Ratings

Across all U.S. insurance sectors, Standard & Poor's Insurance group believes that the level of industry capital is sufficient to absorb the credit impairments from mortgage-related assets currently expected in 2008. Within Canada, exposure is small relative to U.S. insurers and compared with their capitalization. Standard & Poor's projects a high-end loss of $18 billion for all North American insurance sectors. The loss constitutes less than 3.0% of insurance industry statutory capital. Accordingly, exposure to, and losses expected from, subprime-related RMBS will not be a direct driver as Standard & Poor's reviews its stable outlook on the following insurance sectors: U.S. and Canadian life and personal and commercial property/casualty (P/C) insurance, reinsurance, and managed care. Nevertheless, the secondary effects partially caused by the subprime RMBS issues—including poor market liquidity, capital market dislocations, lower interest rates, and a looming recession with the potential for higher credit defaults and higher unemployment—will figure more importantly in any review of the sector's ratings outlook.

Standard & Poor's has taken four rating actions to date directly related to exposures in troubled mortgage-related assets (see Table 1). In each case, further volatility within their portfolios might result in additional rating actions. We continue to have ongoing discussions with these issuers on the details of their exposures and valuation of the securities.

Table 1

North American Insurer Rating Actions Resulting From Subprime Exposure
	—Financial strength rating—
	Current rating/outlook	Previous rating/outlook
American International Group Inc.
Feb. 21, 2008	AA+/Negative	AA+/Stable
Beneficial Life Insurance Co.
Various rating actions: Oct. 7, 2007-Nov. 19, 2007	A/Negative	A+/Stable
Scottish Re Group Ltd.
Jan. 31, 2008	BB/Watch Neg	BB+/Negative
Security Benefit Life Insurance Co. and First Security Benefit Life Insurance and Annuity Co. of New York
Various rating actions: Jan. 16, 2008-Jan. 18, 2008	A/Watch Neg	A+/Stable

Based on information provided to us by the companies, though P/C, Canadian life insurers, and health insurance companies do have some exposure to the subprime issues, the vast majority of companies in these sectors have nominal exposure. Exposure is far more significant for the life insurance sector, but even there, for most rated companies, we do not believe it to be a significant issue.

AIG has the largest exposure of any U.S., Canadian, or European insurer. About half of the company's total exposure resides in its consolidated insurance operations, principally the U.S. life insurance operations. AIG's insurance companies' exposure to and expected loss in underperforming RMBS and related loss estimates is included in our industry statistics and tables. In addition to AIG's insurance exposure, there is an equally large exposure that is not included in this report's statistics at AIG's noninsurance financial products company. Our negative outlook on AIG reflects the continued uncertainty around estimating its economic losses and fair market values in its U.S. mortgage securities exposure. Standard & Poor's believes that AIG will ultimately recover a meaningful portion of the 2007 unrealized market valuation loss, but the timing and the amount are difficult to estimate.

In our view, for North American life insurers, the potential impact of the RMBS problem is the effect on the general economy. Although we do not believe the direct exposure to subprime RMBS will threaten the life insurance sector, RMBS credit losses—combined with the low interest rates, volatility in the equity market, and a threatening possibility of recession and its impact on increasing credit losses in the corporate bond portfolios—will challenge the life sector and could lead to negative pressure on ratings.

Within the P/C sector, we believe indirect consequences of depressed subprime asset valuation issues could have a more material negative impact on commercial insurers. Our main focus relates to the cost of possible investor litigation. Some of that cost may be recovered from the affected institutions' directors and officers (D&O) and errors and omissions (E&O) insurance policies. Insurers that wrote such business on banks, mortgage bankers, brokers, appraisers, and various other financial service providers in the residential housing market will be most at risk. At present, Standard & Poor's believes that it is too early to have a definitive view of the industry's total prospective losses in these lines. However, estimates in the market for total casualty losses from this business range between $3 billion and $8 billion, which would be in addition to the range of projected direct subprime losses previously noted. Clearly, these losses would affect insurers globally.

Another aspect is the fall in equity values following the subprime asset write-downs and the decline in confidence in the capital markets. For a limited number of insurers, losses arising from investments in equities could be a rating factor. Generally, we believe the global industry is significantly less vulnerable to equity devaluation than in the past.

