The claims thrown up by the financial crisis put the private trade and investment insurance markets in a stew, but who could have predicted with certainty the effects, asks Kevin Godier.
The political risk insurance (PRI) and trade credit insurance (TCI) markets ran into a wall of claims in 2008/09, when the fallout from the autumn 2008 Lehman Brothers insolvency sent western financial markets into a tailspin. Memories among some underwriters were cast back to the 1997/98 Asia and CIS crises. Among those practitioners longer in the tooth, the turmoil recalled events a decade or two even further back, when ‘hot spots’ such as Cuba, Iran, Iraq and Nicaragua pushed loss ratios among some PRI players to levels where a market collapse had seemed plausible.
“Where 2008/09 was different from before was the sight of banks and insurance companies going bust,” says Graham Bristow, UK-based ATC head of corporate at the Aon brokerage. “It was certainly the worst situation I have experienced. Not just the size and volume of claims, but the difficulty in predicting where the next claim would come from, when we had no control over what was happening in overseas markets.”
A clear mirror to the claims paid by the private TCI market is held up by the figures produced by the International Credit Insurance & Surety Association (ICISA), whose members account for over 95% of the world’s TCI business. Net of recoveries and reinsurance, ICISA’s TCI members paid out claims totalling €2.055bn in 2007, and €2.027bn in 2010, sandwiching the much heftier amounts of €4.457bn in 2008 and €4.53bn in 2009. Volumes rose again in 2011 to €2.615bn, and then to €2.951bn and €2.877bn in 2012 and 2013.
Robert Nijhout, ICISA’s executive director, contrasts the 2008/09 situation in TCI markets with the early 1980s, “when the big loss figures lasted much longer, for three or four years”. The key difference this time around, he stresses, is that “it required only two years to get the loss ratios back to an acceptable level”. The ratio among ICISA’s TCI members of claims paid compared to turnover stood at 45.6% in 2007, rising steeply to 84.9% and 87% in 2008 and 2009, then returning to a very benign 36.3% in 2010.
“It is remarkable how quickly it all progressed, so that the third year into the problems produced a better ratio than the year when the crisis started,” Nijhout says. “Our industry was manual in the 1980s, whereas underwriting systems work in real-time now.”
A similar pattern to the ICISA trend emerges in the TCI claims handled by Aon from its UK clients with UK and overseas debt. These rose from 1,416 in 2007, when the US sub-prime mortgage problems began to reveal the extent of the problems miring financial systems, to 1,691 in 2008 and a peak of 1,777 in 2009 , before dropping back to 881 and 924 in 2010 and 2011.
Andrew Share, director of enhanced information, collection and claims at Coface UK, says that notifications from policyholders began to climb towards the end of 2008: “2009 was the most difficult year for insurers as the recession began to bite and you only have to look at the trend of insolvencies to see the steep climb. Loss ratios climbed to historic highs for many insurers but the industry delivered what it was designed to do. Claims paid were also at their peak by the end of 2009.”
The biggest TCI market losses “were probably in Spain, but were very widespread”, observes Mike Holley, chief executive of credit insurer Equinox Global. In the UK, says Bristow, “retail was at the fore, and also construction”. Nijhout also cites construction and retail, and suppliers to both these industries.
Some very chunky claims were experienced in the PRI market. “Despite the lack of official statistics, our information from brokers was that premium in 2008 came to US$1.8bn, and that claims were somewhere between US$3.5bn and US$4bn,” says Louis Habib-Deloncle, the chief executive of Garant. “Around US$3bn was paid out. But once recoveries were complete, the figure came down to below US$1.8bn, giving a loss ratio of below 100%,” he adds.
Numbers provided by Charles Berry, chairman of BPL Global, fall into a comparable ballpark. “In November 2009, we estimated US$4bn of problem cases for the PRI market, stemming from the financial crisis, and US$2.5bn of likely paid claims,” he says. “Net of recoveries, we projected a US$1bn to US$1.5bn pay-out. I wouldn’t want to change those overall estimates today.”
The biggest claims linked to the credit crisis were between 2009 until 2010, observes David Maule, executive director, credit and political risks, at Arthur J Gallagher. “The very large payments were linked to two countries. Ukraine’s banking and steel sectors probably accounted for about US$750mn, while the payout for Kazakhstan was around US$500mn, mostly for BTA Bank.” Maule highlights some “decent recoveries in Ukraine, perhaps as much as 40% to 50% of the claims paid, which had allowed insurers to dip their toes back in prior to the latest crisis”.
Kade Spears, head of political and credit risks, at The Channel Syndicate, says that “the real area of concern was emerging market banking systems, such as Kazakhstan, but recoveries were good, depending on how proactive one was”. He adds: “In fact, aside from a few Brazilian softs, most people made recoveries.” Claire Simpson, political risk underwriter at Hiscox London Market, points to Bahrain, as well as Kazakhstan and Ukraine. “Even Bahrain is providing some tiny recoveries,” she says. Maule emphasises that markets were pleasantly surprised at how Libyan claims worked out to be “much smaller than expected – US$50mn at the very maximum”.
