Players in the political risk insurance (PRI) business discuss the biggest issues facing the market, including regulation, capacity and pricing.
Roundtable participants
- Catherine Aubert, head of trade credit and political risk insurance, Société Générale
- Joe Blenkinsopp, deputy global head – political risk and trade credit insurance, XL Group
- Silja Calac-Schneider, head of global trade risk management, UniCredit
- Paul Coles, head of trade risk distribution, global treasury solutions Emea, Bank of America Merrill Lynch
- Olivier David, head of special products, trade credit and political risks, Atradius
- Paul Davidson, chairman and CEO, financial solutions, Willis
- Mark Gordon, joint general manager, syndication and asset distribution, Sumitomo Mitsui Banking Corporation (SMBC)
- Volker Handrich, director, head of trade and supply chain finance, Swiss Re Corporate Solutions
- Julian Macey Dare, international head, political risks and structured credit, Marsh
- Marta Perez Plaza, vice-president, project and infrastructure finance, Swiss Re Corporate Solutions (Chair)
- Laure Reboul, deputy head, insurance group, BNP Paribas
- Mike Rutherford, president, capital risk solutions, Axis Capital
- Matthew Strong, partner, credit, political and security risks, JLT Specialty
Perez Plaza: What are the key requirements for insurers and banks when using political risk insurance (PRI) and how are they changing given recent regulatory developments,such as Solvency II or Basel III?
Calac-Schneider: We are now trying to manage risk-weighted assets through the hedging of our trade finance business. To use risk insurance, we need to make sure that we can manage these and freeing up credit lines is the easiest way of doing this. As long as you fulfil the requirements of the solvability regulations in Germany – and they are following Basel III of course – we can free up credit lines. With risk-weighted assets, it gets more complicated because as a bank, you need to have risk models that can use insurance ratings. And then the pricing of the insurance will also play a role in our requirements. The worse the rating of the insurance, the higher the price you have to pay for the insurance, the less you can use the insurance. So over the years, it has become more complicated for banks to use insurance.
Aubert: To be quite blunt, I think the key requirement for a bank like Société Générale is that the product works. It seems quite obvious but it is key. In this respect the insurance wording is quite important. We have managed to convince insurers in light of the implementation of Basel II a few years ago to limit the conditionality and the exclusions to the extent possible in order to make the insurance product a ‘Basel II-compliant guarantee’. There was an alignment of interest between banks and insurers at the time and Basel II definitely boosted the utilisation of insurance by banks. So we have appreciated insurers’ flexibility in amending policy terms but ideally what we would be looking for is a first demand guarantee format instead of an insurance policy. We know that some insurers are already proposing it and some are considering it. To finish on the wording we also pushed the idea of having a template policy wording for banks, similar to the ISDA format that we have for credit default swap (CDS), butwe haven’t had any success so far. The other key requirement for banks to use PRI is competitive pricing. Insurance is only one of the distribution tools at the bank’s disposal and is in competition with CDS, secondary sales, sub-participation, and so on.
I mentioned wording, pricing and I would now like to make a few comments on the insurance market itself. In the last few years, we have seen new entrants in the market, which is good because capacity has increased quite dramatically but at the same time, a few players have exited the market. We do not wish to work with opportunistic players as it is important for us to retain the same panel of insurers on our transactions in order to manage waivers and restructurings, as the case may be, as smoothly as possible.
Gordon: At SMBC, counterparty issues are a focus at the moment. Relationship, of course, is important. If I was to talk about the counterparty issues, single ‘A’ rating is a minimum for us. That is a policy decision. It is about size as well. There are certain insurers that are rated at the appropriate level but they may be too small for us to consider. One issue, which is not a problem at the moment but could be, is correlation. We were not active at all with the mono-lines. One of the reasons I was able to sell insurance internally is because we have this diversified financial institution and if credit insurance starts to represent too great a portion of the insurer’s income then we will, at some stage, have issues with that, but at the moment it is not a problem.
Coles: Another useful point we raise when comparing PRI with other types of investors, or something we look for anyway, is: who has a good understanding of the underlying transactions? Of course, people who know trade finance understand what to expect, they have a common understanding of what a trade finance transaction should look like and also how it should operate. This in turn can make the whole process easier and would influence our decision-making on whether or not to use PRI.
