Trade Credit Insurance and the Global Credit Crisis

The severe, widespread, and persistent economic downturn has featured the retrenchment of bank credit, the “drying up” of letters of credit, and the virtual disappearance of the secondary banking market. These conditions have triggered a significant rise in payment defaults and corporate failures, which in turn have been reflected in a significant increase in claims against trade credit insurance policies.

Indeed, the three major trade credit insurers all had high loss ratios for this coverage line in 2008, and the performance has worsened during the first six months of this year. As a consequence, for the past several months, credit insurers have been reviewing their exposures and reducing them with respect to industry sectors and specific countries, as well as individual buyers. Unfortunately, for businesses seeking to purchase credit insurance, this has translated into an unprecedented reduction in available credit limits.

As the size and frequency of claims rises, both insured businesses and their insurers have become increasingly burdened with claims and collections processing. Furthermore, there is no coverage available at all for certain industry sectors and businesses seeking to insure transactions in specific countries. Businesses that have had significant claims or poor recent loss history are experiencing dramatic premium increases. And, some are finding it difficult or impossible to renew their coverage at any price. Frequently, there is no alternative market once other insurers have seen the loss ratios and/or bad debt experience.

Nonetheless, the news for businesses with potential credit exposures is not completely negative. During the first two quarters of 2009, as the overall level of exposure has increased substantially, the good news is that insurers are still providing coverage albeit at higher costs. The greatest impact has been on what the insurers consider to be high-risk buyers and trades. Meanwhile, many credit insurers continue to be willing to insure businesses that have effective credit management and sound business plans. In fact, even a business in an industry sector or trade region that has had difficulty obtaining coverage in the past may be able to obtain cover if its credit management record is exceptionally strong.

On the other hand, a company with poor credit management—even in what insurers might consider a desirable trade sector—may find it difficult to obtain credit insurance. In this environment, insurance brokers and advisors can help insurers understand an individual company’s credit exposure and make informed underwriting decisions.

Given the challenges present in the traditional insurance market for trade credit insurance, some firms have been exploring alternatives such as “top-up” cover, other insurers, accounts receivable purchase agreements, and government support.

Top-up cover is insurance that sits above whatever protection might be available under a firm’s existing trade credit insurance policy, thus raising the overall amount of protection available to the firm.

While a limited number of insurance companies are willing to provide this type of coverage, it is not available to address risks in all parts of the globe. Further, top-up cover generally has very restrictive terms. Several insurers will only provide this cover if the risk is “investment grade” or better. Most insurers willing to provide the coverage do so to address capacity shortfalls while maintaining strict underwriting standards. There are also potential issues related to the sharing of salvage. Notably, if the top-up insurer doesn’t agree with the primary underwriter’s assessment of the exposure, it will limit its level of participation in the program.