Reinsurance // Credit & Surety. Global Credit Insurance Monitor 2017

Transcription

1 Reinsurance // Credit & Surety Global Credit Insurance Monitor

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3 Foreword We are pleased to present the XL Catlin Global Credit Insurance Monitor 2017, a comprehensive survey of the credit and surety insurance market based on 29 in-depth interviews with credit insurers and corporate risk managers across the globe. The survey and report was conducted and written by Dr. Schanz, Alms & Company, an independent specialised (re)insurance consultancy based in Zurich, Switzerland. As a leading global credit and surety reinsurer, XL Catlin is committed to engaging in an informed stakeholder dialogue, facilitated by improved market insight and transparency. Accordingly, this report provides a general assessment of the status quo and an outlook on future credit insurance trends. For the first time, we compare the attitudes and opinions of policyholders and credit insurers to examine the evolution of purchasing strategies and, even more relevant, ways of growing the global credit insurance market. For XL Catlin, the growth prospects of credit insurance go far beyond the commercial opportunity. The more fundamental question is how to ensure that credit insurance makes its optimal contribution to economic growth and, consequently, the prosperity of societies. By its very nature, credit insurance can be viewed as a lubricant of domestic and international commerce. Trade allows companies to grow and incentivises them to constantly improve on their products. It also increases income levels and is proven to be the most effective tool to reduce poverty. However, trade is fraught with risk. Problems can arise with regard to payments and potentially even defaults. Whether a counterparty will honour its obligations towards a policyholder can be difficult to assess, especially in unchartered markets. Credit insurance is a product designed to support traders in addressing these and many other risks. This lubricating role of credit insurance is particularly beneficial in times of decreased bank liquidity and reduced appetite for lending, both domestically and cross-border. These considerations inevitably lead us to the question of the insurance protection gap, whereby firms, householders and individuals buy less insurance than economically beneficial. Quantifying such gaps is challenging, even in the area of natural disasters where the protection gap is usually referred to as the share of uninsured catastrophe losses against total economic losses. It is evident that this definition has some flaws as not all losses can and should be insured. But in the credit markets even this crude measure is virtually impossible to establish. The following report adopts a pragmatic approach and focuses on identifying specific areas where credit insurance could expand beyond its current scale and scope. The majority of credit insurers and policyholders agree that the level of insurance coverage currently purchased is adequate. However, both insurers and policyholders see significant potential to expand protection and thereby generate not only additional revenues for insurers but also support policyholders in building their franchise. Against this backdrop, the market must work to address actual or perceived coverage gaps, increasing the economic and societal utility of credit insurance. I hope you enjoy reading this report and very much look forward to your feedback. Sincerely, Peter Schmidt Chief Executive Asia Pacific, Latin America & Global Credit and Surety XL Catlin 3

4 Methodology The findings of this report are based on in-depth and structured telephone interviews with executives representing 29 regional and international insurance and credit insurance companies, brokers, export credit agencies and buyers of credit insurance also called the seller in this report. The policyholders who supported this research belonged to industries such as fast-moving consumer goods, commodities producers and traders, pharmaceuticals and IT companies. Altogether, the interviewees participating in this survey represented revenues of USD 565 billion in The interviews were conducted by Dr. Schanz, Alms & Company, a Zurichbased research, strategy and communications consultancy, in the summer of Participating companies according to their revenues in USD million: 65.48% 28.71% 5.79% 0.03% USD million Insurers and Credit insurers Brokers 158 Export Credit Agencies Policyholders 4

