All of the pundits, be they economists, financial analysts, advisors, or credit insurance underwriters, agree that we are in a serious global economic and financial crisis. Indeed, it is looking more and more every day like financial Armageddon. While there is no agreement on when the crisis will end (indeed we will only know that some months after it has ended!), the expectation is that it will be long and severe. Business failures globally will increase dramatically; of that, we can be absolutely certain.

In fact, through October, 2008 the number of business defaults worldwide is up nearly fourfold compared to the same period last year. As a consequence, it is not business as usual for the Accounts Receivable Insurance (ARI) underwriters. Not surprisingly, claims are up dramatically in 2008, and reports of overdue accounts being reported, as a precursor to future claims, are also up. Unfortunately, as economies flourished prior to the current debacle, underwriters aggressively drove premiums down to unrealistic, and, indeed, unsustainable, levels in their naïve pursuit of market share.

Unfortunately, as claims and overdue premiums rise, underwriters are withdrawing coverage on those buyers whom they consider to be at greatest risk of defaulting. This is quite a separate matter from their client’s own experience with their buyers. To the insured, this is really a double whammy: first, they have lost the coverage at precisely the time when it is most required from a risk management perspective; and secondly, they see the availability on their bank line greatly diminished as the insured Accounts Receivable base impacts their bank’s margining formula.

It is not entirely surprising that the underwriting “philosophies” of the ARI underwriters have changed rather significantly. When global economies were growing, and the mortgage crisis was a theoretical phenomenon best left to intellectual debate, underwriters would adjudicate credit on the basis of “soft” information: credit and bank reports, trade history, and the insured’s ability to mitigate risk. “Aggressive” underwriting was a further convenient way to buy market share.

Today, the underwriters are demanding “hard”, or quantitative, information in order to assess the underlying credit quality of the buyer. In most cases this information is not publicly available, such that the underwriters will be asking their insured clients to leverage relationships with their customers to source current financial statements. Specifically, the underwriter will be focusing on liquidity, liquidity, and liquidity! Profitability, of course, will also be looked at closely, but it is the liquidity of the buyer that will be critical. How much cash is available? When is the bank line up for renewal (in this environment, with banks becoming increasingly and unrealistically skittish, the concern is that the line will not be extended)? Are there any significant debt maturities on the horizon?

Decent coverage can still be found. But, it cannot be found at the premium rates available a year ago. At the same time, existing insured clients and new buyers of ARI can expect to pay considerably more. Furthermore, underwriters will require far more buyer disclosure than has traditionally been required. And if a company has had a particularly bad run of losses, they may well find themselves without coverage, or with coverage with very significant self-retentions. Nevertheless, adequate coverage can still be had.

Fortunately for Canadian clients, Canada is in a rather unique situation. Canada’s Export Credit Agency (ECA), the Export Development Canada (EDC), is virtually the only ECA in the developed world that still offers ARI in direct competition with the private sector. For years the private sector has been lobbying for EDC to exit the ARI business, arguing that they have the financial and technical capacity to offer corporate Canada the ARI coverage that they need. EDC has performed admirably in the current environment and has not wantonly engaged in the broad reductions in coverage that we have seen from the private sector. EDC has not traditionally participated in the myopia of buying market share through aggressive price competition and, hence, they are much better positioned to weather the current storm. We would anticipate that EDC will stay the course, and continue to offer comprehensive cover on export Accounts Receivable, for an appropriate level of premium.

Keith Milloy, President
Canadian Financial Insurance Brokers Ltd.
and ARI specialist