Fitch Ratings says the European insurance industry's risk from various US sub-prime mortgage exposures is minimal based on the agency's analysis of data surveys and various public and non-public disclosures. Consequently, Fitch does not expect to take negative rating actions on any European insurers due to US sub-prime-related credit issues for the remainder of 2007.

Increased default rates in US sub-prime mortgage portfolios have resulted in significantly higher cumulative loss expectations, and consequently, rating downgrades in primarily the subordinated classes. Fitch expects further deterioration in US sub-prime mortgages, specifically in the 2005 and 2006 vintage years resulting from a number of adjustable rate mortgage loans moving into the reset phase. The combination of 'teaser' interest rates on adjustable rate mortgages and institutional money flowing into the mortgage market seeking higher returns resulted in intense competition in the US sub-prime mortgage origination market. The reason vintage years 2005 and 2006 are looked at with more scrutiny is because increased competition in the US sub-prime mortgage arena led to relaxed underwriting standards.

According to Fitch's review of 41 European insurance groups, the fixed income investment portfolio of the rated groups is extremely high quality with typically in excess of 97% being investment grade. Out of this 13 had US sub-prime exposure of approximately USD13.1bn, representing less than 0.5% of total investments (for the 13 groups) and between 2% and 5% of net assets. One notable exception to this is the Aegon Group (principal subsidiaries rated IDR 'AA') which has slightly more significant expose through their US entities with 4% of invested assets and 55% of net assets exposed to US sub-prime. However, 70% of this exposure is 'AAA'-rated, with the remainder all 'AA'-rated. In addition, none of the group's exposures have to date been either downgraded or placed on rating watch.

In addition to direct exposures, European insurance groups could be exposed to US sub-prime mortgage problems through investments in residential mortgage-backed securities, asset-backed securities and collateralised debt obligations, as discussed above. There is also US sub-prime exposure through what insurers term 'alternative investments', which typically means hedge funds with US sub-prime risk. Assessing US sub-prime exposure in 'alternative investments' can be especially challenging because some hedge funds sold US sub-prime exposure short and actually benefited from the industry's troubles. Such holdings of alternative investments appear to be minimal.

Since US sub-prime mortgage exposure is not a significant direct risk for the European insurance industry, Fitch's primary concern is deterioration in other sectors of the credit market as a result of US sub-prime mortgage problems. Currently, it is apparent in the market how liquidity has been negatively affected by fear over US sub-prime mortgages, which has led to a repricing of credit risk. The impact can be seen in increased credit spreads in both structured and corporate bonds that result in unrealized losses inside insurance company bond portfolios.

The impact has also been felt by issuers in various industries being unable to roll over commercial paper programs, or issue debt, at favourable terms. However, most of the European insurers reviewed have minimal immediate liquidity needs, and are thus well positioned to weather a 'capital markets storm'.

Fitch will continue to monitor developments in the US sub-prime mortgage market and its impact on the European insurance industry. Fitch believes that the industry's exposure to US sub-prime mortgage-backed securities is both modest and concentrated in the higher layers of investment-grade securities. In addition, litigation surrounding the US sub-prime mortgage market will result in directors and officers liability and errors and omissions insurance claims.