5 Summary of key findings Overall market assessment Credit insurance is a highly relevant product for buyers and sellers alike. Protection against default by trade debtors, in particular in uncertain political or economic times, is the key driver for purchasing the cover, followed by the need to access financing as well as ensuring adequate corporate risk management. As such, credit insurance has become an essential part of corporate governance, required by investors, banks and rating agencies. However, credit insurance is a volatile product. In economically or politically stable times, when claims and margins recede, sellers tend to underestimate their risk, question the value of the product and resort to self-insurance. As demand declines, insurers become opportunistic and offer more generous risk capacities. However, when risks and claims increase, insurers reduce their credit limits, shorten capacity and eventually decline or withdraw cover. In the current market environment credit insurance is becoming more relevant in order to obtain pre-financing of a trade deal and as a means for cash-flow optimisation. In response to regulatory pressure, banks have become more cautious, creating opportunities for insurers to access new markets, products and client segments. Still, even in the traditional risk transfer segment penetration is low. The market is limited in size and is suffering from a lack of innovation and a mismatch between supply and demand. As a result, sellers choose other forms of risk protection or mitigation, which ultimately undermines the credit insurance product s overall value. Expected market dynamics In the current market environment of excess capacity, exposures rise and rates decline. Accordingly, credit insurance buyers state that the volume of cover they purchased in the past 12 months has either increased or remained stable. 90% of interviewees expect this trend to continue for the next 12 to 36 months, while those that predict a drop in volume complain that the higher risks they have to take to increase their sales are not accepted or exempted from their coverage. Despite the trend towards higher volumes at lower prices, credit insurance providers predict their premium income will increase over the course of the next three years. While in the past 12 months volumes have declined, going forward the market is expected to improve as the global economy continues to grow, demand from emerging markets increases and as credit insurers expand into risk financing, often in cooperation with banks or factors. According to two-thirds of interviewees, rates declined in the past 12 months. Going forward, half of the executives polled expect further rate reductions in the next 12 months as additional capacity enters the market and while losses stay low (with the exception of Latin America). The short-term outlook on profitability is more favourable. While 63% of the executives polled saw profitability decline during the past 12 months, going forward 50% expect profitability to improve, driven by economic recovery and lower claims in emerging markets and rebounding commodity prices. Some 87% of interviewees expect credit exposure to outpace GDP growth over the next 12 months although rates continue to fall, whereas GDP growth is robust or expected to rebound, following the past contraction in Latin America. As a result, premiums are expected to grow more slowly than GDP over the next 12 months. Only in markets where exports and infrastructure investments are set to grow substantially will credit insurance premiums outperform GDP growth, as expected by 37% of interviewees, while 25% say that both will move in tandem. Purchasing and sales strategies Two-thirds of credit insurance buyers consider themselves to be sufficiently protected by policies. When a company purchases a whole turnover credit insurance policy, all its trade receivables are included unless explicitly declined by their insurer. In addition, they use a combination of different measures to assess, minimize and mitigate their counterparty risks. The majority of those that consider their current level of protection as inadequate would like to buy more protection, but cannot find cover for the specific type of risk or amount of risk taken on from individual customers. Concurrently, at least 69% of the credit insurance providers surveyed consider policyholders to be adequately protected. Still, risk awareness is low, in particular in times of a robust economic environment, and therefore 31% of insurers consider policyholders protection to be insufficient. Generally speaking, however, credit insurance penetration is still low. As a result, to most credit insurers the expansion of their footprint, both in their home market and abroad, is their primary objective. Tightening their underwriting discipline or further reducing costs is of lesser importance. Almost one third (32%) intend to launch new products closely aligned to client needs that allow them to enter the SME segment. These new products are either targeted towards the financing component of insured trade receivables or enable them to grow into further trade sectors. 5

6 The amount of risk that policyholders retain varies greatly according to the industry they operate in, type of clients and the country of domicile. In addition, policyholders tend to retain more risks if they are in a strong market position with a specialist product. They may mitigate much of their risk through means other than credit insurance, for instance by requiring stricter payment terms. In contrast, policyholders selling a commoditized product tend to insure all their credit risk. Covered by whole turnover policies for up to 100% of their risk, they will often not sign a deal unless it is insurable. In current economic conditions, one-third of credit insurance buyers retain more risk than 12 months ago. Large policyholders typically reduce their insurance cost by shifting from whole turnover to excess-of-loss polices. Likewise, another third said that they retain less risk, as they capitalize on favourable insurance market conditions and the rising risk appetite of insurers or, as a matter of corporate governance, retain as little counterparty risk as possible. According to the policyholders polled, balance sheet protection is the primary reason for purchasing credit insurance. Access to bank financing and the ability to improve liquidity through working capital optimisation comes second. Third, credit insurance is seen as the most efficient, transparent and acknowledged way to manage credit risk and to comply with corporate governance requirements. When buying credit insurance, most policyholders pursue long-term strategies. 78% of credit insurance buyers stated that they have not changed their purchasing strategy in the past 12 months, nor do they intend to change it in the coming 12 months. To adjust their credit insurance needs according to market conditions, policyholders often combine insurance with other forms of risk mitigation or protection. However, the supply side also shapes the volume of insurance purchased. Policyholders state that they would buy more or different risk protection if policies and limits were less rigid or if insurers risk appetites were more flexible. The cost of insurance, as well as terms and conditions, have less of an influence on the overall purchasing strategies of credit insurance buyers. According to interviewees, demand would increase if products were tailored in such a way to allow policyholders to operate in more dynamic markets with potentially higher risk profiles. How to grow the credit insurance market Policyholders tend to exclude certain risks from their credit insurance purchasing. Lack of risk awareness might be one reason, while disregarding them as minor might be another. Equally purchasing may be driven by desire to keep the good risks and only insure the higher-risk business. By contrast, certain risks may be excluded because the cover is not available or is excluded by the insurer. According to credit insurers, policyholders, in particular SMEs, tend to exclude domestic risks. When margins are tight, the cost of credit insurance can be decisive, but also the complexity of the policy the contract wording, its proper interpretation and its practical application can pose a hurdle. Large global sellers with a strong market position choose credit insurance for financing purposes, more than for its risk transfer benefit. They are able to retain a portion of the credit risk on their balance sheet or manage it through tighter payment terms. Almost 90% of credit insurance buyers surveyed state that the current suite of credit insurance products does not fully meet their protection needs or that conditions are too rigidly applied. They encourage their insurers to offer more flexible and tailored products to capture the potential for additional demand. Larger companies would prefer to differentiate between different types of risks. Policies are said to be too static, restricting policyholders from conducting additional business, as insurers focus on their risk model and not sufficiently on supporting their customers in growing their business. Finally, policyholders said that policies should be more reliable and predictable, in particular during times of economic stress. Credit insurers agree that there is significant room for improvement in order to capture the opportunities for additional credit insurance demand. The most frequent suggestions include reducing product complexity, enhancing client servicing, improving the reliability of credit insurance solutions and adopting a new approach to pricing that takes into account the characteristics of the clients risk profiles. 6

