Insurers and the financial services sector face increased exposure to legal action arising from the meltdown in the US subprime mortgage market, international broker Marsh says.

The world’s largest broker has warned of a potential rise in liability claims – particularly in directors’ and officers’ (D&O) and errors and omissions (E&O) – as contagion from mortgage defaults by high-risk borrowers spreads across world credit markets.

Marsh says the subprime crisis has already caused several US mortgage lenders to go bankrupt and several hedge funds to collapse. It has also spurred a ratings downgrade of 2005 and 2006 vintage residential mortgage-backed securities.

Jill Sulkes, a managing director in Marsh’s Financial Institutions Practice, urged insurers, hedge funds, banks and ratings agencies to examine their D&O and E&O exposures.

Securities class-action lawsuits have been filed against several bankrupt mortgage operators for releasing false or misleading statements about their financial results. Lawsuits also have been brought against hedge funds and securities firms for misleading investors about their exposure to subprime mortgages.

“Although the D&O and E&O insurance market has been largely stable, if there are a high number of costly claims under these insurance policies, this trend may reverse and costs may begin to rise,” Ms Sulkes said.

“Companies should be prepared to provide a detailed description of their subprime exposure to their insurers when purchasing D&O and E&O coverage.”

Subprime defaults have also sparked concerns over the degree to which insurance companies and pension funds are exposed to securities backed by sub-prime mortgages, such as collateralised debt obligations and collateralised loan obligations.

Both are used as structures to “insure” against possible losses in subprime mortgage losses.