Back to the future

GTR and Willis Towers Watson gathered a group of industry-leading bankers and underwriters in mid-October to discuss the future direction of the political risk and trade credit insurance market, the ongoing resilience of the business in the context of the Covid crisis, and the challenges it faces as it attempts to diversify away from oil and gas.

Roundtable participants

• Robert Lloyd, managing director, portfolio management and distribution, Lloyds Bank
• Claire Simpson, global claims director for Financial Solutions, Willis Towers Watson
• Jerome Swinscoe, president, Tokio Marine HCC – Credit Group
• Andrew van den Born, managing director, global head of CPRI for financial institutions, Willis Towers Watson (chair)
• Christophe White, global head, transactional cover unit, Euler Hermes
• James Wilson, head of credit and political risk, UK and Continental Europe, The Hartford
• Shaheen Yusuf, managing director, structured finance and head of EMEA credit and political risk insurance, Deutsche Bank

van den Born: Last year’s roundtable was conducted virtually, and here we are, 12 months later, sitting around the table in person, which is evidence of a return to some sense of normality. That being said, I would suggest that a lot of the challenges that we faced last year, to a large extent, still exist. Last year there was definitely a flight to quality, with both banks and insurers employing stricter underwriting guidelines around credit. This is a continuing theme with the result that I think this year we’ve been experiencing an origination issue. We have a market that is arguably awash with liquidity; everyone’s chasing the same assets resulting in margin compression and oversubscription. Would you say there is too much liquidity in the market, and what are the consequences of this?

Lloyd: There is definitely excess liquidity in the market. If you look back to the financial crisis of 2007, it took the central banks a very long time to react. Arguably, this time, they’ve overshot it. As a bank, we’ve certainly got a huge amount of liquidity compared to where we were in the past. The capital markets are benefitting from this, and corporates are taking advantage of the situation to fund themselves. Many people are bypassing the banks, or using the banks as stops, and going instead to the capital markets. To a large extent, banks are getting disintermediated, or we’re sat with big backstop liquidity facilities. We’re just one of a number of counterparties with excess liquidity fishing in a very small pond, and we’re all being super selective.

When we move a little bit down the credit spectrum, it’s still very much a sector-by-sector outlook as the economy opens up again. Away from the names we are all after, in terms of supply and demand, there’s not enough supply, but there’s plenty of demand.

Yusuf: I would echo that. Where we are actually winning the trades, what we’re seeing is sometimes we get refinanced quite quickly, because there’s so much liquidity. Where corporates feel that they can refinance themselves cheaper, in a year to two years, they’re doing so. That’s quite frustrating.

Swinscoe: In terms of the dislocation as a result of the excess liquidity, you’ve touched on pricing, and that’s certainly something we see. We’re also starting to see underwriting standards slip on the lending side, and perhaps on the insurance side as well. That’s where there are potential concerns – if risks are not priced appropriately then you’re going to have issues down the line. There are also concerns with security not necessarily being obtained in the way it should for certain types of transactions.

Where there is this flight to quality with everyone wanting to do good business, there are also weaker obligors that are able to raise money, but probably not at the right terms. In some cases, this is reaching levels that may be unsustainable, and we’re seeing that particularly with sovereigns. There are plenty of countries able to raise money at very cheap terms where debt-to-GDP levels may not be sustainable, but also where money is being lent without enough of a focus on what the funds are to be used for.

So liquidity is an issue, the fact that we’re seeing prices being squeezed is an issue, but there are many, many problems beyond that, and we are seeing the beginning of that.

Another difficulty is that that there is too much liquidity in some areas, but some of that is pulling away from some of the weaker debtors, and these companies are starting to become a lot more fragile, and even collapse. Where creditors had the patience until recently to extend terms, to potentially provide additional funding, that is starting to go away. We’ve seen plenty of defaults with companies that were able to survive until very recently.

White: The whole situation is exacerbated by this flight to quality because there is all this uncertainty that is still there. We can pretend life is back to normal because we’re back in the office, but it certainly isn’t, and we don’t know what’s around the corner. That’s causing underwriters and banks to stay in that safe area, and so we have all this extra money sloshing around on the same deals, which means we all get less margin but also a smaller slice of the deal. Then when you do get on, as Shaheen said, you end up getting taken out within two years anyway.

van den Born: Last year, the insurers retracted from a number of Covid-related or impacted sectors. That appetite is coming back, although perhaps we are in a situation where there is arguably more appetite on the insurance side than there is on the bank side. Looking at the emerging markets, where we know capacity is perennially tight, is that still the case? Are you still finding it hard to find capacity?