7 Introduction to the credit market Credit insurance is essential for both domestic and global trade, which, according to the WTO s trade forecast for 2017 ( is earmarked to grow by 3.6% in 2017 and 3.2% in 2018, slightly ahead of global GDP growth. The importance of credit insurance as a protection against the default of a trade partner has increased with the liberalization of markets and the increase in cross-border shipments in recent decades. In 2016 the ratio of trade to GDP growth had fallen below 1:1 for the first time since However, in 2017 it is expected to recover and to outpace GDP growth. Lower commodity prices had put developing economies under pressure, affecting their power to purchase goods from abroad. However, the trend for reduced import demand reversed in 2017 due to a resurgence of Asian trade flows and increased import demand from North America. While the global credit insurance market continues to grow, the established markets have stagnated due to declining rates. Global statistics on the market are hard to obtain. The members of the credit and surety trade organization ICISA reported credit insurance premiums of around USD 6.4 billion in 2015, up from USD 6.05 billion in According to Swiss Re, global trade credit insurance premiums were USD 10.6 billion in 2013, with Europe traditionally being the most important trade credit insurance market. While this remains true today, the share of emerging markets, particularly China, has increased significantly over the last decade. Innovation has also taken place in the form of tailor-made products. Insurers now offer risk capacity for trades with a higher risk profile. Risks on individuals, i.e. private buyers or consumers, contribute only marginally to credit insurance revenues. This will remain unchanged for as long as overthe-counter payments are the dominant form of trading, and while secure payment insurance schemes have had little success. To date, online trade has not yet been a driver for additional growth in credit insurance although some insurers have launched policies that secure buyer s interests when placing an order. Insured trade volumes are expected to increase further as global trade continues to rise in an ever more interconnected global economy. The potential for growth is substantial since credit insurance penetration is still low and large portions of account receivables remain uninsured. Geopolitical uncertainties are likely to create additional demand for credit insurance protection, since a number of leading economies question the benefits and even the validity of international trade agreements, which enhances the attraction of credit insurance as a means to mitigate trade related risk. Political and economic uncertainties characterize the current global trade environment, including a lack of clarity in government policy actions as well as monetary, trade and fiscal policies. Potentially this uncertainty might stimulate additional demand for credit insurance, but might also create significant downside risk for exporters. The imposition of trade restrictions and tariffs to protect domestic industries has become a more serious threat to free trade, most notably under the current US administration. Such action would affect exporters of certain goods and possibly cause a decline in trade volumes. The attraction of credit insurance as a means to mitigate trade credit risk has increased due to a number of positive developments. Online platforms to purchase credit insurance and to manage credit risk have enhanced decision making and swift communication between insurers and policyholders. Likewise, the cost of credit insurance has become a less decisive factor for sellers, given the continued decline in rates over recent years. 7

8 8 Monitor results The credit insurance market

9 Differentiating credit insurance buyers according to their purchasing strategies + Policyholders High margins and specialist products Insure only the high exposures Insure only short-term receivables Insure all risks, not always find cover No cover > no deal Low margins and generic products Insure all, carry no risk - Retain no risks Risk retention Retain more risks + Policyholders take very different views when considering their credit risk. Some regard all their outstanding account receivables as credit risks that they have to insure, while others differentiate between risks and deliberately retain some, which they might mitigate through other means. Retaining credit risk is, however, not always the choice of the policyholder. Access to risk protection is frequently determined by the availability of insurance capacity. Companies might seek cover, but credit insurers have a natural interest in excluding certain risks or at least limiting exposure to more critical risks. Conversely, companies may prefer to purchase protection in a more selective manner. However, standard whole turnover policies do not allow exclusions but cover all trade receivables, also to limit adverse selection. The amount of cover policyholders purchase depends to a large degree on their market position and the industry in which they operate in. Generally speaking, companies can afford to be more selective, the more distinct their product, the larger their margin and the stronger their overall market position. For instance, a market leader in a premium segment will be able to achieve favourable payment terms, which reduce counterparty risk or allow it to retain the risk on its own balance sheet. By contrast, a producer of a generic and less differentiated product which only generates a low margin is in a weaker position and cannot afford the risk of a default as it could badly affect their balance sheet. As a consequence, companies often insure 100% of their credit risk or seek to retain zero risk. To them, credit insurance becomes a conditio sine qua non. If they have not or cannot find cover for a risk, they will abstain from signing the salespurchase contract. Credit insurance thus becomes an essential precondition for doing business, but also a limiting factor. The policyholders surveyed state that they struggle to find (sufficient) cover for their risks or that policy limits restrict them from doing more business. At the other end of the spectrum we find credit insurance buyers that retain a large portion of the risk themselves or that pursue other means of risk mitigation or diversification, such as adjusting payment terms, requesting letters of credit, self-insuring the risk or transferring better risks to a captive insurer while offloading the higher exposures under a stoploss cover provided by a credit insurer. The risks that policyholders seek to cover or exclude is to some extent a judgement call. Their assessment may be influenced by past experience and a short-term risk perception. Credit insurers and brokers emphasize that policyholders risk management recurrently underestimates the scale and time in which future risks will emerge and change, while they overestimate the quality of so called good risks exposures to familiar key accounts that policyholders assume they know inside out. Finally, the classic transfer of a credit risk to a credit insurer is not always the main motivation for credit insurance buyers, in particular for large corporations. For larger companies, efficient management of working capital is more important. They view credit insurance as a precondition to obtain bank finance or optimize their cash-flow. 9

