Trade Credit Insurance

To what extent should we expect the demand for Trade Credit Insurance to increase in the UK and what are the major factors affecting the same?

Initially the research paper begins with an Introduction on TCI’s processes, technological advances and key features. The report further proceeds with Results and Findings column, confronting data on several key economic factors affecting TCI on a macro scale.

The Discussion and Analysis column extrapolates the data in Results and Finding to build a linkage with TCI. The rationalization would be bi-polar, with evidence supporting and contrasting rising TCI demand. Subsequently, the report touches upon the UK’s current economic environment and TCI’s recent market status. A link between the two would enable an understanding of key variables involved.

The conclusion at the end of the report would suggest whether the demand for TCI will rise or fall by considering both aspects, driving and restraining forces for demand. Although quantitative facts and figures have provided objective numerical forecasts, we have also adjusted those expectations using experience and insight (judgement) to improve upon those forecasts. This would conclude the argument proposed by the research question.

Note:

1. Supported sources are provided as hyperlinked superscripts in particular paragraphs.
2. Definitions of terms written in italics is provided in Glossary section at the end of this report.

Today corporates all around the world extensively engage themselves in Financial Risk Management processes to mitigate their exposure to adverse consequences resulting from threats and uncertainties; TCI is one such process. The objective of TCI is to indemnify the supplier against losses which arise as a consequence of a buyer’s inability to pay. It does not aim to replace profits lost on the transaction. A credit insurance policy is designed to meet the needs of the policyholder’s business and is actively managed throughout the lifetime of the policy. A key feature of credit insurance is the assessment of creditworthiness and monitoring of the policyholders’ customers, assigning them each a credit limit – the amount the insurer will protect them if the customer fails to pay, less any agreed pre-determined excess. The process of TCI is disclosed in Figure 1. The TCI market is authorised and regulated by the Financial Conduct Authority (FCA).

The market for TCI is embarking upon online platforms in a digital era, enhancing efficiency and availability. The market is $8b in terms of written premiums where Europe was by far the biggest TCI user according to 2018 figures. Account receivables typically represents 40% of the company’s assets, where 1 out of 10 invoices becomes delinquent. Today the market is in a boom phase where it facilitates millions of pounds of trade everyday.

There are numerous variables affecting the TCI market today in UK but those mentioned in figure 2 poses major impact. This report will be touching upon each factor in detail in the context of the UK Economy.

UK has been ranked on 8th position in the WTO list of top 20 leading traders of goods and services in 2008 and 2018 with exports totalling to $519.3b and stood 2nd in the list of top 10 dynamic traders in 2018, reporting growth of 10%. These figures suggest the high credit risk exposure of UK in a global perspective.

Giant corporates including, Monarch Airlines, Palmer, and Harvey & Misco failed in 2017. The domino effect was continued in 2018 with the insolvency of Carillion, Toys R Us and Maplin. ABI’s annual TCI statistics highlight that claims paid to businesses due to non-payment of debts in 2017 totalled £225m, the equivalent of £4.3m every week. This is up 7% from 2016 – the highest since 2009.

Recent situation in FY19Q1 has not been great either. According to a recent report published by The Institute and Faculty of Actuaries, the TCI claims have hit a 10 year high. Statistics show that there were 5,114 TCI claims in FY19Q1, highest figures than in any Q1 of past decade. Government figures show that company insolvencies have increased by 6% in FY19Q1 compared to FY18Q4 and value of claims rose by £1m reaching £48m, with corporate insolvencies up at 13%. The report suggests that the causes for insolvencies and rising insurance claims are

1. Continued Brexit uncertainty
2. Lower consumer spending
3. Week currency (GBP)
4. Competition from online sales

Stockpiling due to Brexit uncertainties has left businesses at risk of insufficient TCI. Businesses are considering stockpiling as a speculative strategy to tackle any delays caused by potential trade restrictions due to Brexit uncertainties since half of the food supplies are imported by UK where major contribution comes from European Union. Industry groups have started stockpiling vital goods, for instance non-perishable food products, pharmaceutical supplies and vaccinations. UK currently spend around £50b a year on medicinal and non-perishable food imports from the EU. Stockpiling a month’s worth of supply could cost about £4b, increasing costs by 8%.