David: From an insurance point of view, I would say that what is important is that all sides understand. Because actually it is not just the insurer and the insured; there is also the broker involved, who is important in the relationship. Sometimes you also have a corporate involved and you have got financing from the bank. You need to make sure that everybody understands the policy and the expectation that you have. Also beyond the policy, the long-term relationship and partnership between some insured and some insurers makes a huge difference because we understand each other, we understand how we work and when you have grey areas in claims, that’s when you see how you can actually fix the problem and bring everything home on all sides again. We do not take every business we see. We select the risk but also mostly, we select an insured. From the insured part, they should select their insurer. Today, you have got 30 or 40 potential insurers that could offer some insurance for financing trade or just global trade.
Reboul: I think as a bank, there is an operational risk for us when using an insurance policy. As a centralised insurance group our role is to help business lines meet their policy obligations and control the operational risks – training the business, making them understand what the product is really about and how it works in case of default. On the other hand, we select insurers which we believe really understand the business we are trying to sell to them because for us, the day things start going wrong, it is essential to have an underwriter in front of us that has a thorough understanding of the transaction.
Rutherford: I think, as an insurer, the counter-alignment of interest is key. So we are looking for a bank that actually is retaining a reasonable proportion of the risk that we are being asked to take as well. If things do go wrong, you see alignment playing through.
Blenkinsopp: I think Mike is absolutely right. Risk-sharing is crucial to one of the decisions that an insurer will take when deciding which transaction to support, or not. I would agree with a lot of what has been said, in terms of partnership and long-term relationships. These risks can be quite complex. It is terribly important that the insurer takes the time to listen to the client and the broker as to exactly what the structure is, making sure that the insured is actually providing relevant detail that is easily-absorbed by the insurer, so that we understand exactly what it is that you are looking for and the documentation to support that.
Associated with that is a consistency of message that the insured delivers into the market because whilst it may be perfectly fine to use more than one broker, most of the insureds around this table will only choose one transaction for one broker, and if they are using a second broker, use another broker for a different transaction. That is about the clarity of purpose. It is important to make sure that there is not a muddled message for the insurer, especially when we have large transactions that are heavily syndicated coming into the market.
Handrich: From my side it is important that insurance is seen to work as expected and to have proven that it will pay losses. In addition, it is important that it is seen by clients as a relatively simple product that is easy to transact. From an insurer’s perspective, more information from clients will help to carry forward this story. In some cases, we could find additional capacity if we simply received more detailed information on the underlying risk. Obviously, there are some risks that are more straightforward and require less information and others that are more challenging. Finally, to repeat what has been said before, I think the alignment of interests is key to ensuring more widespread usage of insurance.
Strong: Just picking up on the understanding of risk point, we have heard about transactional understanding but I think it is also important for both sides to have an understanding at a strategic level. The more time the bank and the insurer spend with each other, with the insurer learning and understanding about the bank’s strategy as well as on a transactional level, the better. This then leads into the track record point in terms of claims and willingness to pay, which is key as well. The market has performed very well recently, but it is important that this continues and from a broker’s perspective, you look to work with those markets that have demonstrated willingness to pay.
Davidson: Can I just comment on Catherine’s point about when the underwriter exits from the market? In recent times – the last five years – we have had two reasonably visible withdrawals. Both withdrew for reasons wholly unrelated to what had actually happened in the preceding five years. I suppose it illustrates the fact that the syndication market that we have, of the breadth and size it is, with 40-some players, has actually demonstrated the durability of the market, having been through the most extreme loss experience that this market has seen since I have been in the game. One of the benefits of having a market like that is that it is actually capable of absorbing shock, in contrast to the traditional mono-lines, and I do not think there is any way that one can guarantee that there is not going to be an underwriter coming out of the market. That is just the way the market operates: every market, not just the insurance market.
Gordon: The bank market is the same.
Davidson: It is not only whether the market is sustainable over time. I think it has demonstrated that it is. It is interesting looking at it from the banking point of view and the insurer point of view. We are in danger, I think, of agreeing with each other this afternoon. The only observation I had outside of that is the need for diversity in the portfolio that is presented within the market. The greater diversification of the portfolio, the more durable it becomes and I can certainly recall a number of occasions where there was a certain one-dimensionality.
Aubert: There is still some one-dimensionality because there is a lot of capacity on trade-related and secured transactions but only limited players for non-trade-related or unsecured business globally and even more for obligors located in OECD countries, oddly enough. So there is a lot of capacity but I would say a lack of diversity.
