Cruz Gonzalez, lenders solutions team leader Europe and global head of receivables & SCF at WTW, discusses the transforming non-payment insurance market, and how insurers and banks can work together to share the associated risk.
Financing international trade can be a risky business. But non-payment insurance has long provided much-needed protection for trade finance lenders against the risk of borrowers – both buyers and suppliers – defaulting on their debt.
Until recently, this type of insurance primarily worked on a single risk policy basis, providing coverage for individual contracts. However, factors such as high costs of lending and distribution, coupled with the smaller size of deals when executed on an individual basis, are pushing the market in a new direction, and demand for portfolio solutions is growing at a significant rate. Indeed, there has been a notable shift in recent years towards structuring policies that encompass portfolios of single assets, such as accounts receivable insurance. What’s more, there is an increasing demand from banks for products that can include a portfolio of multi-asset classes.
By adopting this portfolio-based approach, lenders can streamline their processes, resulting in greater efficiency of time and resources compared to the traditional method of binding policies on a case-by-case basis.
As the landscape shifts, insurance companies must adapt accordingly to ensure clients have the protection they need to support their global trade activity.
Mitigating risk
Unlike conventional financing or credit issuance, trade financing goes beyond the management of solvency and liquidity risk. Trade finance is exposed to a much broader spectrum of variables and risk factors – from the individual risks of each stakeholder to political instability, currency fluctuations and unfavourable changes to economic conditions. All of which could ultimately result in a buyer or seller being unable to meet their payment obligations. Non-payment risk, also known as credit risk, is a primary concern for funders and borrowers, and the current complex environment – including high interest rates, global political uncertainty with nearly 100 countries having held or still to hold elections this year, as well as attempts at large-scale warfare that could result from the armed conflicts already underway – is resulting in caution, emphasising the importance of implementing robust risk mitigation solutions.
Non-payment insurance, which effectively transfers all or part of the risk of non-payment from a funder to an insurer, has proved an invaluable tool in mitigating credit risk within trade finance.
And the benefits extend beyond sharing risk. Non-payment insurance helps to facilitate global trade by enabling banks to provide solutions to their corporate clients, and thus corporates to do business with their own clients – such as by allowing them to offer extended payment terms to buyers – thereby supporting the end-to-end supply chain and strengthening relationships within them.
Working with an insurer also enables banks to gain insights into the market overall, positioning them with greater knowledge to help them deliver effective client solutions. Furthermore, if a claim is raised, working with an insurance partner can help to save both time and money when it comes to the recovery process.
A shifting market
With 80-90% of world trade relying on trade finance, accessibility and the streamlined provision of funds is critical.1 But the current landscape – including the high costs of lending for individual, smaller-sized deals and the complexities of managing internal credit limits – is creating challenges for banks. These factors, combined with the fact that Basel regulatory reforms are set to further shake up global capital standards, mean that banks are altering how they approach insurance in order to better manage their capital requirements and reduce their risk-weighted assets (RWA). As such, they are adopting a targeted approach, focusing on deals with a better expected outcome.
For insurers, however, the resulting high concentration of large, well-rated corporates in the market may result in capacity constraints. As such, it is essential that a way forward is established that supports growth, allowing banks and insurers together to offer funding beyond the typical corporate clients alone, with the pool of accessible trade finance widened to include smaller businesses, which are equally important components within global supply chains.
A sustainable model for growth: all roads point to portfolio
To address this, there has been a shift in bank focus: individual non-payment insurance is on the way out, while portfolio structures, which can accommodate a wider range of risk, are firmly in.
In trade finance, numerous established portfolio structures exist. Whole turnover policies, for instance, cover all of a business’s accounts receivables comprehensively, allowing a consistent pricing model across the entire portfolio. But importantly, for portfolio solutions such as these to be able to overcome today’s challenges, banks need to be prepared to offer a more diversified, attractive portfolio to insurers. In turn, with the insurers able to cover the range of businesses within that structure, banks can offer support, cover and limits to their clients that they would otherwise be unable to.
As well as creating opportunities for economies of scale, there are several factors that favour portfolio structures, including:
- Pricing is currently highly competitive both for insurance and funding. Portfolio structures allow banks to offer better pricing, and thereby support business growth.
- Credit limit relief. By shifting from individual cover to a diverse portfolio structure, insurers are more comfortable increasing their line sizes, enabling banks to offer more capacity in order to continue servicing their clients – and enabling bank growth.
- Centralised strategies. Banks are increasingly looking to distribute insurance across different teams in order to optimise its benefits. Portfolio diversification strategies are therefore no longer just about selling assets or bringing in other banks; they also increasingly now incorporate insurance.
To facilitate portfolio structures, accommodate high credit limits and avoid capacity concentration within the market, banks need support from a wide range of insurers. As a result, insurers are shifting towards cooperative structures, moving away from a previous reluctance regarding co-insurance and syndication arrangements. This collaborative approach enables insurers to better support their bank clients, positively impacting the growth and satisfaction of corporate needs.
Collaboration: the key to portfolio success
WTW is helping bank clients that are looking for support with insuring their lending books. In parallel, we also recognise our role in educating insurance companies, many of which remain reluctant to write transactions on a portfolio basis given the lack of resources or information to do so. Leveraging the expertise of others within this area can result in a win-win solution for all parties.
Given that most underwriters in the non-payment space don’t have the credit risk teams to underwrite a portfolio with potentially thousands of buyers, a key first step is for insurers to become adept with setting specific criteria to encompass transactions that may be eligible to be covered under the structure. Criteria can easily be established by leveraging and analysing the bank’s existing underwriting and credit procedures, rather than carrying out these procedures separately. Once this process is in place, with banks and insurers working collaboratively to build joint criteria for the benefit of both parties, a true risk-share partnership can be created.
For insurers, adopting this approach requires a mindset shift as much as procedural understanding. All stakeholders need to be receptive not only to new solutions, but to new ways of working to ensure the portfolio approach can be optimised. However, the momentum for risk-share partnerships is beginning to build in the industry in response to rising demand, with a growing number of market players now operating in this space.
Facilitating the shift from single risk deals to portfolio solutions is certainly underway, but more needs to be done in terms of guiding and supporting insurers, and ensuring banks can provide the transparency that insurers need to be comfortable with relying on their credit analysis. Here, WTW is taking a leading role.
This is only the first step for WTW, however. In the coming years, the insurance powerhouse has its eyes set on mixed asset classes, looking to implement portfolio solutions across the board. Watch this space.