Rising insolvency rates, as illustrated by the uptrend in total liquidation and creditors’ voluntary liquidation since FY16Q2, illustrated in Figure 2, in England and Wales result in higher claims and in turn losses for the trade credit insurers. Compared to FY19Q1, insolvency rates were up by 0.6%. The major contributor to this was the extra 74 insolvency cases compared to FY19Q1, a 3.4% increase which was followed by the construction industry at 1.2% increase. These figures underscore the fact that TCI demand is expected to rise especially in FY19 and FY20. Euler expects insolvencies to rise by 15% in 2020 in case of no-deal Brexit which has a 40% chance of enforcement.

UK economy is highly driven by 3 sectors considered as leading economic indicators, namely, Service, production and manufacturing and construction sector. Today these sectors are experiencing a downfall warranting an economic slowdown.

Service sector is the largest sector in the UK contributing more than 75% of the GDP. The sector mainly comprises of finance and business services, consumer-focused industries, such as retail, food and beverage, and entertainment.

Service sector growth has been declining for the past few years beginning from 2016. The sluggish growth was caused by weakness in consumer-faced industries, declined from 4.5% in 2016 to 1.8% in 2017.

The service sector contribution has declined significantly from FY17Q1 to FY19Q2  and growing at 0.1% which is the weakest quarterly figure. The markit/CIPS Purchasing Managers’ Index (PMI) was 49.5 in September 2019, down from 50.6 in August. This was the 5th time in over a decade that the PMI has been below 50. This signals a decline in the service sector amid lower demand and brexit uncertainities.

The Manufacturing sector has been facing adverse conditions lately, where the production has declined 1.7% from a year earlier in August 2019, as explained by the graph below, being the fifth consecutive monthly decline. UK Make Executive Survey report suggest that disruptions due to cyberattacks represent the most significant risk, apart from brexit, at 63% and a quarter of manufacturers are planning to take appropriate actions against it. Given the substantial role of Manufacturing sector in the economy according to the above figures, the risks of cyberattacks may cause higher default rates and insolvencies. As per a survey published by The Guardians, export order books increased among the 358 manufacturers in the survey which was supported by weaker GBP but this was offsetted by a decline in domestic demand leaving the industry in a vulnerable position ahead of Brexit decision. Companies identify account receivables as one of their main assets and taking appropriate measures to maintain a prominent cashflow system. More than 50% of the companies surveyed have already insured protection against bad debts or will insure against bad debts.

The PMI by the IHS Markit/CIPS fell to 47.4 in August, down from 48 in july. This was the fastest contraction pace since last 7 years. Companies in England and Wales rose to 4,320 in FY19Q2, the highest in more than 5 years.

The construction sector has encountered the same fate, facing a downturn for the fifth straight month in September 2019 due to brexit uncertainties and sluggish demand. The Markit/CIPS UK PMI dropped to 43.1 – 43.3 from 45 last month. Commercial sector was the hardest hit and civil engineering activity dropped at its fastest pace in almost a decade. The longer the higher costs and downturn in the sector persists , the tougher it will become for the sector to recover.

United States is the largest importer of UK goods and services and has yet maintained this position. Due to critical issues, for instance the US-China trade war, the economic slowdown and the rising tariff in the US, UK is experiencing economic challenges which may call for loss in business confidence and higher unemployment. Slowdown in the US and China is expected to extend to next year which leaves UK under vulnerable circumstances, in the midst of Brexit.