10 The credit market's strengths and opportunities Credit insurance has always been a niche market with a limited number of players. As such it provides a certain protection to incumbents against new competitors, the impact from excess capacity on rates and margins, as well as against the advances from technological change affecting the wider insurance industry. Furthermore, market penetration is low, and many customers remain uninsured and also unaware of their true counterparty exposure. Therefore, the upside potential in the market is significant. It comes as no surprise that credit insurers are bullish about the industry's prospects. Among those that rely on credit insurance as protection against the default of trade debtors, the product enjoys a high appreciation and relevance. In particular, during periods of political or economic uncertainty where margins are under pressure, credit insurance is of the utmost relevance. Many policyholders recall the financial crisis and periods of increased claims frequency and severity, as recently experienced in Latin America. In fact, to many companies, their account receivables represent their largest or on average their second largest asset on their balance sheet. As such, credit insurance attracts attention from the key decision makers within a company. However, the credit insurance industry is undergoing a structural shift at least in mature markets. Traditionally, protecting the policyholder against the impact from a credit default has always been the primary function of credit insurance. Protection against non-payment has been complemented with the risk management that credit insurers provide to policyholders, supporting them with comprehensive data on their clients and suppliers a service that is of paramount importance in times of heightened corporate governance. Credit insurance has always been a prerogative to access bank finance and thus to optimise and steer a company's working capital needs. However, as a result of the financial crisis in , financial institutions have become subject to stricter regulation and are incentivised to optimise their capital efficiency by focusing on their core competences. Lenders reduced their risk profile by reducing the issuance of letters of credit while credit insurers in search of growth opportunities have been eager to fill this vacuum, either as a stand-alone service or in partnership with banks or factors. Market weaknesses and threats Overall premium volume in credit insurance remains small in comparison to general lines of insurance. Its size might pose an advantage and shelter the market from excessive competition, but it is also a disadvantage because diversification options are somewhat limited and volatility more accentuated. The market is highly dependent on economic cycles and is largely driven by export trade, which nowadays is responsible for 90% of the premium income in credit insurance. Hence, in economically or politically stable times, when claims and rates decline, sellers tend to underestimate or misjudge their exposure, question the value of the product and substitute the product through self-insurance. The insurance executives surveyed for this report point out that in mature markets we are currently in a prolonged credit cycle, where rising supply is met by declining demand, thus resulting in lower margins. Insurers become more opportunistic and offer risk capacity more generously also in response to the rising amount of excess capacity, which is pushing from general insurance providers into the credit insurance sector. On the demand side, policyholders might seek to overcome slow growth in established markets. They tend to venture into new and possibly more distant markets, where information on creditworthiness is harder to obtain. Thus, the risks that come into the market are larger, less transparent, inherently more volatile and more difficult to price. However, in Latin America, we observe the opposite. In contracting economies claims rise and insurers reduce their limits and cut back overall risk capacity, eventually even withdrawing cover. Policyholders remark that credit insurance is a somewhat "fair-weather" product. Under stable market conditions, when risks are comparatively low, insurers are willing to provide larger credit lines. However, once the cycle turns, or if companies venture into markets with generally lower credit scores, the availability of cover is limited or nonexistent. These phenomena are further accentuated by the relatively small number of credit insurance providers, globally and regionally. As a consequence, credit insurance is seen as a static and not very innovative product. However, in the digital age, where corporate information and accounts are accessible online, part of the value proposition of credit insurance has come under pressure. To avoid excessive commoditization of the product, insurers have to step up their game and further invest in their service provision and in technology if they are to maintain their margins. 10

11 Policyholders: Credit insurance volume to increase, in line with policyholders revenues Up Down Stable Development of total volume next 12 months Development of total volume next three years 33% 33% 56% 56% 11% 11% Development of relative volume next 12 months Development of relative volume next three years 11% 22% 22% 67% 56% 22% Policyholders expect that the total amount of credit insurance that they will purchase will remain stable (56%) or increase (33%) over the course of the next 12 months. Only 11% of interviewees expect a decline in volume. The increase in volume is driven by policyholders taking advantage of lower rates, which means they can buy more cover at unchanged or even lower rates. As such, exposures may rise while premium volume actually declines. In addition, policyholders point out that investors, regulators, rating agencies or clients demand that they protect their balance sheet to comply with stricter requirements either in corporate governance or in regulation. Also in an effort to reduce their risks, banks encourage policyholders to adequately protect their trade receivables. In markets where risks improve, large companies try to purchase cover more selectively shifting from whole turnover policies to excess-of-loss protection or other structured products. Subsequently the total amount of coverage declines, while policyholders retain more risk. Conversely, some companies also stated that fewer risks are covered relative to their total turnover. This is because insurance cover is hard to obtain as they expand into markets of higher risk. For the next three years, policyholders appear to be slightly more bullish with regards to the amount of cover to be purchased. 56% of interviewees expect insured shipments to increase, while 33% see no change. Those that are more upbeat assume that sellers will benefit from an acceleration of the overall economic activity, which should also benefit buyer s revenues and thus also the amount of credit protection purchased. Relative to policyholders revenues, for the next 12 months interviewees expect insured shipments to remain either stable (67%) or to decline slightly (22%) due to lower rates. In the longer term, policyholders predict that their revenues and credit volumes purchased should move in tandem. Insurance purchases will profit from stronger economic activity and increase in parallel with policyholders revenues as, for instance, commodity traders are able to realize higher prices. 11

