Members of the audience stifled a few giggles as the familiar soundtrack from the blockbuster movie Titanic was played. It may have seemed absurd but it was really no laughing matter

We were at a debate on the global credit crunch and how it could affect the insurance industry. Last year’s predictions that the insurance and reinsurance industry would escape the subprime collapse unscathed are now being reconsidered. In its renewals report Benfield said the subprime crisis was a “potential cloud on the horizon”.

While most of the fallout have so far been focused among the specialist mortgage and bond insurers, losses revealed by Swiss Re and XL suggest the impact will not remain isolated. “Bond insurance losses are permeating into the mainstream,” warned Julian Spence, senior vice president of Transatlantic Re London, speaking at the debate.

Those reinsurers that avoid being hit on the asset side may find themselves with a significant underwriting exposure. Guy Carpenter’s predictions that directors’ and officers’ (D&O) losses from the subprime crisis were likely to reach $2bn now seem conservative. Recent reports suggest this figure could go as high as $9bn.

The credit crunch debate was held in London on a sunny Thursday morning. The same day XL Capital revealed its fourth quarter losses could go as high as $1.7bn. The losses – primarily as a result of its exposures to financial guarantee insurer Security Capital Assurance – promptly led to rating downgrades from Fitch and AM Best.

In a separate announcement, bond insurer Ambac confirmed it was facing a massive $5.2bn pre-tax credit derivative hit. Fitch downgraded its rating by two notches in anticipation of the colossal loss. Earlier in the week, RenRe and PartnerRe had revealed they were writing off their $200m investment in Channel Re, MBIA’s financial guarantee reinsurer. In December, MBIA’s ratings were placed on negative watch by Fitch after the insurer said it expected a $1bn shortfall.

“Market sentiment has changed in the last week,” said Spence. Everyone is watching the spate of downgrades in the bond insurance sector with alarm. The sector collectively insures $2.4trn of debt around the world and relies on its triple-A ratings. If the insurers are downgraded, the bonds and other assets they guarantee will also lose value.

Remarkably, that sunny Thursday was possibly a worse day for the global stock markets. French bank Société Générale revealed rogue trader Jerome Kerviel had cost the company $7.2bn. Share prices tumbled at the end of an already turbulent week with the US Federal Reserve cutting interest rates by an unheard of 0.75% in a last ditch effort to stave off recession.

As Celine Dion faded into the background, Mike Holley, director of special products at credit insurer Atradius, warned of a “crisis of confidence”. Unlike the famously doomed Titanic, Holley said the global credit market would be hit by two “icebergs”. The first was the mass of consumer defaults which resulted in the US subprime crisis. The second iceberg – yet to hit – would be corporate defaults. “There are a lot of sick companies out there,” he said.

Global recession now seems inevitable. It would be wrong to assume that reinsurers will escape the next downturn unscathed. Granted most are conservative investors and it is unlikely Warren Buffett will be riding to the rescue of any other ailing reinsurers (the famed Oracle of Omaha recently snapped up a 3% stake in Swiss Re).

Any other subprime victims will make themselves known as the final year results trickle in. But the real sting may be yet to come. Two and a half years ago the industry had only to snap its fingers and hey presto! it had raised $30bn, replenishing dented balance sheets after Hurricane Katrina and taking full advantage of hard market opportunities.

Will fresh capital flow into the industry in the same way should it experience a sizable loss in 2008? In the absence of a liquid market, surely that will be the real test. Reinsurance companies may once again be anticipating record results and wondering what on earth to do with all that surplus capital. The wise amongst them will put it towards strengthening their hulls and bracing for that second iceberg.