The current dislocations in the capital market have made it a less-effective economic means of securing long- and short-term funding and capital, a clear negative on the financial flexibility for all insurance sectors. For a limited number of insurers, these conditions are more serious, as a failure to either refinance existing debt or issue new debt could be a rating weakness. Concerns in this area are offset, however, by the capital adequacy of the sector as a whole, which is at a cyclical high. Cash flows are similarly strong.

The outlooks on Europe's insurers are predominantly stable and are expected to remain so, despite the continuing disruption in the capital markets. To date, there have been no rating actions arising from subprime losses and the associated capital market disruption. There have been outlook revisions to Fortis Group and Irish Life Assurance PLC, which were mainly influenced by their banking operations, and AEGON N.V. European insurers are generally conservative investors (partly because of regulatory constraints), with the vast majority of their investments deployed in government and highly rated corporate debt, bank deposits, and equities. The resulting credit risk is moderate in our view, except for those groups with large U.S. life insurance subsidiaries (as is the case with AEGON N.V.). Furthermore, insurers are rarely forced sellers because such investments are used to back long-term life insurance liabilities. Losses on subprime-related exposures are not expected to dent the industry's performance significantly given the typically small allocations. Such losses on the life side are further limited by policyholder participation. Even on a mark-to-market basis, the losses of the European industry as a whole (excluding U.S. insurance subsidiaries and banking operations) were only $5 billion based on our survey. After including these operations, the consolidated losses on a mark-to-market basis were $12 billion. In large part, these are likely to be restricted to a small number of groups: Allianz SE, ING Groep N.V.,ING Groep N.V., and Fortis Group via their banking operations as well as AXA, Swiss Reinsurance Co., and AEGON N.V.

Since August 2007, when our first subprime survey of the insurance sector was conducted, market-value deterioration and projected loss rates on the troubled portfolios have increased significantly, and projected losses have expanded to other mortgage classes that had been less affected. The problems have been accelerating, not slowing. As an illustration, the investors' subprime performance benchmark, the ABX-HE-BBB-07-2 index, declined about 70% in the past six months.

Although economic losses on some of these underlying mortgages are real and we expect additional projected economic losses, in our view, current market valuations of these securities are low because of a substantial illiquidity discount, which might be clouding market credit loss expectations. Nevertheless, since the initial survey, securities' credit conditions have deteriorated substantially, demonstrated in part by downgrades of the securities and some bond insurers that might have wrapped the mortgages or CDOs.

The delinquency and projected default rates of the pools of subprime loans from 2005-2007, and particularly from vintages 2006 and 2007, have increased substantially in the past year. Now, a slowing U.S. economy and falling U.S. home prices have weakened the capacity and, increasingly, the willingness of borrowers to repay and have reduced recoveries on sales of foreclosed properties. For example, Standard & Poor's Structured Finance group has increased its lifetime loss projection for the 2006 vintage of subprime loans to 19%, based on a 42% default rate and a 45% loss severity. Table 2 shows Standard & Poor's Structured Finance group's cumulative net loss assumptions on a variety of RMBS collateral types, which includes the latest changes to the 2007 vintage subprime and Alt-A default released April 25 and 30, 2008, respectively.

To gauge the risk of insurers' exposure and the impact of losses on insurers' financial strength, Standard & Poor's is focusing on the security vintage (year of mortgage securitization), borrower type (subprime, Alt –A, closed-end seconds, home equity lines of credit [HELOCs], CDOs, CDO squareds, etc.), and initial and transitional rating level in conjunction with stressed loss expectations to calculate cumulative expected losses. The calculations are very sensitive to the underlying loss levels of the mortgages in these instruments, which have risen several times over the past few months as mortgage performance metrics have deteriorated (data include the revised RMBS cumulative net loss assumptions announced on April 24, 2008, by Standard & Poor's Structured Finance group to the 2007 vintage). Of note, given the relatively recent origination of the underlying mortgages, actual losses on the securities backed by these mortgages are currently low but are projected to increase. Therefore, expected losses could occur over time and are currently reflective of the high foreclosure rates and loss severities expected upon liquidation of the underlying collateral for many of the securities. The underlying cumulative net loss assumptions by asset class are seen in Table 2.