Davidson: I do actually agree. The point that I was making was that the world has changed profoundly in this market we are talking about. I have just come back from Latin America, and it is perfectly clear that we are going to have to move into some new environments, not least of all because pricing is an issue for everybody in this discussion. It also generates the sort of margins that are going to satisfy the shareholders, so I think this diversity issue is going to be also about broadening out, rather than more of the same.
Blenkinsopp: Also, I think in any marketplace there must be a certain appetite. There are certainly plenty of alternative credit trade insurers with lots of appetite for short-term unsecured trade credit. There are, as you say, plenty of players who have interest in medium and longer-term secured structured finance credit, and it is the development of this extra piece of the market that you are talking about, the unsecured working capital piece which is a little bit of a challenge. In part I suspect it is the point that Paul [Davidson] was making bilaterally; that it is a riskier environment to write an unsecured trade or non-trade transaction, in many respects, even in OECD markets. The flavour seems to be that emerging markets, secured transactions – for some insurers, not everyone – tend to be a more interesting proposition for their own balance sheet.
Macey-Dare: A lesson I have learned from working with banks in particular is that transparency is crucial. You have a conditional policy, which may be treated as a guarantee, and the disclosure of relevant information plays a key part in insurers understanding what is being insured and whether they ultimately choose to underwrite that transaction. When you talk about the commercial element, we actually have had similar experiences where some of our biggest political risk non-payment placements in the last couple of years have been in the EU. Insurers and reinsurers need to develop a deeper understanding of the business of their partner banks, rather than trying to second guess the end business they should be writing. Working together, they should understand where the problems lie and what the risks are, while gaining more insight into the similarities and buying triggers. If one works together, I think the insurance market can partner a lot of these transactions very efficiently indeed.
David: Just to finish in answer to Catherine, she mentioned the wordings on conditionality, I think. The wording we have has proved to you and to other banks that it works as it is, with the conditions. I understand that the banks, for regulatory reasons, might want fewer conditions, fewer exclusions, fewer priorities, but at the moment, it is fairly comprehensive already, it works, and it is also difficult for us as insurers to reduce or to soften the wording further without getting into a financial guarantee that makes us play in a completely different arena. These are different regulations for us, and dealing with other insurers, and so we have to find the right balance. But I think that the past five years have shown the banks, in general, that the product works as it is.
Aubert: I am personally convinced that the product works in light of my long experience dealing with this market, but I would like to have claims statistics publicly available for the whole market. This would help to convince banks’ senior management and risk people that insurers do pay claims and even sometimes when they don’t have to.
Reboul: I would agree with Catherine that it is a real challenge going into the credit committee with an insurance policy with its conditionality and having people say: ‘Well, I can consider that, because you have a conditional policy.’ It is a real challenge internally. It only takes one of them not to comply to destroy the whole thing.
Gordon: I think that is fear. The issue is: as a standalone product, you need to compare it to what else is available. I have said internally, I will take insurance over CDS all day long, depending on what it is. If you are a holder of protection on Greece recently, you have had a very nervous few months finding out whether you were going to be paid or not. I would rather be sat with a nice Basel II or Basel III compliance insurance policy in my hand every day.
Calac-Schneider: This is exactly the point. Basel III has made our job a little easier because we now have clear regulatory rules, which we have to follow. So my legal department follows those and now, when I get a security from an insurer, whether I get it through CDS or whether I get it through bank guarantee, I know which conditions I have to fulfil. As long as my insurance partner fulfils them, I have no problems with credit anymore.
Perez Plaza: I think we should move onto the second point, which is the outlook for trade finance markets in the short to medium-term.
Reboul: We have seen a large step-back over the last year in terms of the volumes we have done with the insurance market because of the deleveraging and the sale of assets. Today these issues have been addressed and our business lines have been given adequate capital and liquidity. How is that going to translate into immediate business for the insurers? That is difficult to say. We do not expect to have an overnight change. In addition, the fact that business lines have been requested to distribute more will translate into smaller insurance capacity requests. For the time being, we have noticed more requests for insurance for medium-term structured transactions.
Coles: I predominantly deal with the bank investor market for short-term trade finance transactions. Increasingly clients are looking at building their portfolios and more players are coming into the market as buyers because they are interested in trade finance; they like the sound of the asset class, its properties and its track history. They are looking for somewhere they can invest but there are not that many alternatives. The loans market has not been as active recently either, so we are seeing more players turning to trade finance. That means there are more mouths to feed. It will be interesting to see over the next year how this dynamic pans out, and whether people still need to distribute as much. I am interested to see how 2013 will shape up in that respect.
