Reinsurance Tutorials #21 - Season 2
Hi everybody 👋
Today, and for the last Reinsurance Tutorials video of the season, we will talk about Credit & Surety!
Credit and Surety are two highly-specialized financial lines of business.
This explains why only a few players provide this type of insurance coverage around the world, compared to property or liability where the players are greatly numbered!
Let’s start! ⏬
Trade Credit Insurance
Firstly, let’s focus on trade credit insurance. Basically, this type of insurance enables a company to manage the risk of payment default by its debtor customers. And unfortunately, the majority of all companies have already faced this situation at least once. By providing this type of insurance, insurers contribute to the development of companies, no matter how large they might be!
The insured is the company selling the goods or services. In the event the buyer (that is to say the creditor company) cannot pay the seller, then the insurance policy provides for the reimbursement of the debt, up to a certain amount. If the buyer is from the same country, it is called a domestic risk. If not, we refer to it as an export risk.
A claim occurs when the buyer is in default! What are the reasons for this type of situation? There can be a variety of explanations: the client suddenly becoming insolvent and goes bankrupt, payments do not arrive on time, losses are incurred because of changes in exchange rates or even because of conflict…
How the insurer manages these risks ?
At first, the insurer agrees to allocate a credit line for a buyer and then monitors the situation so that the guarantee may evolve very quickly. This is a very dynamic approach and the insurer can choose to reduce the credit line if it considers that the situation of the buyer is deteriorating sharply. To evaluate the buyer’s risk, the insurer will pay attention to: the probability of default, the business sector, the country involved, etc. The insurer also provides for services such as risk prevention for the client at risk with daily financial monitoring of companies.
As you can imagine, mitigating the Covid-19 pandemic was one of the main concerns regarding this line of business. Insurers have deteriorated the ratings of many buyers. Many governments put in place exceptional back-up schemes to support insurers so that they didn’t cut off their support to the buyers. If this hadn’t happened, we would have had a crisis situation at the very beginning of the pandemic. As these schemes are temporary and the situation with the crisis remains blurry, much uncertainty remains concerning this issue.
According to the International Credit Insurance & Surety Association (ICISA), since 2010, insurance premiums for this line of business vary between 6 and 7 billion dollars (for ICISA members) and the claims ratio ranges from 40 to 50%. For the time being, the loss ratio for 2020 is 60%.
The credit line of business is often put in parallel to surety business which is a financial line of business but it is not the same in purpose. Let’s take a look at this subject.
A bond binds two parties through an obligation to perform. A surety bond is an agreement granted by the insurer that guarantees a monetary compensation in case the performing party doesn’t manage to meet its commitments.
There are mainly two groups of surety bonds:
- Contract-related guarantees, one of the main industries related to this type of bond is the construction sector.
- First, the bid bond: the insurer protects the buyer against the risk that the seller would withdraw his product or service offer after being awarded the contract.
- Second, the performance bond: the insurer agrees to indemnify the buyer in case the seller would not perform the work in accordance with the terms of the contract.
- Guarantees related to financial authorities: these are for example custom bonds, when the insurer guarantees the payment of taxes due by carriers and commissioners on goods transported or in custody. There are also tax bonds, waste processing bonds or European agriculture bonds for instance.
Links are very strong with local legislative framework, which explains why the Surety market is more developed in some countries such as the United States or, more closely, Italy. It seems quite obvious then that insurance players need to really understand the importance of mastering the legislative context.
The underwriting methods used by insurers to manage the quality of debtors can be quite similar to those developed for the credit business. And we won’t go any further into this topic at this time.
Regarding figures, the ICISA also reports an insurance premium of between 5 and 6 billion dollars, with a claims ratio below the credit claims ratio; that is to say a 20 to 30% annual average since 2015. As far as 2020 is concerned, the ratio remains under 30%.
For both lines of business, and for both the insurer or the reinsurer, large accumulations can be an issue. Indeed, an insurer can have many policies with several insured companies that cover the same buyer, or the same sector or country.
And regarding the reinsurer, the latter may have several treaties (basically a quota share with an excess of loss on retention) with many insurers. This increases the chances that a large accumulation will occur.
This is why it is important that the actors manage the exposure of the portfolio they write in its entirety and develop specific tools to do so. Otherwise, a buyer’s bankruptcy could generate insurmountable losses for the industry.
This video ends the season two of the reinsurance tutorials. Thank you for all the attention you have given us.
We sincerely hope that all those videos may have interested you and we remain available to discuss with you of course !
Bye for now 👋
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