12 Credit insurers: Premium volume to expand in the next 12 to 36 months Premium volume next 12 months Premium volume past 12 months 33% 13% 47% 20% 47% Premium volume next 3 years 40% 43% 50% Up Down Unchanged 7% The credit insurance executives polled are slightly more bullish in their market view than policyholders. 47% have seen an increase in premium volumes in the past 12 months while 40% noticed a decline. The overall low credit insurance penetration still provides opportunities for growth, in particular in emerging markets. In addition, trade finance enjoys double digit growth rates in some markets. In Latin America, as a result of recent economic contraction, claims increased and thus credit insurance demand is slightly higher. However, although pricing might still be adequate in some markets, credit insurers complain that the prolonged soft market has seen excess capacity spill over from other lines of business into credit insurance, which drives competition. insurance protection. In Latin America, past insolvencies contribute to a heightened risk perception, which will drive demand. In addition, risk financing is expected to continue its above average growth path as banks are expected to continue scaling back their exposure in the guarantee segment. Going forward, credit insurers are more optimistic about the development of their line of business. For the coming 12 months, 47% of interviewees expect premium income to accelerate. For the next three years that share increases even further to 50%. Likewise, the share of those that see falling volumes drops from 20% (next 12 months) to just 7% (next three years). Generally speaking, insurers hope that credit markets have hit bottom and assume that especially strong export markets and commodity-driven economies will expand and stimulate the need for credit 12

13 Credit insurers: Decline in rates to slow down Development of rates last 12 months Development of rates next 12 months 31% 25% 25% 69% 50% Up Down Unchange 69% of the credit insurance executives interviewed have seen rates decline over the past 12 months. However, the interviewees are more optimistic going forward, as the share of those expecting a further decline in rates falls to 50%. In Latin America, we observe the opposite trend to Europe or Asia, with insurers still having to recuperate and recover from the high loss ratios experienced during the economic crisis. Here, rates are on the upswing as the memory of recent defaults is still vivid among policyholders. The rate erosion is due to the continued availability of excess capacity, which dampens rates in credit insurance. General insurers have expanded into credit insurance as they seek growth opportunities. As competition heightens, in particular for good business, newcomers (who enjoy the benefit of having no legacy book to manage) can afford to undercut incumbents to build market share. While the supply of credit insurance has risen, demand, at least in some mature markets like Japan, has weakened. As default rates have fallen since the financial crisis and loss ratios are low, doom scenarios now appear less likely to materialise. Thus, risk awareness is waning. Insurers looking to escape price pressure focus on niche segments or markets off the beaten track; they try to avoid generic whole turnover policies and instead concentrate on structured products or financial guarantees. 13

14 Credit insurers: Profitability to improve markedly Development of profitability last 12 months Development of profitability next 12 months 6% 14% 31% 50% 63% 36% Up Down Unchange Credit insurers profitability is expected to improve markedly. According to 63% of the executives polled, profitability was somewhat down for the past 12 months, but 50% believe that over the next 12 months it will improve. The current low margin environment is due to a combination of squeezed rates and declining insured shipments as demand for insurance protection slows. In addition, it is also affected by rising expenses as insurers have increased their efforts to access top line growth. In some markets, profits are also under pressure due to high losses in past years. Insurers that have maintained higher profit margins claim to have not only strictly managed their portfolio, but also diligently reduced cost. Going forward, interviewees expect that the costs of securing new business will remain high, as they aim to expand geographically and increase their investments to broaden their portfolio and access further, more profitable client segments. However, ultimately the executives surveyed assume that higher rates in conjunction with rising volumes and also a decline in losses due to strong economic growth will benefit earnings. 14

15 Credit insurers: Exposure to grow faster than premium volume Will exposure outpace GDP next 12 months Will premiums outgrow GDP next 12 months 13% 25% 37% 87% 38% Faster Slower In line The majority of insurers interviewed (87%) are convinced that credit exposure will outpace GDP growth over the next 12 months as rates continue to fall, while credit limits are increased and as clients switch from whole turnover policies to excess-of-loss solutions. Therefore, while exposures expand, premium volumes remain constrained. In the meantime, GDP growth remains robust or is expected to rebound following the past contraction in Latin America. In terms of premiums versus GDP growth, 38% of the insurance executives surveyed expect that the former will not keep pace with the latter over the next 12 months. In markets where exports and infrastructure investments expand substantially, credit insurance premiums may outperform GDP growth, as expected by 37% of interviewees. Similarly, insurers with a strong bias in credit risk protection for banks state that they enjoy double digit premium growth rates in their markets, which obviously well exceed GDP growth. 15