Wilson: The market was very heavily exposed for the same countries going into the crisis. Last year, the questions being asked were: do you want to put another dollar of exposure into the countries where we’re already heavily exposed? Or is this an opportunity to diversify our exposure base? Also, we weren’t necessarily getting a return that reflected the change in risk of the last 18 months.

Looking across our portfolio, the last year has given us an opportunity to go up the credit curve. There was dislocation, but there was an opportunity there as well. The Hartford was new in the London market. We started underwriting – the first line went down – in week one of lockdown, so there was opportunity for us because we didn’t have a legacy book.

Yusuf: Where we have seen insurance come in is where we have multilateral involvement. Sometimes multilaterals will take the first loss and the insurer will take the second loss, but then they’re more comfortable because there’s more diversification of the risk. The preferred creditor helps as well.

The other problem with those countries with limited capacity is that a lot of these transactions tend to be long dated, and they’re not really amortising fast enough. So it’s not even like there’s a churn of those capacities.

Swinscoe: That’s an interesting point, because we’ve been talking about this flight to quality where we’ve all been looking for the same types of transactions. But over the last 18 months we’ve also found it interesting to be able to expand our relationship with multilaterals, where they obviously tend to play more of a countercyclical role. We were able to do transactions that we would have probably not seen otherwise at terms that were very decent, in sectors and countries where we have limited exposures.

Back to one of the previous points, we were able to diversify in that way, where the focus was not necessarily so much on investment grade-rated counterparties, but sustainable projects over the long term in countries where we have limited exposure and where you have this great need for countercyclical support.

van den Born: By the same token, with multilaterals increasingly coming to the market for facultative support, there is a danger that they end up cannibalising the market for the banks as well.

Going back to the point about new entrants to the market, last year, and to a degree this year, a lot of insurers have concentrated on continuing to prioritise support to their key banking clients. Rob, as a new user of the product, have you been getting the support you need from the private market?

Lloyd: We are very new to insurance, and we have found the support over the last 18 months to be phenomenal, both from the insurers and the brokers. We’ve been led through that journey. As we develop the product internally, we’ve found that help invaluable.

van den Born: James, as a relatively new entrant in the London market, you’ve said you’ve had the luxury of not having a legacy book. Are you still being relatively selective?

Wilson: The fact that a lot of business was being conducted virtually as a result of the pandemic made it slightly harder for us to start relationships in the London market, so for the most part we were relying on clients we had met in brief already, or who we had a strong relationship with from our time in the US market.

For those companies – and banks – that didn’t know us, their biggest concern was onboarding us as a new entrant, and we faced a lot of questions about our commitment to the market. This was certainly the case during the first half of last year. When things started opening up a bit in September, I think people started to realise that we had been binding transactions and supporting clients who gave us good opportunities, not just clients we knew.

But it was very hard in last year’s environment to market effectively as a new entrant. We could market, but to do it effectively and demonstrate that this is not a Lloyd’s syndicate, it’s a US$22bn revenue insurance company, was challenging.

van den Born: Whereas there have been a lot of new entrants to the market, which is positive because it demonstrates resilience, and all this additional capacity is good for the most part, we have also experienced a couple of recent exits from the market, such as QBE in the US, and Zurich on a global basis. For the insurers around the table, that probably presents opportunities, and no doubt you’re getting approached to take on this business – although some of these transactions were probably priced in a different economic environment. For the banks, when an insurer exits, does that cause you issues internally? Does it tarnish the image of the product?

Yusuf: It really depends on how that process is managed. If the party that is exiting has a team to manage the existing positions and the run-off, then I don’t think it would have a detrimental effect. But if that wasn’t done, and the relationship didn’t matter, that would be tricky. But we certainly haven’t seen that.

Swinscoe: The financial strength of both Zurich and QBE is still there and is sound. I suppose you’d have more of a concern if a company were just to collapse, then there would be questions over whether there will be people to manage the situation, and funds to pay out any claims. Fortunately, in these instances, that’s unlikely to be a worry.

