As the mature economies of the world come out of recession, there is increasing appetite for insureds to manage some of their own credit risks, writes Helen Yates.
The failure of a major customer, or several smaller customers, can severely impact the health of an organisation and even lead to an insolvency. Mitigating credit risk is therefore essential. One of the best and more cost-effective ways of doing this is to take out trade credit insurance. Historically, companies selling their goods would look to transfer 100% of their credit risk, but increasingly credit insurance has become more of a partnership.
A special feature of traditional whole turnover products is the right to reduce or cancel the credit limit on a buyer at any given time. This ability to manage credit limits allows the insurers to react to a buyer’s credit problems before they worsen. For obvious reasons, this right was exercised frequently during the crisis, but for many insureds it was felt insurers often reacted too quickly and cancelled cover unfairly.
“Post the crisis the biggest development has been non-cancellable cover,” says Tim Smith, leader of Marsh’s trade credit practice in Europe. “Through the crisis the underwriter had the capability of cancelling cover at any time. So if you were selling something to me and suddenly my finances looked poor, an underwriter could pull cover on me immediately. So you would have the choice of continuing to trade totally uninsured or to withdraw trading from me.”
“Non-cancellable cover would mean you could buy cover selling to my company for a full 12-month period. Irrespective of my day-to-day performance, you would have cover secured for a fixed term,” he adds. “That offers companies a lot more security and confidence around the continuance of trade.”
There was a backlash against trade credit insurers following the financial crisis. More recently, the failure of some big high street brands in the UK including Comet, Jessop’s, HMV and Blockbuster has again given credit insurance a bad name. While some of this is clearly media misinformation, suggesting that credit insurers brought down Woolworths and Comet by refusing to extend cover to their suppliers, there is pressure nevertheless on the industry to restore trust in the product.
The trade credit market has moved on considerably since the financial crisis, with insurers offering excess of loss (XL) products and newcomers to the market going head-to-head with the big three.
“There were a number of traditional underwriters that took action to address the increased claims volumes in 2008 and 2009 by cancelling a lot of the cover,” says Neil Ross, trade credit regional manager at AIG Europe. “That had a material impact on the business. There were a lot of policyholders who left the marketplace.”
“Since the crisis with all the government intervention with quantitative easing that’s been in place both in the UK and US the level of losses has been pretty good, although more recent trends suggest there is a slight pickup in the loss trend,” says Ross. “Underwriters have been looking for ways to attract people back into the credit insurance marketplace and so far there’s been limited success,so that desire is really helping to drive innovation.”
The Association of British Insurers (ABI) statistics show that trade credit premiums have recovered since the crisis and are back at £334mn, the same level of gross written premium (GWP) by the market in 2007. Claims have also dropped substantially, from over 27,000 at the height of the crisis, to nearly 11,000 in 2012. However, the total number of policies was 10,550 in 2012, down from 14,086 in 2008.
While the drop in policyholders could also be attributed to an increase in mergers and acquisitions and the greater number of insolvencies, there is also a feeling that the trade credit insurance market must rebuild its reputation. “Companies have merged, or they’re accessing credit insurance through a master policy, but generally the number of policyholders has declined in the UK and the total premium spend remains relatively static,” says Ross. “So people are looking at new ways of trying to attract companies.”
Rise of seller insurance
One way of attracting companies is to offer non-cancellable XL covers, something insurers such as Equinox, AIG, Markel and ACE have been promoting. The advantage, say the XL proponents, is that it can reduce volatility in credit management by offering certainty of cover and increased transparency.
“If you go as an insured to the ‘big three’ – Euler, Coface and Atradius – and say: ‘I want to buy as much credit insurance as I can as far down as I can’, they will say: ‘Fine we can sell you our whole package, our whole service and we’re not too worried about you taking a retention’,” explains Bernie de Haldevang, head of FINPRO international, credit and political risks at Aspen Insurance. “Because they’ve got access to information and they’re not too worried about the legislative process, they understand the court systems and they know they can enforce debts – none of that is an issue.”
