Shares of Aflac Inc. (AFL) dropped to their lowest level since mid-2000 Thursday after an analyst said the insurer's exposure to hybrid securities issued by European banks, including Royal Bank of Scotland Group PLC (RBS), is a "rapidly escalating concern."

Aflac shares fell as much as 39% to $22.08 in morning trading after Morgan Stanley analyst Nigel Dally told the firm's clients to avoid Aflac's stock owing to its $7.9 billion of exposure to securities that have been sharply marked down after European financial firms announced large losses this week.

"If even a small portion of these losses are realized, the hit to Aflac's capital ratios could be substantial, and their overall capital adequacy could be significantly less than most investors believe," he said.

A spokeswoman for the Columbus, Ga., company wasn't immediately available to comment.

Dally said the value of securities issued by Royal Bank of Scotland, which said Monday its losses last year could be the largest corporate losses in the history of the U.K., dropped as low as 15 cents on the dollar this week, while similar securities issued by other European banks have declined 30% or more to well below 50 cents on the dollar in many cases.

About 80% of Aflac's $7.9 billion hybrid securities come from European financial institutions including RBS, Dally said.

He estimated that if Aflac was to take a hit from its exposure to these securities of more than 15%, its capital ratio would decline to a level where its credit ratings would be at risk and the company might need to consider taking steps to raise more capital.

Dally said Aflac's rationale for holding the securities was based on the idea that the European banks would be viewed by the governments as too large to fail. "Faced with a distress scenario, Aflac believed the respective governments would step in to provide support," he said.

So far, the U.K. has backed that idea up, injecting GBP37 billion ($51.3 billion) into RBS, HBOS PLC and Lloyds TSB Group PLC.

But after RBS said Monday its loss during 2008 would be between GBP22 billion and GBP28 billion, it became clear that the U.K. government would have to commit more to prop up its failing banks, and investors feared it would have to go so far as to nationalize them.

Dally said Aflac's bet that the U.K. will backstop RBS and other banks is risky, because if it and other banks are nationalized outright, all classes of stock, including the preferred shares Aflac holds, could be wiped out.

Aflac is scheduled to report its fourth-quarter results on Feb. 2, in which it will announce losses, if any, on its hybrid securities portfolio.

Aflac shares were down 30% to $25.31 in recent trading. Just over $5 billion of the company's market value has been wiped away so far Thursday.

-By Ed Welsch, Dow Jones Newswires; 201-938-5244; edward.welsch@dowjones.com

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