Surging bankruptcies boost case for trade credit cover
British businesses have had a torrid time in recent months, leading to record pay-outs by trade credit insurers. With tough trading conditions showing no sign of easing any time soon, will insurers pull out or step up to the plate? Eleanor Wragg reports.
Last year saw the number of British businesses collapsing into bankruptcy reach a four-year high, with figures from the UK government’s insolvency service painting an even gloomier picture for 2018. In Q2 this year – the latest period for which data is available – total new company insolvencies in England and Wales were up 12% versus the same period last year. In Scotland, that figure was 18.2%, while Northern Ireland posted a 108.3% year-over-year increase. Meanwhile, a growing number of firms are struggling with sales short of forecasts and delayed or discontinued contracts, with data compiled by EY showing profit warnings up 29% year-over-year in Q2 2018. Good times for business these are not.
But amid the carnage, trade credit insurers are diligently picking up the pieces. They collectively paid out £92mn in Q2 – the highest quarterly figure since the Association of British Insurers (ABI) started keeping records in 2007, and due in large part to the impact of the blockbusting January collapse of UK construction firm Carillion.
The UK’s retail sector has been the most visible casualty of these difficult times, with British high streets left resembling Swiss cheese as political and economic storm clouds take out former stalwarts of shopping, from House of Fraser to Poundworld. The reasons for this are manifold, among them rising inflation, national minimum wage increases, the rise of online shopping and structural changes in the way consumers spend their money. The fall-out from the Brexit vote is the most obvious factor, with the resultant deterioration in sterling pushing up import prices for firms already operating on slim margins – although secretary of state Dominic Raab has been swift to downplay the suggestion that the UK’s decision to leave the EU is entirely responsible for British businesses’ woes.
Not enough take-up
Although ABI figures show the UK’s trade credit insurers currently cover a record £340bn of trade to help businesses navigate the increasingly tricky environment, the association says that too few firms are using trade credit insurance, and that more needs to be done to encourage them to buy the product.
“The ripple effect of high-profile insolvencies like Carillion can have a devastating impact throughout the supply chain, impacting thousands of firms,” says Mark Shepherd, assistant director of the ABI in a statement. “Never has the importance of trade credit insurance been greater – the survival of any business could be at risk without it. Yet with 13,000 policies in force there remains a significant protection gap with too many firms operating at the mercy of non-payment of debts. This gap needs to be closed.”
“The examples of Carillion or House of Fraser are big and very damaging. But they are also great flags in the sand to say, look, people who didn’t have it might not survive. Those who did have it will survive,” says Trevor Price, managing director of the Global Trade Credit Alliance (GTCA). “There are plenty of suppliers to House of Fraser who are teetering on the edge because the loss is so significant that they may not recover from it. And that domino effect is awful for them, but it highlights the queue out of the door for people who now want cover on other retail names.”
Laura Ferguson, director at insurance broker Parker Norfolk, says that the recent bankruptcies have resulted in an increase in interest and enquiries from companies looking for trade credit insurance, mainly in retail and construction.
“If we could get cover on all the high street names, we could sell a lot more policies,” adds Price. “And not all of them will go bust and not all of them will bring down underwriters, because they have got the reinsurance behind it. It is always a difficult balance of supply and demand.”
Nice cover if you can get it
But as the commercial environment worsens, some insurers are losing their nerve. In October, major trade credit insurer Atradius reportedly halted its credit cover for companies supplying high street retailer Debenhams. This came after Euler Hermes said it would reduce the value of goods it is prepared to underwrite between manufacture and sale at Arcadia Group, the owner of Topshop. Speaking off the record, one trade credit insurer says: “We try to pick up on new trends and new behaviours. Right now, we have a reasonable amount of concern about what the weather looks like out there.”
Cut cover can lead to suppliers demanding payment up front, putting further pressure on working capital. For those firms already on the brink, losing cover can create an irreversible tipping point. It can also damage the perception of trade credit insurance, which is still overcoming an image problem after it was criticised during the global financial crisis for being “an umbrella that closes when it rains” when underwriters of traditional cancellable coverage cancelled several hundred thousand credit limits. Ten years on, though, insurers have become innovative in finding ways of better assessing risk to avoid having to go home at the first sign of rain.
“In the previous bank-driven recession, the underwriters learnt that they needed to be in receipt of more up-to-date data than simply filed accounts. They have worked really hard to stimulate the flow of management information from companies so that they have the finger on the pulse and don’t have to overreact if something dramatic happens,” says Price.
Nonetheless, in the tightrope walk between providing sufficient cover and staying afloat, something has to give, and the price of protection looks likely to go up. Wilfried Verstraete, chief executive of Euler Hermes, recently told the Financial Times that his company is targeting an average 5% increase in pricing, saying: “We have not reduced our exposure or our risk appetite in the UK, but we have become more careful.”
“The issue with raising prices is that if one underwriter raises premium rates, another can simply undercut them,” says Rob Farquharson, director of trade credit at Parker Norfolk. Although Euler Hermes’ rival Atradius is yet to announce a price hike, he believes that it will likely follow suit.
The worst of times for companies, the best of times for insurers
As crucial issues relating to the UK’s exit from the EU in March 2019 remain unresolved, companies have become increasingly jittery about their ability to stay in business, with a recent survey by the Chartered Institute of Procurement & Supply showing that executives at one in 10 firms fear bankruptcy if Brexit causes customs delays of as little as 10 to 30 minutes. Given this outlook, the trade credit insurance industry has a prime opportunity for growth as companies start preparing for the worst.
“What impact is Brexit having? For us, because we do a lot of new business activity, we are having a great time,” says Price at the GTCA, adding that – for now – there is plenty of capacity, although the longevity of that capacity is less certain.
He goes on: “It’s never guaranteed. If the underwriters do what they know they need to do, which is to put up prices when the commodity becomes more valuable, then they should be able to sustain more losses. A positive state of mind is needed; when the demand increases we must find ways to capitalise on this.”
He advocates holding greater reserves for the difficult times ahead and pricing for the risk when people want the cover, rather than “dancing to the short-term demands of shareholders when the losses hit”. This, he says, should lead to a sustainable market which increases when demand spikes.
Even for those companies taking a more sanguine view of Brexit, trade credit insurance offers a much-needed crutch. “We are seeing more enquiries for alternative markets, although I am not sure to what extent this can be attributed to Brexit and to companies potentially looking to trade for the first time outside of the EU,” says Farquharson. “It is fair to say that the current environment means it is a good time for businesses to look at credit insurance.”
Logically, the performance of the trade credit insurance market should be almost diametrically opposite to that of the economy, so when there is a bust, insurers should be booming in terms of new business, says Price. “That unfortunately doesn’t happen, because the underwriters’ reaction to failure is to become more cautious in writing risks and often leads to tightening of risk portfolios, and they start to withdraw or reduce cover to the weaker companies.”
However, to maintain a sustainable industry, underwriters need to make hay when the sun shines and store up reserves to meet the demands when times are tough. Recent high-profile bankruptcies have created fear across suppliers, who are now looking to take up more credit insurance, but whether credit insurers have the capacity and the appetite to cover them remains to be seen.take me back