Captives and Trade Credit Insurance. Paul Kunzer February 3, 2015

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2 Captives and Trade Credit Insurance Paul Kunzer February 3,

3 Trade Credit Insurance Primer Insures against insolvency, protracted default and political risks of insured s customers (Buyers) Covers outstanding value of accounts receivable at time of loss Typically covers portfolio of accounts receivable with terms of sale up to 90 days, but flexibility of structure exists Cancelable and Non-Cancelable underwriting philosophies = different products apples and oranges 3

4 Why do companies purchase Trade Credit Insurance? Protect against non-payment risk for their portfolio of accounts receivable Facilitate attractive financing Expand sales Supplement credit risk management Penetrate new foreign markets Reduce bad debt reserve Finance CFO/Treasurer/Credit Manager makes the insurance buying decision

5 Two Competing Philosophies Characteristic 1. Credit Limits Underwriting 2. Credit Management Underwriting Discretion Risk Retention Named customer ( Buyer ) coverage, risk insured set by insurer Generally lower deductible program Larger discretion to sell to Buyers per Insured s credit due diligence Generally higher deductible commensurate with discretion Cancelable Limits Generally Yes Generally No Costs Applicability Higher unless increase risk retention and with more credit limit fees Smaller, middle-market companies looking for credit assistance Lower given higher retention, lower fees Larger companies seeking more catastrophic protection and credit flexibility Service Decentralized underwriting from sales Direct underwriter relationship

6 Why are multinationals looking at Captives? Captives can fill the void where cover is otherwise too costly or unavailable Key benefits Coverage Stability Control Flexibility Financial reward Cost Global Difference in coverage Uniform Predictable cost Coverage Control Stability Reward In a Hard Market Laws of Supply and demand work to Insureds disadvantage Coverage constricts Coverage available only at rates which do not make economic sense Insufficient recognition for loss experience or deductible retention Flexibility 6

7 Why are multinationals looking at Captives for Credit Insurance? Captives traditionally are a risk tool used when policyholders are dissatisfied with the product or market W hole Turnover Credit Insurance model failing for many companies Outsourcing credit management to Credit Underwriters - Interests not always aligned Captives help retain premium in the market which would otherwise have exited 7

8 Risk profile of Manufacturer Pre-crisis limit coverage 89% coverage by buyers 92% coverage by exposure Cover not available on 11% of Higher Risk Buyers Risk Grade 1 2 Risk Grade 2 15 Risk Grade 3 Risk Grade 4 Risk Grade 5 Risk Grade6 Risk Grade 7 Risk Grade 8 Risk Grade 9 17 Risk Grade

9 Risk profile of Manufacturer Post-crisis limit coverage Sector impacted by downturn Risk profile shift to higher grades WTO Insurers culling of limits 64% coverage by buyers 72% coverage by exposure Risk Grade Grade Risk Risk Grade Grade 2 Risk Grade Risk Grade 3 Risk Grade 4 Risk Grade 4 Risk Grade 5 Risk Grade 5 Risk Grade6 Risk Grade6 Risk Grade 7 Risk Grade 7 Risk Grade 8 Risk Risk Grade Grade 89 Risk Risk Grade Grade Risk Grade

10 Consequences - Companies are having to evaluate the true scope of Credit Insurance protection WTO Credit Insurance perceived by some as a flawed product Companies view and attitude to Credit Risk changing Elevated to CEO level Bank liquidity not available to fund bad debts, particularly in subsidiary locations Shift from ground up programs to more sophisticated excess of loss Non-cancellable structures and credit limit certainty demanded Accepting higher levels of self retention to improve risk coverage Captives now on the agenda

11 The advantages and disadvantages of Captives Recognition that credit is a risk traditionally self insured Most companies create a Bad Debt reserve Don t see reserves for fire and property damage etc Self Insurance - often means no insurance Should CFO s and Treasurers expose the Board / shareholders to the consequence of major credit loss without undertaking some form of risk mitigation? Stand-by credit facilities from banks to cover unforeseen losses are both harder and more costly to negotiate Audit requirements place greater emphasis on contingency planning including adequate liquidity to meet the going concern test. With no guaranteed bank support, reserving needs to fill the gap

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16 Practicalities and how it works Once a decision made to establish a Captive: 1. Feasibility investigation to identify the most effective structure and location 2. The captive will need capital, Premium or funding to retain own risk and meet losses right from the outset. Covering the risk gap between premium and possible maximum loss is key Credit Loss Reserve product to spread funding of retention 3. Brokers, underwriters and independent managers offer various Captive set up and management facilities 4. Although captives can turn a general reserve into a tax allowable premium, most plans should allow for fiscal and regulatory change, and seek tax neutral status

17 Bridge The Gap Compelling reasons why clients may wish to increase risk retention: Historic resistance by captive managers to include credit risk in captive Practical difficulties of managing credit risk Complexities of managing a Trade credit program Perceived high level of administration Efficient IT platform is key to making Credit Captives work

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