In the second of Four Key Issues impacting trade credit risk over the next year, we look at the higher coverage needs, the challenges of securing coverage on buyers at home and abroad and some solutions to respond to these challenges.
Securing Coverage Post-COVID-19 will Remain Challenge
At the onset of COVID-19, underwriters led by Euler Hermes moved quickly to cancel or restrict buyer coverage. In response Government Export Credit Agencies, ECA established programs to augment private sector underwriter coverage shortfalls, to support sales in a contracting economy. Canada's ECA Export Development Canada (EDC) offered additional domestic and export capacity on a buyer-by-buyer basis through reinsurance of many underwriters. Like many ECA supplemental coverage programs, EDC’s domestic capacity program is likely to end at the end of 2021. As we recover from COVID-19 and underwriters better understand the impact on an industry-by-industry basis they are returning to a looser credit position to write more coverage in the developed world where vaccination rates are high and COVID-19 cases have materially declined. It is unlikely the private sector response will be sufficient to bring coverage back to pre-COVID-19 levels and many policyholders will be left with coverage shortfalls.
These shortfalls will be exacerbated by the need for much higher limits in many industries. Supply chain bottlenecks have led to some product shortages and increased demand has led to higher and much more volatile commodity prices in lumber, steel, logistics, food and more. Lumber prices peaked at over 4 times their historic 5-year average and while they have come down recently, they remain approximately twice this average. While it was already challenging to maintain coverage on private sector companies where financial disclosure is limited, now policyholders require limits often more than twice the normal trading limit.
Our experience is that most shortfalls are driven by limited financial disclosure or a superficial analysis of the information. Policyholders are best served with a specialist broker like NFP that actively resolves coverage shortfalls by soliciting private sector company bank and financial information, analyzing these financials and making sound recommendations to underwriters. At a macro level the resulting higher inflation will lead to higher interest rates and borrowing costs making financial disclosure and the need to identify the higher risk companies more important.
Resolving Coverage Shortfalls – A Case Study
Expand Sales and Improve Lender Advances
A protein trader bought and sold meat in the US, Canada, Mexico, Brazil and Columbia. As with most traders in this industry, the company had low margins and high leverage, so trade credit insurance was used to cover all sales to avoid the material impact of a bad debt on profits and to maximize financing. With the impact of COVID-19 on the economy, the policyholder’s underwriter cancelled and reduced cover on 14 buyers, materially impacting the ability of the company to do business.
The company had historically worked directly through an agent of the underwriter. After the underwriter’s adverse action restricting coverage, the company saw the need for change. They established NFP as their broker of record. NFP immediately took a two-pronged approach to get to the heart of the issue and re-establish coverage. NFP went to 15 markets to identify an underwriter more receptive to the client’s customer risk. At the same time, NFP identified why the coverage was restricted. In almost every situation, it was information related. NFP, whose team speaks a number of languages, then contacted the CFOs of all 14 buyers to obtain financial information — in most cases under a confidentiality agreement and, where necessary, we obtained third party confirmation of the buyer’s liquidity from their lender. NFP then analysed the financial information across profitability, capital structure and liquidity as well as understanding the extent of COVID-19’s impact on the buyers. NFP then presented their recommendation and analysis to the underwriter to secure coverage.
Of the 14 coverage shortfalls, NFP was able to reinstate full coverage on 10 buyers and partial coverage on two buyers. Two buyers were identified as not being credit worthy, where the policyholder should consider pre-payment or cash-against-documents.
Given the economic environment, most other underwriters were not willing to take on additional exposure in this segment so NFP only received quotes from three of the 15 markets. Fortunately, with the resolution of most of the coverage shortfalls through information gathering, the incumbent underwriter remained the best solution and the client was able to maintain that relationship.