Non-cancellable excess of loss (XOL) limits enable businesses to protect trade flows throughout the economic cycle, while supporting a return to growth for them and their clients
By Christian Vollbehr, Head of Trade Credit Europe, Multinational & Strategic Accounts, AIG
As countries across the globe position themselves for a return to full economic activity in 2022,
businesses will be weighing up their own challenges ahead.
A relatively quiet period for insolvencies in 2021 is expected to change this year, and the benign claims experience which has endured for several years in the trade credit insurance market is now believed to be coming to an end. The claims ratio started to tick up in 2020 according to ICISA trade credit insurance statistics.
Rapidly increasing inflationary pressures, rising interest rates, ongoing supply chain disruption, and febrile political situations in multiple jurisdictions are also set to drive change in the trade credit landscape.
Industry sources anticipate the rate of global insolvencies could increase, and UK businesses were also reporting significant financial distress in Q4 2021, according to Begbies Traynor Group who state that a greater number of insolvencies among SMEs will emerge in 2022.
Corporate insolvencies are expected to be driven in part by the cessation of remaining government pandemic relief programmes, coupled with a sluggish return to economic growth.
Alongside this, the expiry of state-sponsored schemes in the UK and a number of European countries, designed to preserve trade credit market capacity throughout the pandemic, has further complicated the picture.
These temporary, government-backed reinsurance schemes — such as the £10 billion Trade Credit Reinsurance Scheme in the UK, were aimed at speeding up economic recovery through helping businesses to continue accessing trade credit insurance. Trade credit insurers were able to lower their overall exposure by ceding a portion of the risk to these government reinsurance backstops.
Turn in the cycle
In the trade credit sector, the soft market dynamics that preceded the pandemic have returned (source: WTW Insurance Marketplace Realities 2022) — following a short period of hardening where demand surged due to covid-related economic challenges and fear of insolvencies increased, prior to the introduction of government support schemes intended to protect the supply chain.
In 2022, however, a rapid contraction in capacity is now predicted, particularly among markets writing cancellable coverage.
In this environment, businesses reliant on credit insurance to keep operating and to continue generating growth will be seeking greater certainty of coverage.
Much of the mainstream capacity in the trade credit insurance market is written on a cancellable basis which means carriers may change their risk appetite at any point during the policy lifetime.
Writers of non-cancellable cover, by contrast, don’t have the option of withdrawing cover when the cycle turns, when buyers’ operating results or credit ratings deteriorate, or when the risk profile of particular countries or industry sectors worsen.
These carriers can only change their risk appetite at policy renewals (typically, every 12 months), giving policyholders not only continuity of cover during the policy lifetime, but also contract certainty in their business operations.
Risk sharing and XOL
While both cancellable and non-cancellable credit insurance involve some form of risk retention, with the latter risk sharing is agreed up front, in the form of a deductible set to reflect the insured’s loss experience, risk tolerance, and financing arrangements.
Deductibles may be lower, or even non-existent, with cancellable coverage, but insureds could also be exposed to unexpected risk sharing if the carrier decides to cancel and/or reduce coverage limits during the policy lifetime.
Coverage for credit risks can also be structured on either a ground-up or XOL basis. A ground-up policy will cover frequency losses. However, in certain situations a limit on a large buyer might be reduced or cancelled when it is needed the most since this buyer may represent a significant part of the client’s income. Loss of such a limit or buyer in the middle of a downturn may trigger financial instability of the insured. With the prospect of a greater frequency of major insolvencies in 2022, the potential benefits of an XOL cover for these systemically relevant losses is therefore clear to see.
Another difference between cancellable and non-cancellable policies is that while carriers effectively take control of the insureds’ credit management with a cancellable cover, on XOL policies with non-cancellable limits the insurer allows more freedom for policyholders to take key decisions themselves.
Of course, not every business is large enough to employ a team of credit managers. However, the non-cancellable XOL market has evolved its offering to make it easier for smaller and medium-sized companies to take control of their credit risks.
So called hybrid policies are one solution, which specifically address companies that are looking to benefit from non-cancellable cover, but still want to rely on insurers’ support to manage credit limits on their behalf. Some insurers have started to blend solutions, e.g. with cancellable limits on smaller buyers and non-cancellable limits for large buyers. AIG has gone a step further by using its TradEnable Xtra technology and its XOL experience to create a non-cancellable solution specifically designed for companies that are embarking on the journey to achieve full XOL-readiness over a period of time.
As a number of recent surveys have noted, CFOs repeatedly reference political risk as a key area of concern for their businesses.
Historically, political risks have been somewhat overlooked by the wider credit insurance community. But with the prospect of a perfect storm ahead, with rising insolvencies and political instability across multiple jurisdictions ahead — it makes sense to have a comprehensive policy that covers all non- payment scenarios — whether they are due to a buyer becoming insolvent, or to a currency transfer being blocked for political reasons.
A comprehensive non-cancellable policy will likely cover both economic and political risks which, combined with locked-in limits for the full policy term, gives insureds greater certainty in their business operations. Companies can not only protect their trade flows throughout the entire economic cycle, but can also stand by their customers during difficult periods. And if an insured’s customer base remains intact, the company’s own sales will recover more quickly, once a more robust trading environment returns.
Global trade is increasingly reliant on complex supply chains.
Companies will be keenly aware that the ability to trade more freely across multiple markets not only makes it easier for them to get back to sustainable growth, but also to be better-prepared for weathering the next economic storm.
We recognise that our clients include multinational organisations with global exposures and have therefore invested heavily in technology to support our trade credit offering, in order to help companies that trade globally to set up multinational insurance programmes.
Our new platform enables us to offer a quicker response to clients, while also enabling them to benefit from one of the largest multinational networks in the trade credit insurance sector. Certainty of cover for trade credit clients is effectively a life insurance policy for their business, that will enable them to trade through the most trying of conditions and into a new era of growth.
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