16 Credit insurers: Competition and capacity to further increase Development of number of players in the market*: Development of capacity next 12 months: 31% 25% 69% 75% *Results for the past and coming 12 months are unchanged Up Unchanged A majority of interviewees (69%) expect that the number of credit insurers active in their markets will remain unchanged for the next 12 months, while 31% predict an increase. With an abundance of excess capacity in the market, and insurers seeking opportunities to grow their top line, the number of credit insurers has been rising, in particular as rates in credit insurance are still perceived to be more adequate than in the more mainstream lines of business. been reduced. Elsewhere, where risks have come down as the quality of insured risks further improved, or where rates, terms and conditions or volumes are under pressure, insurers provide greater capacity per risk so as to at least retain their share of business. Since data on default risks has become more accessible, entry barriers have come down. However, many national markets are relatively small and are dominated by a few sizable players, which are sometimes sheltered from an excess of competition through regulatory hurdles. While new insurers have entered the market, others retrench. And while losses have been significant in some places, rates have fallen and thus the potential for profitable growth is perceived as insufficient in current market conditions. In terms of risk capacity, 75% of the executives interviewed expect a continued increase over the course of the next 12 months. Only in markets where there have been recent losses, limits have been tightened and thus capacity has 16

17 Monitor results Purchasing and sales strategies 17

18 Policyholders and credit insurers agree: Credit insurance buyers are sufficiently insured Yes No n.s Policyholders: Are we sufficiently insured? Credit insurers: Are PH sufficiently insured? 11% 31% 22% 67% 69% From the point of view of the credit insurance buyer, 67% of interviewees consider themselves to be sufficiently protected. In fact, if companies are covered by whole turnover policies, all their trade receivables are subject to these covers. In addition, policyholders may use a mixture of different measures to assess, minimize and mitigate their risks. The stronger the buyer s market position, the more likely they are to utilize a bundle of risk management measures, of which credit insurance is just one. They might combine excess-of-loss policies with their corporate captive, use different payment terms to limit their exposure such as advance payments or cash on delivery but also make use of letters of credit or bank guarantees, factoring or public export credit agencies services (ECA), if export markets or payment terms go beyond what private sector credit insurers can offer. Ultimately, depending on the strength of their balance sheet, self-retention or self-insurance may also play a prominent role. However, the amount of protection that policyholders purchase depends also on how they assess their counterparty risks which, in companies with a more advanced approach, can include a scoring process of each trade debtor. Many sellers regard their long-standing and stable client relationships as an effective form of risk protection. Typically, policyholders will retain what they regard as good risks while seeking protection for high risks. That obviously creates an intrinsic conflict with the credit insurer, which might view such a mechanism as a means of adverse risk selection, leaving the credit insurer with a less balanced insured portfolio. When a company s product is more generic and its customer relationships more easily replaceable, profit margins will be smaller and its risk tolerance reduced. Consequently, the dependence on credit insurance will be larger. Thus, policyholders will state that they only execute trades for which they can find credit insurance. Concurrently, 69% of the credit insurance providers interviewed consider their policyholders to be adequately protected. This assumption is based on a combination of different factors. First, there is no shortage of risk capacity in most credit insurance markets. Thus, policyholders could buy more protection, if they wanted to. Second, most policyholders are covered by a whole turnover policy, which by definition encompasses the client s entire portfolio. Third, the current economic and political environment is fairly robust and stable. Fourth, where clients buy excess-of-loss policies, they can usually rely on a strong balance sheet, which is sufficiently robust to absorb a certain amount of risk. Finally, credit insurance should not be reduced to its risk transfer function as it can be a precondition for sellers to obtain finance and optimize working capital needs. However, there is also a flip side which focuses on the missed opportunities of generating additional sales. Credit insurers point out that policyholders tend to underestimate the risk they carry on their balance sheet and the impact that bad debt might have on their cash flow if affected by a default. According to credit insurers, sellers tend to lull themselves into a false sense of security and regard credit insurance as unnecessary when they assume to know their clients best. Differentiating between good and bad risks, they frequently try to keep their key accounts off cover, but in credit insurers experience, these are the accounts that, if they default, cause the largest disruption. Furthermore, in particular in the SME segments, margins are tight and sellers cannot afford insurance, irrespective of the availability of risk capacity. Furthermore, many SMEs perceive classic credit insurance policies as too complex, cumbersome and not sufficiently aligned to their interests. And finally, there is the question of business not being done because the buyer cannot find protection. 18

