2020 will go down in history as the year when a perfect storm hit the world, writes Fabien Conderanne, Regional Head of Financial Solutions, Asia Pacific, at Willis Towers Watson.
While the risk of a pandemic had already been identified in the past, for instance during the SARS outbreak that started in the Guangdong province in China back in November 2002, killing about 800 people and lasting for almost a year, no one had imagined that the whole world would have to shut down borders, ground airplanes and ask residents to lock down for an extended period of time in order to fight a new and mysterious virus. As of press time, several countries in Asia Pacific have managed to keep the virus under check and are experiencing no, or a very low numbers of new cases. Sadly, many more countries (particularly in Europe and the Americas) are experiencing a new wave of infections that will bring more casualties and economic disruption. For all, the hopes of a vaccine have created tremendous expectations.
Seen from the lenses of the credit insurance market in Asia where I operate, this year has also been a perfect storm. The market has been rocked by major defaults and, as a consequence, insurers have had to make major adjustments to their credit appetite for new transactions.
We usually view the credit insurance market as being divided between the short-term trade receivables market and the single risk credit and political risk market.
Moderate increase in short-term trade credit claims
Claims in the trade credit space have increased compared to last year, as evidenced by loss ratios (measuring claims incurred against premiums) reported by the big three insurers Euler Hermes, Atradius and Coface in their nine month (9M) 2020 publications being 15 points higher than in 2019, at around the 60% mark. This moderate increase is largely thanks to the support measures implemented by Governments in various countries to avoid a massive wave of insolvencies, including providing reinsurance to these credit insurers through public schemes. In Asia Pacific, trade credit insurers have experienced an increase in smaller frequency claims, but the level of large claims remains limited. Coface, for instance, has published a loss ratio of 51% YTD in Asia Pacific, a very healthy level.
As a result, trade credit insurers have remained profitable for the 9M 2020 period in Asia and globally. They have managed to maintain healthy top lines by increasing premium rates at renewal to reflect the deteriorating credit environment. And they have withdrawn cover on the weaker portions of their portfolios, with overall exposure now being 9% lower than at the end of 2019. While these cuts have affected clients who rely on credit insurance coverage for managing risks or for financing purposes, some of the reductions were accepted as a reflection of lower overall trade volumes in 2020.
Single risk credit insurers have experienced major losses in Asia in 2020
In the single risk market the situation has been quite different and major losses have hit the market in the last 12 months. Many of these losses were primarily related to fraud cases, particularly in the commodities trading space.
The largest one is the well-publicised case of Hin Leong in Singapore, which filed for bankruptcy on April 17, 2020. According to press articles and court documents, the company overstated its account receivables and inventory balances and failed to report losses on derivatives products.
Banks and financiers were left with US$3bn of debt that the company is unable to repay. We estimate that about 10% of this amount was covered by single risk credit insurers, a significant amount representing more than one year of premiums for single risk credit insurers in Asia.
Sadly, this was not an isolated case and insurers are also facing large claims on cases such as Agritrade, Phoenix Commodities or NMC Health. We estimate that these large cases, in the aggregate, amount to three years of premiums for the whole market, meaning insurers would need three years without any losses to make up for it (actually more than that, when considering they also need to cover their costs). Having said that, it should be noted that insurers in this market are well diversified globally and while their Asian books have recorded losses, they generally experienced decent loss ratios on a global basis. Moreover, they form part of large property and casualty groups which carry strong financial ratings and are able to absorb volatility in their credit insurance books.
One common factor of these large cases is that they are not really Covid-19 cases: they may have crystallised at the time when Covid-19 hit the world, but most of them have taken roots in prior years, well before this crisis.
How did the market react? What is next?
Many insurers consider that more insolvencies will eventually come when government support measures are being rolled back, particularly in Europe. As a result, insurers have generally stayed away from taking new risks in the industry sectors most affected by the crisis such as air travel, hospitality and the private obligors that have a non-investment grade rating. Instead, they focused on better-rated entities and sovereign-owned entities.
While there is a willingness from insurers to increase their pricing on deals, this has not always proven possible on the best rated names due to a ‘flight to quality’ on the origination side as banking clients have not always managed to meaningfully increase their originating margins.
Among this gloomy picture, there are a few glimmers of hope, thankfully.
One is that Asia might be the first region to economically restart after the crisis and the fundamentals of a young population and a growing (consuming) middle class are intact despite the crisis. Many large countries in Asia (China, Vietnam, Thailand) have managed to keep the number of cases at a very low level and are best placed to preserve or resume economic growth in the quarters to come.
Another one is that certain industry sectors have actually weathered the storm reasonably well. The infrastructure and construction sectors, for instance, have proven extremely resilient. Insurers have acknowledged this and continue to support project finance deals.
And finally, some sectors have even emerged stronger, such as e-commerce and data centres. Again, these continue to be well supported by insurers.
While the year 2020 will be remembered for the pain inflicted on populations by the pandemic, the economic disruption and the resulting losses to the insurance market, it is very encouraging to see that the credit insurance market has remained resilient and has continued to support clients throughout the crisis.
Credit insurance remains a very efficient tool to manage and mitigate risks for our corporate clients, and it offers an alternative distribution channel for our banking clients to help them manage their capital requirements. And I believe the current crisis will demonstrate this once again.