Blenkinsopp: From an insurer’s perspective, we have certainly seen an increase this year in the number of structured commodities transactions that are closing, and I think that is probably as a result of a couple of items. Firstly, the worst of the global financial crisis is obviously behind us, although there is plenty of risk still out there and the EU situation is not completely resolved from a credit perspective. Commodities are fundamental to economic growth and all the world population statistics point to rapid growth of the population, especially in Asia, and where there is demand for food and for oil and gas, that is only going to drive further demand for finance, which hopefully will increase the demand for insurers.
The second aspect that I would just like to touch on is that we have seen a re-emergence of trader-funded business; so the Glencores, Vitols and Trafiguras of this world actually being the lenders of record. So the traditional bank insurers actually have come looking for not just emerging market counterparty risk but also counterparty risk on those traders.
Calac-Schneider: I see the same as Paul. The traditional short-term trade finance business is stagnating at the moment. The WTO statistics show that the traditional letters of credit (LCs) and standby LCs guarantee and the short-term flow businesses are contracting quite significantly. I think this is always a predecessor to an increase in structured longer-term transactions. So I think there is potential in the open account space for next year.
Perez Plaza: And what impact is pricing having on the market at the moment?
Gordon: I think it is a more benign environment than it was a year ago for funding, for the market as a whole. This debate has been going on for a while and of course we know that a big component of certain margins is funding cost, but that is not the only income banks receive. I am talking against the banks here. Banks obviously take a fee for their ancillary business. In the environment we have now in the loan markets, banks have been working very competitively for business and that can mean that in certain cases, deals are getting done well below where the risk premium should be. I think that debate will continue but I am now aware of many banks that previously did not apply funding costs to their origination units that are universally doing so now.
Rutherford: It is a tough one for an insurer, the lack of transparency, for obvious reasons, but also I think the recognition that the treasury is probably the biggest profit centre of the bank. So for us, it is very difficult. The more transparent a bank can be about its funding cost, the more comfortable we are working with that bank. In particular, we see the same transactions from so many banks very often, and choosing who you are going to work with may depend on the funding cost.
Gordon: Do you think insurers will ever move away from a percentage of margin and just have a fixed risk assessment and it should be ‘this many’ basis points?
Rutherford: I actually think that happens already, Mark, to a certain extent, because most insurers will have their own internal modelling as to what they think the price of a particular risk ought to be and in some respects that is almost the last consideration. If the risk fits the risk appetite and the strategy of what an insurer wants to put into the portfolio, the price can be negotiated. As a straight percentage of margin, that is a very blunt tool.
Aubert: I do not have a specific issue with the premium rate being a percentage of the margin because I can understand that in certain situations, banks are in a better position to set the price and that it is more difficult for insurers to have an idea of pricing especially where the obligor is not well known. I can appreciate the fact that the old benchmark of 70% of the gross margin is a thing of the past. Most insurers now definitely quote on the basis of the net margin but I must say that we are still struggling in some cases with a number of insurers who are slower or not willing to take this into account.
Davidson: It is difficult to separate the compensation entirely because whatever the premium is, it has to make economic sense. The days of the standard 70% margin have well and truly gone. As Mike was saying, the nature of the relationships that exist allows for much more constructive conversation. But it does ultimately have to make economic sense and my impression is that it is actually becoming a more diversely competitive environment with not just the international banks but local banks, emerging in many areas. You have entirely different cost of funds issues. Inevitably, there is always going to be a slight tension because you have two parties coming from a slightly different perspective.
David: Pricing depends on how much each party is ready to actually spend on any single transaction. Sometimes for insurers the pricing is at the end because there is never enough premium to pay a bank. Our job is to try to get the best risk but how willing is the bank to be transparent and to spend time explaining what price it is worth to them? We have our internal rules and we have our minimum price. The banks have different obligations, and we have different obligations depending on our capital base and how we are structured. So this 70% is not going to work for everybody anymore but everybody will have a different minimum price, and the banks will have to accept that.