Table 2

Asset Class Cumulative Net Loss Assumptions*
	(%)
Vintage	Alt-A	Subprime	Closed-end second	HELOC	NIM
2005	2.8	8.5	17.3	10.4	8.5
2006	5.5	18.8	40.0	15.8	18.8
2007	7.5	22.6	40.0	13.0	17.4
*From Standard & Poor’s Structured Finance group.

After stressing the underlying loss assumptions, we compared each insurer's expected losses with its statutory total adjusted capital (TAC) to get a sense of their balance sheet capacity to handle losses. We also compared expected losses to annual earnings to measure the magnitude of expected losses to their earnings strength.

The performance of specific subprime RMBS depends on several factors, including portfolio composition, structure of the waterfall and the amount of subordination, and the existence and amount of excess spread. Some 'BBB' rated subprime RMBS instruments from 2006 will pay through maturity, whereas some higher-rated subprime RMBS from 2006 might ultimately default. In Table 3, you can see the loss factors corresponding to vintage, rating, and collateral type used in this analysis. The data in Table 3 are the result of Standard & Poor's Bond Insurance group's application of stresses to the expected losses provided by our Structured Finance group (Table 2). The losses in Table 3 straight lined and do not consider timing of realized losses (For insight into methodology and stresses used, see "Detailed Results of Subprime Stress Test of Financial Guarantors," published Feb. 25, 2008, on RatingsDirect, the real-time, Web-based source for Standard & Poor's credit ratings, research, and risk analysis). To develop an expected loss projection, we used Table 3. Where insurers provided detailed breakdowns of exposures, we applied the entire table and, though not a significant component for insurers, we also made separate adjustments for CDO and CDO-squared exposures. For those firms lacking sufficient detail (usually vintage), to apply the entire table, we assumed the most severe vintage, rating, or collateral charge from Table 3 for the lacking information.

Table 3

Tranched RMBS Tranche Loss Assumptions*
	(%)
Vintage/original rating	Alt-A	Subprime	Closed-end second	HELOC
2005
AAA	0.0	0.0	0.2	0.1
AA	3.0	2.5	15.3	18.3
A	31.6	22.2	45.5	57.7
BBB	66.2	45.9	65.0	74.5
BB and lower	90.5	60.3	75.0	76.1
2006
AAA	0.0	1.4	22.6	1.4
AA	29.4	50.2	86.1	56.3
A	77.5	82.3	96.0	86.2
BBB	90.9	88.7	96.6	93.9
BB and lower	96.6	92.2	97.4	96.9
2007
AAA	0.7	2.6	21.5	0.9
AA	66.3	57.5	84.9	49.6
A	91.3	83.4	94.5	84.4
BBB	96.2	89.2	95.9	92.4
BB and lower	98.2	92.4	96.9	96.3
*NIM transactions were not tranched.

Tables 2 and 3 have been updated for the most recent Structured Finance cumulative net loss assumptions by asset class (April 29 and 25, 2008). These tables were initially published on Feb. 25, 2008, by the Standard & Poor's Bond Insurance group in an article titled, "Detailed Results Of Subprime Stress Test Of Financial Guarantors." The methodology was also explained in that article.

In the rating analytical process, Standard & Poor's is evaluating the insurer's investment portfolio market valuation volatility relative to TAC because we believe that the majority of investments are strategically bought to cover similar-duration liabilities, which, over the long-term, should enable insurers to hold securities beyond temporary or even sustained periods of market-value declines. We acknowledge that in the short term, earnings will likely be more volatile as the market reacts to perceptions of credit weakness and changes in the availability of liquidity. Similarly, we are aware that market valuation methods have their limitations in periods of market disruption. The major offset to these concerns, in our view, is the level of excess capitalization these issuers maintain, which will enable them to absorb the ultimate credit losses tied to these securities. We believe that the majority of the insurers with higher-than-average concentrations have sufficient excess capitalization to manage these risks.

