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Channel Check by Kevin Amrhein Not Past Our Subprime

The effects of the subprime mortgage crisis have yet to be felt by wholesalers or carriers.

By  Christopher Hann

You just knew sooner or later the institutional shock waves generated by the subprime mortgage lending debacle would trickle down to wholesale brokers who deal in professional liability coverage. Fortunately, the effects to date have been more nuanced than catastrophic, unlike the impact felt by the borrowers, lenders and investors themselves. Across the U.S., the practice of lending too much money at interest rates that jumped dramatically over a short period of time to people whose incomes should not have qualified them for such large loans, has led to rising numbers of foreclosures and has caused several lenders to declare bankruptcy. The result, reports the New York Times, has been “a housing crisis of historic proportions.”

Bill Dixon sees the signs. As managing director of the financial risk group at AmWINS, Dixon says that—while the industry is generally taking a wait-and-see approach—he’s heard senior managers at some “very well known insurance companies” express concerns over what’s known as the aggregation exposure. Translation: If the crisis continues to build steam, more and more professions could feel the impact.

“It’s one thing to write coverages for lenders and then watch defaults wreak havoc on lenders themselves,” Dixon says. “It’s another thing to write professional liability for loan originators. As the problems make their way through the system, they touch commercial enterprises that have an ancillary role in the lending process. The effect won’t be felt on a wider scale until those defaults affect other businesses.”

Among wholesale markets, the concern about exposure spreads far beyond the mortgage broker. Just ask Scott Hayward. Vice president for financial services at wholesaler Swett & Crawford in New York, Hayward spends most of his time on risks facing financial institutions, such as hedge funds and private equity firms. He makes it clear that not every hedge fund invested in the mortgage business is in trouble. But there’s no doubt that he’s seen insurance carriers heighten their risk assessment. At least one major carrier, Hayward says, recently sent out a questionnaire to all its financial-institution clients “basically getting a handle on their exposures.”

“Any account that was in transition when this happened went under much more scrutiny,” Hayward says.

When Hayward recently went looking to increase coverage limits for a large New York hedge fund, midterm, he had no takers. “Nobody would put up extra limits,” he says. “Two months earlier, I would have been picking the carrier I wanted.”

Marsh, the world’s largest insurance broker, captured the urgent nature of the crisis when the company released a statement earlier this year warning financial institutions—“including insurance companies, hedge funds, banks and ratings agencies”—that the subprime mortgage mess could lead to a rise in the number of directors and officers (D&O) and errors and omissions (E&O) claims.

Mike Borghesi would agree. “Those companies that have exposure and suffered market deterioration as result of the crisis will definitely have D&O exposure,” says Borghesi, senior vice president of Colemont Insurance Brokers in Chicago. “I think that goes into the evaluation process.”

In fact, Hayward says, the most dramatic changes that he’s witnessed concern hedge funds and private equity firms facing policy renewals for their D&O and E&O coverage. If the underwriter found any mention of collateralized debt obligations or collateralized loan obligations—both forms of mortgage-backed securities—a different underwriting manual was used, Hayward says.

Of course, insurance companies may get hit by the mess from both sides—as underwriters and investors. As Marsh noted in its statement: “The problems have also increased concerns about the potentially large exposure insurance companies and pension funds may have to securities backed by subprime mortgages.”

Dixon says AmWINS has several clients that are “knee-deep” in the residential mortgage industry. It’s not a fun place to be these days. “They’re being absolutely scrutinized,” Dixon says. “That does not mean that the markets aren’t willing to take a bet on them, but every single rock is being turned over in terms of potential areas to underwrite.”

Yet Dixon says the heightened scrutiny does have its advantages. “We see this as a good thing,” he says. “Anything that helps a broker better understand a risk and the potential areas of exposure is going to be on the minds of underwriters. We’re better able to prepare our insureds and our prospects.”

Who knows what the near future will bring. But it doesn’t look pretty. Plenty of real estate-related professions may come under increased scrutiny as well. Might some have particular cause for concern? “If any, I would say the mortgage banker/broker industry,” Hayward says, “because they’re the ones who are putting together these mortgages to begin with. They will definitely have to dot all their I’s and cross their T’s to avoid trouble.”

Hann is a contributing editor.
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