The US has begun escalating chaotic trade wars across many economies, including the UK. For instance, the US, with its stringent protectionist policies, has imposed $7.5B worth of tariffs on food and drink exports. Further the tariffs were extended worldwide for aluminium and steel industries.

Primary feature of TCI is to safeguard sellers against buyers declaring bankruptcy or insolvency. Brexit uncertainty has been one of the most crucial reasons for rising insolvencies and rising demand for TCI. 2018 saw a 12% upswing in UK business insolvencies as increasing late payments, sluggish consumer spending and soft GDP growth weighed on almost every sector of the UK economy.

Figures from the Association of British Insurers (ABI) show that TCI carriers paid out a record amount to help firms cope with the non-payment of bad debts in the first half of 2018, due to the weakened trading environment. The industry hasn’t seen the value and amounts of claims and payments this high since the height of the financial crisis in 2009. Although the ABI figures show the UK’s trade credit insurers currently cover a record £340bn of trade to help businesses navigate the increasingly tricky environment, the association says that too few firms are using TCI. Given the gloomy outlook post-Brexit, the TCI industry has a prime opportunity for growth as companies start preparing for the worst.

TCI claims rose by 40% in 2018 compared to 2017 figures most notably in Construction and Retail sectors. TCI claim payouts reach £5 million a week as the number of claims increased by 60% in the last year, according to new figures released (on 22nd March 2019) by the ABI.

Amsterdam-based Atradius NV, one of the big three trade credit insurers alongside French duo Coface SA and Allianz Group-owned Euler Hermes Group SA, estimates that the number of insolvencies in western Europe will increase 2% and that business failures will increase 7% in the U.K. in 2019 “due to Brexit uncertainty and weaker consumer purchasing power.” Although Atradius has retail and consumer durable exposure in excess of £8b with a 4% increase in Apr 2019 (year-to-date), the insurer claims it’s risk appetite remains high. 2018 saw a 12% upswing in insolvency rates due to increasing late payments, declining consumer spending and falling GDP growth rate. Euler Hermes predicts UK corporate failures to rise as high as 25% in case of Brexit. Were the UK to remain in the EU in 2019, this figure would fall to just 2%, although Euler sees only a 5% chance of this happening.

The key economic indicators in figure 7 in  addition with dominant sectors – Service, manufacturing and Construction – manifesting a contraction, reflects the fact that the UK economy is expected to face an economic slowdown, considering especially the fall in Industry production from 1% in FY16 to -0.3% in FY19. These economic indicators are supported by contractions in Service, Manufacturing and Construction sectors.

Supply chain of many industries in the UK is expected to face liquidity crunch. One of the major reasons being stockpiling due to no-deal Brexit uncertainty leading to potential tariffs among UK and EU. High inventory levels would leave businesses cash trapped and a prolonged stockpiling may increase the default rates. With the tied up liquid funds, stockpiling has created a further financial burden of storage expenses leaving the suppliers susceptible to TCI shortages. Although rising expected default rates from buyers calls for TCI on current invoices, there is a higher chance of inflated TCI premiums and decreased trading activities which aggregates to fall in expected demand for TCI.

UK economy has endured its slowest recovery on record since 2012 and the outlook is merely worsening. With stretched brexit deadline to dec 2019 general elections, another quarter of uncertainties, the economy may face an extended slowdown. Plummeting Purchasing Managers Index (PMI) in all the 3 dominant sectors – Service, Manufacturing and Construction – reflects shrinking business activities which translates to falling number of credit risk exposures.

However, we expect the demand driving forces outweigh restraining forces given the fact that the UK has high recovery rates. This is a period for industries to understand the significance of TCI in businesses. Once the uncertain period terminates, we expect to witness high recovery rates boosting economic activities to higher levels than those warranted before Brexit referendum.

UK corporates are stepping up to purchase TCI with the rising expected insolvency rates, up at 15%, promoted by worsening supply chain processes among dominant sectors. UK economy, being highly sceptical, is expected to experience a downturn with rising unemployment rates and plunging consumer spending. Higher probability of no-deal Brexit, standing at 40%, has further augmented uncertainty.