As of Nov. 30, 2007, rated insurance companies in all sectors had approximately $162 billion in estimated total exposure to problem RMBS (principally subprime and Alt-A) for all insurance sectors. Since then, this amount has declined as a result of write-downs, prepayments, and maturities. For these insurers, 80% of the problem RMBS exposure is rated 'AAA', while only 5% is rated 'A' or below. The high proportion of highly rated securities has been crucial to the industry's relatively low expected loss level. P/C, Canadian, and health insurers generally have minimal exposure to subprime, Alt-A, and related RMBS relative to TAC. Multiline companies, defined as having both P/C and life operations, generally have exposures similar to that of the life insurance companies from their life insurance subsidiaries. The life sector had a greater exposure to subprime mortgage-related RMBS relative to other insurance sectors, and accordingly, its expected loss levels are trending toward 5%, far higher than other sectors.

In our view, the life sector's exposure is centered in a small number of issuers that have a concentration of non-prime RMBS and mortgage-backed CDOs. To date, we have taken rating or outlook actions on four insurers that have large concentrations and exposure to loss. The underlying characteristics of the underwritten collateral are important factors as we review these companies with composition of loan origination year and the type and quality of their collateral exposure. Enterprise risk management is considered important for all insurers to varying degrees based on their complexity and risk; for insurers with sizeable concentrations, we place additional focus on their enterprise risk management and their risk controls and processes.

Table 4

Insurer Subprime And Alt-A Exposure
As of Nov. 30, 2007
(Mil. $)	Combined	Total subprime	Total Alt-A	Exposure to traunches 'AA' and lower	Exposure to traunches 'A' and lower	Total adjusted capital
Total life and health	135,415	78,406	57,009	28,574	8,915	366,351
Property/casualty	26,575	14,739	11,836	3,778	1,099	234,205
Total insurance (reinsurance) industry exposure	161,990	93,145	68,845	32,352	10,014	600,556

Table 5

Insurer Subprime And Alt-A Exposure (%)
As of Nov. 30, 2007
	—Exposure to total adjusted capital—			—% of total exposure by traunche—
	Total Exposure to TAC	'AA' and lower to TAC	'A' and lower to TAC	'AAA' % of total exposure	'AA' % of total exposure	'A' and lower % of total exposure
Total life and health	37.0	7.8	2.4	78.9	14.5	6.6
Property/casualty	11.3	1.6	0.5	85.8	10.1	4.1
Total insurance (reinsurance) industry exposure	27.0	5.4	1.7	80.0	13.8	6.2

Table 6

Expected Losses By Sector
	Expected losses (Mil. $)	Expected losses to total adjusted capital (%)	Total adjusted capital (Mil. $)
Life and health (including Canada )	17,403	4.8	366,350
Property/casualty	1,908	0.8	234,205
Total insurance (reinsurance) industry exposure	19,311	3.2	600,555

Without question, given the level of credit deterioration of the underlying collateral and market-value declines, insurer justification for maintaining original valuations on securities will be tested over the next few quarters. Yet, most of the impairments seen to date are related to the severe spread widening that has occurred across bond portfolios and specific investments in noninsurer financial institutions. Losses on these subprime securities expressed as other-than-temporary impairments, might begin to show in more material amounts on insurers' income statements over time. However, based on discussions with many firms, we do not expect to see large amounts of economic loss relative to total impairments in sub rime or Alt-A RMBS securities over the next few quarters. In our view, the delayed recognition at insurers' financial statements relative to banks and other financial intermediaries holdings' will not augur something new but rather will reflect different accounting rules, tests, securities held, and the willingness and intent to hold the securities until maturity.

Though losses are being (and will be) taken on their holdings of problem RMBS, in the U.S., we believe that the more important issue for the insurers is the second order effect of the RMBS dislocation on the general economy and financial markets. If the current problems precipitate a recession, corporate bond losses will likely escalate, exacerbating the RMBS effect. The severe problems with illiquidity in many markets and types of securities are causing dislocations of their own that are difficult to predict and have led to additional credit worries. In our view, the lower interest rates used by regulators to combat the current market conditions have their own negative consequences on general account portfolio yields, which hurts life insurer operating performance. The weak equity markets have had a negative effect on business lines reliant on asset-value-based fees and on the equities directly held. For commercial insurers, there remains the risk of litigation fallout on D&O and E&O policies.

Although there will be a few firms for which direct RMBS holdings could lead to exposure and losses that will require ratings action for the vast majority of insurers, the problems are relatively small and not a significant rating concern. Standard & Poor's will continue to assess the direct and secondary effects of the RMBS problems on the sector and rated insurers to determine if outlooks are likely to remain stable or be revised to negative.