To flip the question the other way around, there are also concerns when banks exit certain areas, and that can have much greater ramifications than if an insurer exits if that means that funding is pulled where it is critical to the survival of an obligor. This has been the case particularly in the commodities space, where a number of entities have pulled out. That’s definitely had an impact.

van den Born: Historically, our market has had an overdependence on the oil and gas sector. Insurers are looking to reduce their exposure to this sector and diversify their book, which might be easier said than done given it makes up such a large part of the market. Allied to this, there has been a significant uptick in ESG transactions, including green bonds and sustainability-linked loans, as well as in renewables projects, often with very long tenors. In a lot of these transactions there is a ratchet pricing mechanism that is dependent on certain KPIs being met. From an insurers’ perspective, are they being priced correctly? Do your models take this into account? Also, to what extent is there an element of greenwashing in these transactions?

White: We’ve been trying to diversify our portfolio and get rid of that concentration in oil and gas for many years now. That’s been a trend we’ve been following very closely and actively trying to manage. We’re very glad we did. At the same time we’ve been writing more and more green transactions. The Green2Green product has been a core part of our strategy and very well supported by clients.

We are very mindful of greenwashing. There’s an awful lot going around that is certainly on the browner side of green, wrapped up in a green wrapping paper.

Your comment on pricing and tenors is relevant, and increasingly so. We’re seeing these longer tenors getting to the point where it doesn’t add up, and we’re even seeing our banking clients starting to hit the brakes. Just because it’s green, that doesn’t mean it’s magic – there is a point at which it no longer makes sense. And with all this liquidity we’ve talked about earlier on sloshing around, it has driven things to somewhere near the bottom, so it will be interesting to see how that pans out.

Yusuf: At Deutsche Bank, we’ve got a target to hit €200bn of financing and issuance of ESG-linked transactions by 2023; we brought that forward two years. Our support is linked to all three sub-categories around the ‘E’, ‘S’ and ‘G’.

It’s interesting that you talk about pricing – we don’t see that as the main driver. A lot of companies want to have this classification because it means they can then access a much bigger investor base.

White: Consistency in terms of the categorisation of green or ESG is very difficult. We have spent a lot of time putting together our own matrix, together with the UN Sustainable Development Goals and the EU taxonomy on sustainable activities. The frustration is that there is no universally agreed scale on which to measure these things, which is why you get into these greenwashing discussions.

van den Born: At the moment it does feel a bit like if you label something as being green, then it should attract cheaper pricing simply for being green rather than because of any regard to the underlying credit metrics.

Wilson: When ESG is being driven by an improvement in the risk, then we are of course willing to support. However, there is a huge amount of liquidity in the space, some of it being driven by targets – internal and external – and competing against that can be a challenge. This is partially driven by liquidity, of course, but also from a risk perspective. As Jerome mentioned earlier regarding underwriting standards, if it doesn’t improve the risk, are we increasing our risk of paying a claim without the terms and conditions reflecting the underlying risk?

That feels like a challenge we are edging towards with some of these transactions.

Yusuf: It has to stand up commercially. Sometimes the pricing differential is a few basis points so it’s not a huge driver. Companies also want to be seen to be creating a better environment. If every company says they’re going to improve something like gender balance by a percent or 2%, that makes a huge difference. And people want to be associated with that.

Lloyd: Purpose is huge for a lot of organisations. Going back to the fact that there’s no standard, this is something that the banks are struggling with as well.

At Lloyds Bank we haven’t yet solved for how you take that purpose KPI and put it into pricing. It’s not like the regulator has come out and advised everyone on what they ought to be doing.

The closer we get to achieving our commitments, the more distorted the market will be because there’s no benchmarking. What’s that purpose status worth? It’s very difficult to take a non-financial metric and make it financial.

van den Born: We talk about banks and insurers exiting coal, which they have been doing for some time, but a lot of emerging markets still rely entirely on dirty types of coal and cannot become cleaner overnight. These countries can’t be expected to leapfrog to renewables and there needs to be a natural progression.

Swinscoe: We still have the ability to write thermal coal business. In most cases, we choose not to do it, not because of ESG concerns but because of risk concerns. Very often the prospects for those companies are challenged, even in the short term, because we know that it will be difficult for them to raise funding. There are a number of countries that are allowed to continue producing coal, so you can make a case to potentially support these transactions. But from a risk point of view, it is quite difficult to do so.