“If you then go to an insurer who sells XL-type products they basically say: ‘I want to sell credit insurance to an intelligent buyer which has its own risk management process, is willing to take risk on names and obligors, is willing to take risk on its own ability to manage its own credit risk and only wants to buy at a point where there might be a quarterly earnings problem, an insolvency problem or a problem in terms of its ability to continue its business’, and that’s the band it wants to buy. In a developed environment where you can get access to credit information and where you can do your own credit assessment these deductibles work very well.”
XL products require insureds to take on a certain level of risk, and responsibility for risk mitigation, before the insurance will payout. As the name implies, XL products are for claims that sit above a certain expected level. This contrasts to whole turnover, where every single customer on a debtor portfolio is covered.
With XL, the insured agrees to lose a certain level of frictional losses each year with the insurance kicking in when losses go above that agreed threshold. “In the downturn the underwriter knows he will have increased losses and so will take a more arbitrary view on exposures in say, the construction sector,” explains Ross. “The client on the other hand is very close to his existing clients and has a much closer relationship. Their ability to take a level of risk sharing means the underwriter can provide a much broader range of cover.”
Of course, in order for an insured to be able to undertake their own credit management and retain a proportion of the risk the company needs to have access to credit information and technology. In order to be offered competitive rates on XL credit insurance underwriters will first want to see evidence of effective credit management controls and procedures. In this shared risk relationship, the XL underwriters are in fact insuring the seller, whereas the traditional whole turnover insurers will be covering the buyer.
Credit risk solution firms that traditionally developed solutions for credit insurers have more recently branched out to provide these tools directly to enterprises. Credit software providers like Company Watch and Tinubu Square are focusing more on helping B2B companies get a better handle on their credit management.
Tinubu Square points out that for such firms, customer receivables represent more than a third of a B2B firm’s assets. Over 25% of business failures are the result of customer defaults. Write-offs of bad customer debt have grown from an average of 0.5% of revenues to 1% or higher.
“The XL companies recognise the value given by the whole turnover insurers’ product [risk underwriting] and have helped encourage third parties and IT to help fill that gap,” says Richard Talboys, executive director at Willis Financial Solutions. “Companies can buy into third-party software for example to remove their dependency on the traditional trade credit insurer’s risk underwriting.”
“We tend, where we can, to sell against whole turnover and say to the big companies you should manage this risk yourself,” he continues. “You should invest in credit management yourself and do this better and not rely on Euler or Atradius to be the outsourced credit management for you.”
“As a broker we spend time going through our clients’ credit management processes and encouraging people, ‘If you spend x amount of premium with a traditional insurer, you could spend less, just cover the catastrophe and take it on your balance sheet and manage the risk yourself,” he adds. “But some companies like to know a third party is endorsing their decisions.”
One underserved part of the credit insurance market is SMEs, with the ABI’s statistics showing the biggest drop in policyholders has come from the SME segment (customers with profits between £0mn and £3mn). This segment of the market has seen its share of premium reduce from 11% in 2007 to 6% in 2012. “The big issue is SMEs think in a very different way and so we need to design products that relate to the way they operate and that offer a more meaningful level of cover,” says AIG’s Ross.
Big three fight back
Despite the growth in XL credit insurance and investment in technology, the big three’s ability to underwrite billions of dollars worth of corporate credit risk around the world is not at stake. Their insight into different markets means the barrier remains high for others looking to enter this very specialist space.
Nevertheless, the growth in XL products has prompted the leading credit insurers to broaden their offering. A mix of cancellable and non-cancellable limits has begun to emerge from the big three. “It’s fair to say that traditional whole turnover market has recovered very quickly from the crisis,” says Talboys. “They’re back in profit, their premium is under threat and they’re trying to find ways to grow the market.”
Where non-cancellable cover is not available, policyholders have been appeased with limit withdrawal notice periods and more competitive premium rates. But in some cases the traditional whole turnover insurers have gone one step further. In 2012, Euler Hermes set up its own non-cancellable XL team, designed for large and multinational companies seeking protection from exceptional trade credit losses to their balance sheets.
Talboys describes this as “a counter measure”. “They set up an independent team with independent underwriting authority and then expanded it into North America this year,” he says. “This is a move whereby they are directly fighting off competition and giving their clients an alternative.”