Vol 6 (2009) - Issue 4

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When it Comes Down to Trust …

The changes that have occurred in our economies in the last two years have been dramatic, fast and on a scale never witnessed in our lifetimes. We are currently observing the effects of the first global recession since the end of WWII, UK GDP growth is now commonly expected to drop by around –4% in 2009. As a result of the significant drop in demand and major de-stocking that has taken place, the value of world trade transactions between the end of November 2008 and February 2009 has fallen by 22.5%. We now forecast corporate insolvencies to increase by 35% around the world in 2009 and by 56% in the UK. It wouldn’t be a surprise to see the number of companies facing some form of insolvency reaching 9,000– this year (against 3,267– in 2007 and 6,274– in 20082). And the cold reading of these statistics is not even telling half the story of the difficulties that a lot of businesses are facing. Whilst a lot of UK companies have relied heavily on debt to finance their growth, the sharp reduction in demand exposes dramatically the frailties of a number of businesses and the urgent need to restructure. Some among the strongest and fittest will be able to rely upon the support of their shareholders to support them during this process, but a lot of others will be facing more dire prospects.

With such an unprecedented change has come a new paradigm: debt and credit can no longer be taken for granted. Initially limited to banks and financial institutions, this change has progressively transferred to the ‘real’ economy. As for any sudden change, the first natural reaction is one of shock, or anger. Banks have been accused of restricting lending and inflicting unnecessary damages to viable businesses. They will argue with a degree of reason that demand is actually weak from companies with viable business plans. Credit insurers have been accused of taking umbrellas away, just at the point that the rain has come. What people fail to acknowledge, is that the ‘rain’ is heavier and more persistent than anyone could have possibly imagined. And what credit insurers are actually doing is inviting people ‘inside’ when the storm has so obviously started.

The next natural reaction is denial: businesses refusing to accept the need to restructure, refusing to adapt their plans quickly enough and share those with their partners, whilst alleging the credit insurance market has failed. Then, only, comes acceptance. And, as we progress in the crisis, there are signs of the increasing acceptance of the significant changes that are required to maintain trust and confidence in trade transactions between all parties involved.

There is no and there has not been any credit insurance ‘market failure’, but merely a fast, severe and necessary adjustment. Normal market forces are at play as in any parts of the insurance cycle. Prices have increased steeply, as have reinsurance costs, and they will continue to do so for the foreseeable future.

But pricing is only a part of the equation. Credit insurers, in highlighting the possible exposure of their clients to increased credit risk, are only playing their role. As with any insurance product, the credit insurers actions are guided by the premise that they and their clients have an aligned interest in avoiding risks. Suppliers are unsecured, they trade with finite and usually wafer thin margins. These margins are rarely sufficient to allow them to reflect the full risk premium involved in their transactions with distressed debtors. Trade receivables are not traditional financial debt instruments where risks can almost always be priced in the value of the securities. Far too often – the only economically viable alternative for the supplier is to avoid the risk in the first place. These are the situations credit insurers are highlighting when they come to the decision to reduce or cancel the cover they offer their clients for future transactions with a particular company.