UK has verged closer to its first recession since the financial crisis after the country’s dominant sectors unexpectedly plunged into contraction in recent months, in a sign of mounting stress facing the economy as Brexit looms. Falling PMI among Service, Manufacturing and Construction sector has been a leading economic indicator for UK’s economic contraction. The service sector, contributing close to 75% of GDP, has witnessed severe hits in last quarters and is exposed to negative cashflows along with other two dominant sectors.

Macroeconomic links can produce convergence in business cycles among economies. UK-US and UK-EU are such links where UK exports are highly reliant on these countries and we suspect potential trade wars against UK economy. Trade wars are not expected to last long but with the current economic scenarios in place, we expect higher corporate default rates and therefore higher demand for export credit insurance.

However, we expect the demand driving forces outweigh restraining forces given the fact that the UK has high recovery rates. This is a period for industries to understand the significance of TCI in businesses. Once the uncertain period terminates, we expect to witness high recovery rates boosting economic activities to higher levels than those warranted before Brexit referendum.

However, we expect the demand driving forces outweigh restraining forces given the fact that the UK has high recovery rates. This is a period for industries to understand the significance of TCI in businesses. Once the uncertain period terminates, we expect to witness high recovery rates boosting economic activities to higher levels than those warranted before Brexit referendum.

However, we expect the demand driving forces outweigh restraining forces given the fact that the UK has high recovery rates. This is a period for industries to understand the significance of TCI in businesses. Once the uncertain period terminates, we expect to witness high recovery rates boosting economic activities to higher levels than those warranted before Brexit referendum.

Financial Risk Management – Financial risk management is the process of understanding and managing the financial risks that your business might be facing either now or in the future.

No-Deal Brexit – A no-deal Brexit is the potential withdrawal of the United Kingdom (UK) from the European Union (EU) without a withdrawal agreement. Under article 50 of the Treaty on EU, the Treaties of the European Union cease to apply once a withdrawal agreement is ratified or two years have passed since a member state has indicated its will to leave. The two-year period can be extended by unanimous consent of all member states, including the one wishing to leave.

Stockpiling –  The holding of levels of stock which are greater than would be normally required by a person, firm or government agency. Stockpiling usually occurs at times of an actual or expected shortage of a product or in anticipation of a price rise.

Domino Effect – It is the cumulative effect produced when one event sets off a chain or similar events. It typically refers to a linked sequence of events where the time between successive events is relatively small.

Liquidation – Liquidation is a legal process in which a liquidator is appointed to ‘wind up’ the affairs of a limited company. The purpose of liquidation is to sell the company’s assets and distribute the proceeds to its creditors. At the end of the process, the company is dissolved – it ceases to exist. Statistics on compulsory liquidations and creditors’ voluntary liquidations are presented here. A third type of winding up, members’ voluntary liquidation is not included because it does not involve insolvency.

Creditors’ voluntary liquidation (CVL) – It is a formal insolvency procedure which involves the directors of an insolvent company voluntarily choosing to bring their business to an end, and wind the company up.

Compulsory liquidation – It is a formal insolvency procedure which results in a company being forcibly shutdown. The compulsory liquidation process is typically initiated by disgruntled or otherwise outstanding creditors of a limited company through a court order known as a Winding Up Petition (WUP). A WUP notifies a company that a petition has been lodged to bring about the closure of the business and the liquidation of its assets.

Purchasing Managers’ Index (PMI) – The Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. The purpose of the PMI is to provide information about current and future business conditions to company decision makers, analysts, and investors. PMI is a number from 0 to 100. A PMI above 50 represents an expansion when compared with the previous month. A PMI reading below 50 represents a contraction, and a reading of 50 indicates no change. The further away from 50 the greater the level of change.