Credit Insurance: An overview

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Credit Insurance An overview

• Paul G Turner January 2008

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• The goal of any mitigation strategy should be to
  transfer the amount of risk which best improves
  the capital allocation decision while maximizing
  stakeholder value.
• Credit Insurance is speci?cally is designed to
  achieve these goals while providing an
  opportunity for management to protect one of the
  largest corporate assets.

Credit Insurance protects the ?rm against that
which it cannot see, not that which is
inevitable.
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Some background on credit insurance

• The origins of credit insurance date back to the
  18th century and was ?rst introduced in Europe.
• Real expansion of the product occurred post WWII
  as governments introduced Export Credit Agencies
  (ECA's) to help promote trade and commerce to
  rebuild economies.
• Through the 1980's, private companies emerged as
  greater force in the credit insurance market.
• Over the last 10 years, a great deal of
  amalgamation of private and ECA companies has
  resulted in truly global carriers.
• As a result, most countries have abandoned the
  ECA concept as the private markets have more than
  ?lled the needs of exporting companies (Canada
  being a notable exception with EDC).
• Today, the three largest global credit insurers
  command approximately 75 of the total premium
  worldwide and employ close to 10,000 risk
  professionals around the globe.

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The Canadian market

• In Canada, there are many choices for credit
  insurance, both public and private.
• The largest Insurer remains EDC with about a 47
  market share of all Canadian insurance premiums.
• Euler, Coface and Atradius would rank two, three
  and four respectively by premium generation in
  Canada (see table for global premium ranking).
• Coface recently partnered with EDC to take over
  all of the domestic (Canada only) business
  written under EDC policies. They are also direct
  writers and will competitively quote for business
  both with and without EDC as a partner.
• Euler and Atradius have been the most aggressive
  in Canada, devoting signi?cant resources to the
  market. As a result, their product offering is
  extremely competitive with the requisite service
  to support their clients.
• Other markets include AIG, HCC Credit, Zurich
  Emerging Markets, ACE.

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The Canadian market - key participants
Insurer Rating Premium Base(YE 2006) Comments
AIG AA USD52.7 billion (total premium for all lines) Credit Insurance a small part of their overall Offers non-cancelable limits
Atradius A 1.8 billion With the recent merger with CYC in Spain, they are the largest in the world Flexible in tailoring solutions True non-cancelable policy structure
Coface AA- 975 million Newest participant to CDN market Lacking service presence in CanadaAggressive pricing
EDC AAA(backed by the sovereign) CDN90 million Sovereign rating provides policyholders preferred lending margins Strong risk appetite
Euler AA- 1.7 billion Largest number of in country risk experts Strong service presence in Canada
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The product - overview

• Credit Insurance is designed to protect the
  seller from non-payment of its buyer.
• Can be triggered by either the Insolvency of your
  buyer or Protracted Default due to cash ?ow
  problems.
• Other risks covered include repudiation or the
  buyers non-acceptance of goods, and political
  risks.
• The premise of cover is that the Insurer can step
  into your shoes once a claim is paid. As such,
  the underlying contract must be enforceable.
• Premiums are based on the policyholders usage,
  either through assessing a rate per dollar of
  sales, or basis points for credit exposure
  allocated.
• Most policies today are losses attaching
  meaning the coverage is based on a policy being
  in force when goods are shipped, not when the
  loss actually occurs.

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The product - bene?ts

• Expand sales
• Allows company to increase sales to risky
  buyers by transferring the risk of the exposure
  to the Insurer. Since these are usually higher
  margin sales, can add signi?cantly to the
  earnings of the ?rm.
• Can also leverage a company's own large position
  on a buyer by adding incremental or top up
  exposure without increasing the risk to the ?rm.
• Credit enhancement
• Replaces the risk rating of your buyers with that
  of the Insurer.
• Improves overall enterprise risk.
• Improve ?nancing
• Higher margining on AR assets.
• Potential to lower borrowing costs.
• Enables ?exible solutions on securitization and
  discounting programs.

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The product - bene?ts

• Ensure stability of cash ?ows
• Eliminates the risk of non payment of your
  buyers.
• Acts as a form of hedge protecting the earnings
  stream on sales.
• Together, this protects shareholders from
  volatility of cash ?ows due to unforeseen credit
  risk deterioration.
• Risk assessment
• Depending on the resources available for credit
  risk management, the Insurer can act as the
  initial screen as well as ongoing assessment of
  the buyer portfolio.
• Capital allocation
• If capital is limited, virtually eliminates the
  need to allocate capital to AR risk, freeing it
  up for more productive uses.

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The product - pricing structure

• Portfolio / single buyer approach
• In most instances the Insurer requires a spread
  of risk through a portfolio of buyers. The
  premise is they require is a reasonable spread of
  risk taking the good with the bad.
• They will consider a single buyer portfolio as
  long as the risk is reasonable. This is most
  often used when the exposure on a buyer exceeds
  de?ned levels of acceptance within the capital
  structure.
• Aggressive pricing today
• Pricing re?ects the risk premium required to hold
  exposures on the basket of buyers similar to
  pricing debt instruments.
• Can tailor risk sharing proportions (through
  co-insurance and/or deductibles) to maximize the
  value of premium dollars spent.
• Despite the recent turmoil in capital markets,
  Insurers remain aggressive in pricing. This is
  largely due to the fact they are very familiar
  with this kind of volatility and do not
  over-react to a crisis environment. They are
  not totally reliant upon the capital markets for
  pricing structures, rather they use them as a
  guide since the time line is much longer than
  with other credit instruments.