Throughout the production and supply chains, credit lubricates transactions. But oiling the wheels is getting more difficult now, Tony Dowding writes

One of the clearest effects of the recession in the UK has been seen in the credit insurance market, where the government was forced to step in to help companies obtain the cover they needed. These well-documented problems have impacted larger companies in two ways. First, there is the issue of their smaller suppliers being unable to offer credit terms and, secondly, it has affected corporates’ ability to use trade receivables to obtain financing from banks.

Assessing good and bad

A common view among smaller companies is that credit insurers have restricted limits in respect of whole industry sectors, such as retail or construction. However, as Tim Smith, trade credit practice leader at Marsh, explains, the reality is that trade credit insurers grade all companies, and also grade the probability of loss, and then combine the two and come up with an effective risk assessment.

‘It is fair to say that those risk assessments are weighted by industry segment,’ Smith says. ‘If you are a well performing company in a trade sector that has a propensity for bad debt at the moment, you may not be able to exceed a certain lower-level grade. However, if you have a positive trade sector, such as chemicals and pharmaceuticals, or media, you may find a poorly performing company would be a lower grade than the norm, because it is not performing well in what is deemed to be a positive trade sector.’

The effect of this is that smaller companies may have to restrict the amount they supply and the amount of credit they give, even to the most creditworthy of larger companies. Paul Howard, chairman of AIRMIC and head of group insurance and risk management at Sainsburys, says it is probably not an issue for large retail companies that have a good credit payment history and a good financial position. ‘Where it is an issue is where you have suppliers in the house-building and construction industries, for example, where things are slightly more precarious, and maybe for suppliers who supply retailers that have got some well-documented financial problems.’

However, it seems that the situation is getting a little easier, compared with the beginning of the year. ‘We seem to have reached a new, slightly more stable position with regard to credit issues,’ says Paul Hopkin, technical director at AIRMIC. ‘In conversation with AIRMIC members, it seems that they are not sure whether it is the government initiatives that have helped, or whether we have just reached a new level of relationships with suppliers and the availability of credit insurance.’

Smith thinks it unlikely to be a result of the UK government scheme. His understanding is that take up of this has been pretty low. ‘The reason for this, I think, is that most of the credit limits that we have seen earlier in the year were reviewed and cancelled, rather than reviewed and reduced, and the government scheme is essentially a top-up programme.’

The problem is a global one, and the UK is not the only government to have stepped in to deal with the credit insurance issue. The French government scheme involves the French state reinsurer Caisse Centrale de Reassurance (CCR) providing trade credit insurance top-up cover, and a government top-up scheme is also operating in Germany.

However, the problem with all the schemes in Europe is that they operate in isolation. The UK scheme is for UK companies trading in the UK with UK customers, and similarly in France and elsewhere. The various government programmes, therefore, do not cover exports. The schemes are operating on national lines, while the credit insurance issue is a global one.

Growing claims

Looking simply at the UK, figures from the Association of British Insurers show that the total number of trade credit insurance claims in the first quarter of 2009 was 9,213 – an increase of 48% from 6,225 in the first quarter of 2008 – while the total value of claims was £316m, an increase of 166% from £119m in 2008.

Losses have been growing from the middle of last year and have continued to accelerate in 2009. And so, Smith explains, insurers are still being very cautious about the risks they are undertaking. ‘It is more a question of which sectors it is not affecting. Clearly, retail, construction, automotive are affected, but there are very few areas where underwriters will feel confident at the present time.’

In terms of mitigation, Nick Robson, head of credit, political and security risk at Jardine Lloyd Thompson, says, ‘Companies can analyse their own credit risk more rigorously and establish acceptable levels of credit based on a credible modelling exercise. They can also tighten and enhance credit management procedures concurrently with modelling and monitoring single customer and portfolio credit exposure.’

No absolute guarantee

Where larger companies do need to consider credit insurance is when they are looking for some sort of guarantee over their trade receivables when using them to raise finance. Credit insurance is not an absolute guarantee, but it can be structured in such a way as to satisfy the bank’s requirements.

One growing trend is for large corporates to purchase credit insurance on an excess-of-loss basis with non-cancellable credit limits. Robson says that this requires excellent credit management, and it can provide ‘certainty of cover within the parameters of demonstrable good credit management for the duration of a policy period’.

He says that this approach is effective for many companies, ‘but does require a change in culture and operational risk management, where historically credit management has been effectively outsourced to credit insurers through dependence upon credit insurer credit limits and policy restrictions’.

Smith says that Marsh has seen enquiry levels growing dramatically in the past six months or so, from companies that want to use the more catastrophic style structures, or from those considering using captive insurers to offset the first part of the risk and then reinsure with primary markets.

‘Financial institutions are becoming more used to the utilisation of credit insurance for securing finance, that is definitely a factor,’ Smith says. ‘Another factor is that trade credit insurance is now a well-known product, and more companies are therefore becoming aware that it can add discipline to their credit management procedures, and can support their growth into new markets where they don’t know their customer base, and so it can offer additional security for that.’

He adds: ‘So credit insurance is not just about getting insurance for bad debt, it is about getting additional information. Some of the reviews that credit insurers are doing on major companies could act as an early warning system. So a large corporate may not take on that contract if credit insurance isn’t available, because they see it may be a higher risk transaction. Credit insurance can therefore be used as loss avoidance rather than just risk transfer.’ n