White: But where do you take that next? A lot of the banks are now making noises about whether they should be funding into the oil and gas sector. If arguably the green stuff is being priced too thin, what’s the next evolution when the banks stop funding the oil and gas sector, and what ramifications does that have for the pricing or the credit risk of that sector? Especially when we’re still relying on those sectors to keep the lights on.

Swinscoe: For a lot of renewables infrastructure projects, the tenors tend to be very long. But with the oil and gas business we write, much of that is very short term. That allows us the ability to potentially adjust our underwriting approach over time. We chose quite a while back to reduce our participation on medium to long-term reserve-based lending transactions, because we wouldn’t have the ability to go in and out.

van den Born: Let’s change tack slightly to talk about claims. During the course of last year, we all thought that claims in the market might eclipse those of the financial crisis. But the reality is the tsunami of claims that we were expecting did not happen. That’s not to say we have not had any claims. Claire, what’s your take on the situation? Also, for a product that is meant to be binary, in terms of the claims process, is it still too opaque? What’s the role of the loss adjuster?

Simpson: You’re right, the tsunami didn’t happen, but claims activity is up, and in such a situation, the first thing we do is worry about insurer and loss adjuster resource. But I’m pleased to say that everything has gone through smoothly, which is fantastic.

I am concerned about the scope of the loss adjustment process. The onus is on the insured to prove a loss, but when you start to get into some of the stuff that we’re asked for in a loss adjustment, that can extend to documents that go beyond those needed to prove a loss or should have been asked for pre-policy inception not post loss which is a challenge. We’ve also seen a trend for the loss adjustment being combined with a review on potential recoveries so one could view that as mission creep and claims must not be delayed as a result.

In terms of the role of the loss adjuster, it’s really important to us that pre-loss, or with any trouble on the horizon, we bring clients in to explain what the process is going to look like and outline what the expectations are. It is quite an intense process. Nobody likes surprises, and a claim is a time of stress. With claims activity being up we are being tested at the moment and the market is performing really well. But there are things that we can do as a marketplace to potentially finesse loss adjustments going forward.

Wilson: I’ve noticed a race on claims timelines in the policy wording – I’m not sure if that’s being driven by external legal counsel or by the broking community. Sometimes these timelines are not realistic in terms of how the process actually works, which is a concern if the tsunami ever does come. Could the market deal with the volume of claims that quickly? We can, and have before, but why are we reducing the timelines when the process already works well?

We need to think about this area when discussing template wordings for the market. This is a very obvious part of the wording that can be standardised. But we also need to be upfront with clients at the outset when timelines look challenging for them, as well as ourselves, to meet.

Simpson: I’m a great fan of the claims process being well articulated and timetabled, and we work hard to educate clients on this. But if there’s a timeline in the wording and its tight then those are the terms insurers have agreed and need to achieve. As a broker, keeping everything on track is a key part of our role too.

White: Let’s not lose the bigger picture here, which is that the market has performed very well over many years. I think underwriters are absolutely aware of the imperative of the timeliness of payments: the insurance market pays when it’s meant to pay, what it’s meant to pay, time in and time out.

van den Born: What are your predictions for the market over the next 12 months?

Simpson: From my perspective, we can definitely expect elevated claims activity.

Swinscoe: I agree – we’re already seeing an increase in claims activity, and there’s going to be more of that. But then, fortunately, we’re also able to continue writing good quality, new business for strong insureds.

White: For me, there is all this liquidity sloshing around and a lot of companies have been kept going. As that liquidity pulls back and this artificial environment that’s been created by the government’s stimulus disappears, we’ll see who can no longer stand on their own two feet.

Lloyd: I agree completely with that. Particularly in the SME space, a number of companies that should have fallen over have been artificially propped up. I think we’ll see the results of that peak mid-next year.

Yusuf: Digital infrastructure is going to be a significant opportunity, and we’re seeing a lot more financing demands around sectors like fibre and data centres as the world continues to need more technology. The insurance market has stepped up and been very supportive, which we’re pleased to see.

Wilson: The proposed new US infrastructure bill brings tremendous opportunities in terms of the impact on spending and those in that supply chain. It could be the world’s largest investment in renewable energy, which would not only change the US energy mix, but also bring about opportunities across the world for companies to get involved. The impact on global trade could be massive.

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