19 Credit insurers maintain a stable portfolio, predominately targeting large export clients All sectors Finance Manufacturing Commodities Exporters FMCG Type of industry 10% Type of product 15% 10% All types of products Whole turn-over Excess-of-loss Single buyer 15% 5% 50% 25% 10% 50% 10% Changed portfolio past three years Size of client 14% 53% 47% 48% 38% Stable Changed Large-sized Mid-sized All (incl. Small) The credit insurance market is dominated by a few large, global credit insurers, some dedicated specialists operating on a global scale, some well-established general insurers and a multitude of smaller, local players. Broadly, the large credit insurers service all industries, targeting companies with a strong export focus. In terms of products, whole turnover policies are most common, although excess-of-loss and single-buyer policies are frequently written with large clients. Structural changes in insurers portfolios predominately occur in a gradual manner. A slight majority (53%) stated that they implemented changes to their risk portfolio in the past three years either to facilitate growth into new segments or geographies, to comply with bespoke clients demands, or to fine-tune their offerings to adapt to changes in the risk profile to possibly reduce volatility, cutting credit limits or refocusing on specific client segments. Finally, almost half of the executives surveyed confirmed that they focus on large corporate clients. Only 14% target SME-sized companies, predominately because dealing with a multitude of small scale clients requires large resources or strong reliance on brokers. Consequently, many credit insurers shy away from this market segment. However, as pressure increases to generate further top line growth, insurers ponder strategies to access this segment with more standardized and simplified products that can even be sold and managed online. 19

20 Credit insurers aim to expand their portfolio geographically Strategic priority for the next 12 months Where to grow in the next 12 months 8% 32% 40% 39% 53% 28% Grow portfolio Focus on underwriting discipline Reduce cost Geographically Industry sector Product segment Despite prevailing overcapacity in the market, credit insurance is regarded as a growth industry by the executives interviewed. Market coverage is low, which may be why credit insurers focus their strategic priorities foremost on expanding their footprint. This might be both out of an opportunity and out of a necessity, as insurers are eager to grow their top line to deploy risk capacity and meet their return targets, despite declining rates and an intensified fight for new business. Thus, maintaining underwriting discipline is ranked second, which can occur in markets of abundant capacity where insurers are willing to take on more risks to protect their market position. The reduction of cost ranks third, not so much as it is less relevant, but foremost because the insurers polled confirm that efficiently managing cost is an ongoing and essential task to remain competitive. their franchise in the small- to medium-sized (SME) space, expanding into neighbouring markets is a priority for many. Obviously to those who hold a strong position in mature markets, growth in emerging markets, such as Asia or Latin America, is also key. For 32% of interviewees, expanding their product offering to add on either excess-of-loss policies, if they aim for larger corporates, or targeted SME products, if they target smaller players, is the second most mentioned priority. This is followed by broadening the offering to the fastgrowing financial sector, the more efficient, large scale, global or multinational sector, or to the largely untapped SME sector. In terms of expanding their risk portfolio, 40% of the executives polled aim to grow their footprint geographically, both in domestic and external markets. In particular, in bigger markets like the US, Canada, Brazil and China, market penetration is low and is predominately focused on large corporates based in local financial or manufacturing centres. As many players also see an opportunity in growing 20

21 Credit insurers: policyholders risk retention to remain largely unchanged How much risk do policyholders retain Development of risk retention past 3 years 21% 19% 44% 22% 57% 37% 0-25%* 26-50% 51-75% Retain more risk Unchanged Retain less risk *Predominately 10-15% self retention on whole turnover policies The amount of risk retained by policyholders depends on their own strengths. As already stated: the stronger the client s market position and its product, the broader its risk management options. In addition, the amount of risk a client retains is also a reflection of the industry in which it operates. In the export segment, Brazilian credit insurers, for instance, assume that about 75% of the goods sold to foreign buyers will be covered. By contrast, domestic sales frequently go uncovered in Europe as well as in the US or in Latin America. Credit insurance has always been conditioned upon a certain amount of co-insurance with the policyholder. For whole turnover policies clients typically have a retention of 10% 15%, while on excess-of-loss policies the buyer carries on average about 10% of the insured loss before the insurance cover is triggered. Higher retentions also reflect moves by insurers to reduce their limits and exclude more risks in markets where the economy has contracted, such as in parts of Latin America or South Africa. In those cases where the retention decreased, executives stated that policyholders benefited from lower rates and looser terms and conditions. Insurance buyers were able to buy more cover for the same price, while the insurers increased their risk appetite to maintain more business. In the past three years client retention has risen, according to 44% of the executives interviewed. This reflects the stronger balance sheets of clients in mature markets, where credit insurance buyers may shift from whole turnover policies to the more selective excess-of-loss or single buyer policies. 21

