life insurer has significant direct exposure to subprime securities affected by credit problems.

Because of the U.S. life insurers’ lack of exposure to distressed subprime securities, Fitch has not cut any of the insurers’ ratings as a result of subprime mortgage credit problems, Fitch says.

Fitch’s main concern is that deterioration in the residential mortgage market will hurt other sectors of the credit markets, Fitch says.

The recent problems in the subprime mortgage market have dried up sources of cash, leading to a significant increase in credit spreads in both the structured and corporate bond sectors and to unrealized losses in insurance company bond portfolios, Fitch says.

At Scottish Re, Duncan Hayward said Thursday during a conference call that about 74% of the asset-backed securities in the company’s portfolio have ratings of AA minus or higher, and that 98% have ratings of A or higher.

Alt-A securities represent 9% of the company’s investment portfolio. About 87% of the Alt-A holdings have ratings of AA minus or higher, and 98% have ratings of A minus or higher, Hayward said.

Scottish Re set its investment guidelines in 2004, when it raised $4.1 billion through a transaction with another carrier and established collateral facilities for Regulation XXX obligations, or commitments to hold premium payments level for holders of term life policies.

Scottish Re bought a total of $1.8 billion in high-quality, subprime, asset-backed securities in the 2005, 2006 and 2007 vintages, Hayward said.

About 76% of the investments were in securities with ratings of AA minus or higher, and more than 90% of the investments were in securities with ratings of A minus or higher, Hayward said.

In the second quarter, Scottish Re recorded $3.3 million in realized losses and $14.6 million in unrealized losses on subprime asset-backed securities, Hayward reported.

In July, unrealized losses totaled $97 million, or less than 1% of Scottish Re’s investment portfolio, Hayward said.

In early August, $35 million in securities, or about 0.3% of the investment portfolio, was subject to downgrades, Hayward said.

Hayward said Scottish Re has about $1.6 billion in exposure to subprime-backed securities and $685 million in exposure to Alt-A-backed securities associated with 3 securitizations.

Scottish Re believes that the potential for loss is limited, but, if the assets are worth less than the securitization block, then it could be necessary to secure reserve credit outside of the facilities, Hayward said.

If the market value declines are severe enough, there could be a strain on the company’s liquidity position, Hayward said.

Fitch put out a comment stating that it will not change the rating it has assigned to Scottish Re as a result of Scottish Re’s exposure to securities backed by subprime mortgages.

Scottish Re seems to have enough risk-based capital to support current Fitch ratings even if investments with ratings of A or lower and other holdings do poorly, Fitch says.


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