Macey-Dare: You have to see pricing in the context of history. When I started off in this line, banks were very busy in the confirming business and it made good sense to follow the banks’ pricing without second-guessing individual transactions. On standalone, highly-structured transactions, it is beholden to insurers to take more of a view on the return on equity (ROE) they need, but one must bear in mind that there are also many variables at play. What happened to indemnity? One assumes that everything is 90% indemnity. Well, a mandated lead arranger (MLA) may have a very low indemnity or may have other issues that they are bringing to bear in terms of their overall relationship with a customer. So, I think to some extent it is a starting point only and insurers and brokers need to look at where the fees and margin are, how it is earned and when it is paid.
Rutherford: Mark, you also seem to be asking when the underwriter will price things differently. I guess the other part of that is when will the banks actually start making differentiation between the products that are offered now? We have heard that different underwriters are providing different products. Ideally you want an official guarantee. I am not sure that the market necessarily is willing to pay more for those different products.
Gordon: It all seems strange to me because at the time, and still to a certain extent, a full cover solution was important to us but we did not have to pay any more for the full cover. It is quite paradoxical really. But I think the insurers over time will undoubtedly come up with their own view of where the market is and this connection to margin will disappear. Look at the CDS market we have talked about. There is no reference to margin. Heaven forbid! This is the reason that a lot of banks have turned to insurance that in the past derided it – because the CDS market provided no value at all. The disparity between the CDS hedge cost and the underlying margin was enormous.
Aubert: But the size of the CDS market and the size of this market are different.
Gordon: That is right and the transparency you mentioned before is wholly different.
Reboul: My concern on the pricing of insurance is that, even though we appreciate that there is a minimum price for insurance capacity, if we cannot provide the business lines with acceptable pricing, they will eventually find alternative solutions. We have had the case recently in Asia where the insurance premiums have been much higher than the price of bank’s secondary sale –the price difference was between 20% and 40%. The risk we are facing is that people find substitutions to insurance, develop new partnerships and eventually, do not approach insurers anymore for certain types of products.
Calac-Schneider: I completely agree with you on the pricing business. We also have issues with rating models. The insurance market needs to do much more lobbying so that banks get the insurance ratings right. This is a real issue and I think it’s worse with Basel III. Reducing my risk-weighted assets, getting risk-weighting relief and improving my key performance indicators have become more difficult again with Basel III.
Perez Plaza: Where are the current hotspots for both claims and capacity? And does the insurance market have the capacity to satisfy a rebound?
David: I think the market does have capacity. There are plenty of players and there are more coming. Clearly the market can adapt on this issue. On the hotspots, from my perspective, I would say Western Europe is where we have seen most of the biggest claims. I guess it is related to the economy there and also where we see the potential on a single situation in terms of insurance because people are even more aware than they were in the past. I see, for example, more growth in Germany than I see in Asia, which is maybe different from what we read in the newspapers every day. In terms of capacity, I think the issues are mostly on names rather than country. There are big names in Russia, in the US and in Spain where we are running out of capacity but overall, by country, we are fine.
Handrich: I would support these comments with two points. First, I think the insurance industry has both capacity and capital. If a major event were to happen, there would be sufficient capital to pay the claim and remain sustainably capitalised on an ongoing basis. Second, our accumulation methodology and limits are counterparty-driven. That said, in today’s political-economic environment, country risk factors are increasingly driving our underwriting decisions as we aim to manage our portfolio. For example, we have presently only limited capacity in countries like Egypt.
Strong: The large number of underwriters shows that there is capacity in the market and the number of players has grown over the past five years. Underwriters have also increased their individual line sizes and capabilities. I think one of the challenges, capacity wise, is the breadth of the offerings from the market over time.
Another interesting fact regarding capacity is that we have seen a new underwriting centre emerge in Asia. That is a trend that I think will continue. In terms of capacity constraints, there are the usual suspects, country wise: Nigeria, Brazil, Russia, China – and certain obligor names keep popping up. One of the other challenges is that everyone seems to be chasing similar names. We need to make sure there is more capacity available as the banks continue to seek that capacity.
Reboul: If I might say, just talking about capacity, as Catherine was saying, we could do with more non-trade RCF capacity.
Gordon: That can be offered by the market and on a longer tenor as well, if you look at it beyond the three to five-year thresholds.
Blenkinsopp: From a funder insurance perspective, there is certainly more reinsurance capacity available in the market as well. We have seen some new players come in, which has been helpful more on the trade side than the non-trade side. One other observation on that is that there is perhaps less in the commodity finance space, but maybe more on project finance. There is more of a mixed market developing in collaborations between the export credit agencies (ECAs) and private insurers which historically has been a marketplace that has been really quite difficult for the private sector to penetrate.