A reassuring aspect of the claims, according to Habib-Deloncle, was that they were generally unlinked. “Ukraine did have frequency, but Kazakhstan, Dubai and Bahrain threw out just one loss each. It was important that there were no losses of a systemic nature, which we had so often been warned about.”
Simpson at Hiscox argues that the events of 2008 provided a test which the PRI market passed with flying colours. “The experience thus far has been very positive. Claims were paid out in the intended timely manner, reassuring clients, and recoveries have been better than expected, and are continuing to come through.
We spend a lot of time modelling a ‘big bang’, and when it arrived we stuck to our procedures.”
BPL Global’s Berry adds: “Over the two years where the PRI market was severely impacted, 2007 and 2008, our paid claims ratios went to 150%, but we have already recovered enough for those two years to now be below 100%.”
At Garant, Habib-Deloncle believes that an evolution has taken place. “It was significant that, after the 2008/09 problems, no primary capacity or reinsurance was withdrawn. The fact that there has been a very large increase in subsequent capacity is a strong sign of maturity.” He believes that the market’s management of its Kazakh losses has particularly mirrored this. “There were some big issues around Kazakhstan, where there was no awareness that commercial trade debt should hold priority over financial debt, which is often speculative.” After Kazakhstan offered a global rescheduling for both types of debt, with a big haircut in each case, “banks, insurers and export credit agencies mobilised to get Kazakhstan to differentiate, and the commercial debt terms were eventually better”, he says.
There is less agreement on how well the TCI market performed. Nijhout underscores that ICISA members “were able to comfort a huge range of clients in their demand for immediate payment”, and that no members found themselves in financial difficulty. “Only 5 to 6% of credit limits were pulled in 2008/09, which aligned with the 5% drop in GDP. This showed that we stayed on risk with policyholders but tightened the underwriting approach.”
“Credit insurers went in with too much exposure for their capital base,” says another market observer. “So reinsurers, risk managers and rating agencies threatened downgrades unless this exposure was cut, and so you had a stagnation of credit limits in 2009 and 2010.”
Holley contends that little was learned. He says: “Some brokers have learned to spread risks a bit more, use more syndication and make more use of non-cancellable limits. In my view the market should have used the intervening years to make more lasting changes. The main issue remains that everyone competes on price and capacity rather than product or service level. Prices fall to an unsustainable level, then underwriters have to cancel limits when the downturn comes. Why is market penetration lower in trade credit than in many other lines? Because in the worst crisis in living memory we didn’t pay enough claims. Loss ratios were never more than 90% for the ‘Big Three’ in the worst year. I feel convinced that if we could have paid out more in 2008/9, then the industry would be much healthier now, with a bigger premium spend, healthier rates and higher penetration.”
Bristow acknowledges that clients’ need for certainty around credit limits has led to the growth of the non-cancellables market. “We have improved the claims process, so that there is quicker payment due to more automation in the process. Coverage has changed so that limits are written using up-to-date information and accounts.” He also notes that reservation of title powers within credit insurance policies is now broader, providing greater access to stock in cases of insolvency. “Most people are savvier after the recession.”
To discover more detail on the level of credit insurance losses and recoveries, ICISA is undertaking a 10-year study with the Berne Union and the Pan-American Surety Association, using research teams at Swiss and German universities. “The report should show a good ability to recover losses, which will be vital information for Solvency II,” Nijhout says.
Global hot spots
So where are claims currently being reported? Nijhout says these have been growing in northwestern Europe, where “insolvencies are plateauing, in markets such as Germany, UK, the Nordic countries and Benelux, in the aftermath of the crisis effects”. He also highlights a rise in claims in Asia and North America, from a very low level.
Marsh recently noted a growing number of claims in Poland, Italy, and Spain, and an insolvency outlook that “remains concerning for Finland, the Czech Republic, and Morocco”. Tim Smith, managing director in Marsh’s International Trade Credit Practice, says: “We expect the level of claims to rise across Emea this year, which may lead to insurers seeking higher rates for trade credit insurance in 2015, and beyond.”
Coface’s Share highlights that UK and European insolvency trends “are still at pre-recession levels but fairly stable which indicates that risk is still prevalent”. Holley at Equinox says “claims are currently low”, but points to China, India, Brazil and Turkey as future concerns. “Also Russia may still cause problems because of capital outflows and inflation following the Ukraine crisis, though we do not yet see payment delays. In Europe, France and Italy remain a concern for the future outlook.”
In the PRI market, one player observes “a large overall PRI market exposure to Russia”. He comments: “The sanctions are being monitored very closely: we are not expecting any imminent casualties.” Other PRI players note exposure to significant volumes of pre-financing on Rosneft.
Habib-Deloncle explains that PRI practitioners underwrite the risk management of an exporter and the soundness of trading relationships, rather than country risk. “The UAE ranked highly before the crisis, yet needed some very complex negotiations for its debt. Whereas a sound relationship between buyers and suppliers can transcend a financial crisis, especially if these are critical trade flows, performed by experienced companies. Exporters are not foolish, so when they are in a more difficult country, they usually insist on more security.”
However, a steady growth of local regulations in emerging markets since 2006 is “a future challenge”, he predicts. “30% of trade is now intra-emerging markets, many of which do not feel comfortable in following developed country rules. New multinational rules will be required to fully enable cross-border trade,” he concludes.