22 Monitor results Opportunities for growth 22

23 Policyholders credit insurance purchasing strategy remains unchanged Purchasing strategy past 12 months Purchasing strategy next 12 months 22% 10% 20% 78% 70% Unchanged Changed Unchanged Changed n.s. Policyholders purchase credit insurance for three main reasons. First, they use it to protect against trading partners default. By transferring credit risk off their balance sheet, they avoid having to build up reserves themselves for such an eventuality. In addition, they comply with requirements from investors, banks, rating agencies or regulators to pursue proper risk management. Second, credit insurers provide a valuable service by offering fully-fledged risk management services to their clients, enhancing transparency and reducing the risk of a default on trade receivables. Third, credit insurance gives companies access to bank lending and therefore contributes towards optimising their working capital needs. Policyholders pursue long-term strategies when buying credit insurance. Changes are rare, as 78% of credit insurance buyers surveyed state that they had not changed their purchasing strategy in the past 12 months. Drivers for change are obviously their experience with customers defaults such as during the financial crisis in 2008 which led to significant risk management adjustments among the policyholders interviewed. Also, purchasing strategies have been amended so as to make use of credit insurance as a tool for more readily available trade financing and capital relief. In the next 12 months, 70% of policyholders intend to maintain their current strategy. Some policyholders state that they will try to move from whole turnover to excess- of-loss policies to selectively adjust their risk profile. However, others emphasize that they aim to reduce complexity by merging credit insurance policies. Finally, policyholders see themselves constrained by their credit insurers and would buy more or certainly differently designed protection, if policies and limits were less rigid and insurers risk appetite more comprehensive. The policyholders interviewed cite that neither rates nor terms and conditions solely determine their purchasing decision. Although important, the actual nature of the product and the limits provided by the insurer are more relevant. Where client s margins are low and while their sales volumes are high, pricing of a credit insurance policy plays a more decisive role. Interviewees stated that if possible they use a variety of measures to balance their needs against the potential changes of the conditions of their credit cover. Some policyholders prefer products that allow flexible adjustments to the scope of insurance protection purchased, while others state that they might reduce the volume they acquire and instead shorten the payment terms they grant to their customers. Overall, policyholders would prefer to see more flexibility in their policies. For some, the availability of insurance protection can make or break a deal. Hence, the key condition for many policyholders is the degree to which the insurance policy allows them to or prevents them from doing business. 23

24 Policyholders wish for a more flexible credit insurance product Do the products offered suit your needs Satisfaction with the credit insurers (scale 0-5) % Satisfaction with your credit insurers (scale 0-5) 89% Yes No On average the policyholders interviewed cover their credit risk using close to three credit insurers. In 56% of the cases a broker serves as their intermediary, while 33% of the policyholders rely on a mix of direct contacts and support from brokers predominately for syndicated risks. On a scale from 0 (= not at all satisfied) to 5 (= very satisfied), the policyholders satisfaction with their credit insurers scored a rating of When asked specifically about their assessment of the credit insurance product, 89% stated that it does not fully meet their needs. Policyholders complained that, in particular, the standard whole turnover policies are too rigid as they do not allow them to individually assess and select those risks which they would like to be seen as part of the insurance cover. This, however, understandably conflicts with the interest of the insurers to avoid adverse selection. Clients also wish for more flexibility when it comes to limits and exclusions of certain risks. In their view, insurers focus too intently on their risk models, while paying too little regard to the clients commercial interests and needs to build their own franchise. This is also the case among large policyholders who point out that the structural set-up of credit insurers can also be a challenge when trying to find coverage on a global scale. Overall, the policyholders also hope for greater consistency when it comes to the risk appetite of credit insurers. In particular, as a consequence of the financial crisis, credit insurers have been under significant pressure from investors to reduce exposure and volatility. However, larger companies would like their credit insurers to support them with reliable risk capacity, especially in markets of greater uncertainty. In short, those that already buy risk protection selectively point out that they would like more support from insurers when risks increase because this is where they perceive the true value-add of credit insurance. Credit insurers agree to a remarkable extent with the assessment of the sellers. They, too, see substantial opportunities to generate additional business for credit insurance. First, in terms of client segments, credit insurers point out that policies have to become less complex and more transparent to suit the needs of SME-sized policyholders. To successfully address this segment, insurers have to drastically enhance the efficiency of the product, distributing and managing it online. Second, the benefits of credit insurance have to be better explained, as small-scale sellers frequently underestimate the potential of credit insurance solutions in terms of working capital and cash-flow management. 24

25 Furthermore, products should become more reliable and convenient. Insurers might consider removing limit cancellation clauses and also allow for longer payment terms. With regards to pricing, the feedback from interviewees was less consistent. While for low margin businesses and SMEs, pricing can be a deal-breaker, some insurers and brokers felt that rates do not sufficiently reflect the true underlying risks to ultimately simplify the product and eliminate exclusions or even withdrawals. With regard to large corporate clients, credit insurers admit that due to their own size and specialization, they lack the capacity to provide cover to companies in the energy sector, which would benefit from credit insurance. Also, products and risk appetite are not suited for large, complex and longterm contracts, which are common in some industries. Finally, credit insurers still need to do more to ensure that credit insurance can work as a proxy for financial security and replace letters of credit and other instruments that may serve as security for lending. To conclude, credit insurance is still understood as a business with attractive growth potential, benefiting from external forces, such as expanding GDP and in particular increasing global trade and interconnectivity. In addition, market penetration and awareness are still low, especially among mid to small-scale businesses which often run their trade receivable risks without any proper protection. Although ascertaining and quantifying the potential protection gap in credit insurance might prove to be a futile endeavour, policyholders and insurers alike agree on a perceived mismatch between supply and demand. While on the demand side policyholders wish that insurers would position themselves more as a partner for their clients by supporting them in increasing their sales, on the supply side products have to become more flexible and tailor-made to adequately reflect the volatility of the underlying risks. 25

26 XL Catlin contact XL Catlin Limmatstrasse Zurich Switzerland Office: Fax: xlcatlin.com XL Catlin, the XL Catlin logo and Make Your World Go are trademarks of XL Group Ltd companies. XL Catlin is the global brand used by XL Group Ltd s (re)insurance subsidiaries. 26

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