Credit Insurance: An overview

Paul G Turner • January 2008

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 specifically is designed to achieve these goals while providing an opportunity for management to protect one of the largest corporate assets.

Credit Insurance protects the firm against that which it cannot see, not that which is inevitable.

Credit Insurance: An Overview

Some background on credit insurance• The origins of credit insurance date back to the 18th century and was first introduced in

Europe.

• Real expansion of the product occurred post WWII as governments introduced Export Credit Agencies (ECAʼs) to help promote trade and commerce to rebuild economies.

• Through the 1980ʼs, 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 filled 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.

Credit Insurance: An Overview

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 significant 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.

Credit Insurance: An Overview

The Canadian market - key participantsInsurer 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 Canada

Aggressive 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

Credit Insurance: An Overview

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 flow 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.

Credit Insurance: An Overview

The product - benefits• 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 significantly to the earnings of the firm.

• Can also leverage a companyʼs own large position on a buyer by adding incremental or “top up” exposure without increasing the risk to the firm.

• Credit enhancement: • Replaces the risk rating of your buyers with that of the Insurer. • Improves overall enterprise risk.

• Improve financing: • Higher margining on AR assets. • Potential to lower borrowing costs. • Enables flexible solutions on securitization and discounting programs.

Credit Insurance: An Overview

The product - benefits• Ensure stability of cash flows:

• 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 flows 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.

Credit Insurance: An Overview

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 defined levels of acceptance within the capital structure.

• Aggressive pricing today: • Pricing reflects 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.