Retail Credit Insurance | In Practise

Retail Credit Insurance

Former Head of Commercial Underwriting, Euler Hermes UK

Learning outcomes

  • How credit insurance works
  • A hypothetical example of retail credit insurance
  • Cash flow profiles of a typical agreement between underwriter and retailer
  • How an underwriter looks at the risk profile of retailers
  • When and why an underwriter would typically cut coverage
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Executive Bio

Stephen Birmingham

Former Head of Commercial Underwriting, Euler Hermes UK

Steve has over 30 years experience in underwriting trade credit across various different industries. He spent 20 years at Euler Hermes, a leading global credit insurance company, which was one of th first company to reduce coverage for UK department stores in 2018. During his time at Euler Hermes, he oversaw the £80bn commercial underwriting portfolio. Prior to managing the portfolio, Steve led pricing and product development for commercial insurance. Steve remains one of the most experienced underwriters in the UK and has a deep understanding of the frameworks underwriters use when providing insurance for corporates.Read more

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I think a good place to start would be for you to give a bit of background. How did you start in the credit insurance business?

I was a banker and moved from the retail banking side to the corporate banking side, which was really what I was very interested in. I'd spent some time working overseas for a Portuguese bank. I came back to London and went to join this Portuguese bank there. I was in the lending services, the special recovery area of one of the high streets. And then I went out to Portugal, came back and then went to be the credit analyst for this Portuguese bank in London. Also, at some strange point, I ended up heading up their documentary credits department as well. So I was doing credit analysis and doc credits. Suddenly, it got to 1992 and I must admit I was falling out of love with banking. I still liked the financial assessment side of things and then this role came up at a company called Trading Indemnity, which was then the UK's primary credit insurer. And it was really on the risk analysis, credit analysis side that I joined them. They were getting a bit more sophisticated in how they looked at risk at that particular point in time, as an underwriter. And then, after a short period of time, I liked the look of one of these trade underwriter roles that they had and I moved across into trade insurance underwriting. So I became an underwriter with them. And then after that, stayed an underwriter and at one point, you used to wear two hats, you wore the hat of the risk analyst and you also wore the hat of the commercial side of things. And then they split that function and I went down the commercial side rather than the risk side. Then after that, it was looking after a specific trade sector. I used to look after the electronics trade sector and I then moved on to the multinational business side. I then had various portfolios of account management. I eventually ended up the group's head of commercial underwriting in Paris. I then went back into the front office again, I was a regional director for one of their largest multinational regions in Northern Europe. And that was it.

I've always said it's closer to banking than it is to insurance. I also like the question: "Where does it fit in?" If you ask someone, "What do you do?" Well, the fact is you protect a company, protect a company from potentially failing because it's not paid by people.

In terms of the start of the industry, was Trade Indemnity one of the first companies?

That's a good question. The first company was actually in the States, a company called American Credit Indemnity. This was around about 1890 or something like that. It was the first company that started credit insurance. Actually, if I'm not mistaken, at that time, it was a spin-off from Dun & Bradstreet. So Dun & Bradstreet were there providing all this company information and at some point in time someone turned around and said, "Actually, we quite like the idea of this. Rather than just saying, we believe a company is good enough, we'll sit behind it. We'll actually put our money where our mouth is, effectively. And we'll insure that that payment we've said is good is good." Then, there was a bit of a gap. So that kicked off at the end of the nineteenth century. After the end of the First World War, when nobody really trusted anybody to trade with them anymore, there was a real concern about how we were going to start getting trade moving. At that point, each of the main countries in Europe started their own credit insurance markets. So that was when Trade Indemnity came into play. Actually, it was the brainchild of Cuthbert Heath, who I think you will probably know from the insurance company, CE Heath, who have gone on to many different iterations after that. It was really to start people trading again. And the first industry sector, was timber. Nobody wanted to trade timber.

If you were explaining this to a layman, what is the actual purpose and function of the credit insurance business?

What the actual function is: say I'm a company and I manufacture whatever it is and I've got to the stage where either I've got a big contract possibility, I've got somebody I don't know very well or I want to go into a different line of business that I don't know about or I want to expand outside of my region, wherever that is. Effectively, it's like all insurance, it's an asset that I couldn't replace, it would cause me problems. I can then go along and say to a credit insurer, I want to ensure the trade credit receivable that is going to come out of this transaction and if I don't get paid, you'll pay me. Effectively, that's what it is, it's paying for the goods and services you have provided to another corporate entity.

So effectively the credit insurer pays the manufacturer for the goods that they are supplying to the retailer?

Yes. So, let's say I'm selling LCD/ OLED televisions and I get a call from somebody in France and they say, "I want to buy a large quantity of your products." The first thing I can do is turn around and say, "Sure, you send me the cash and I'll send you the goods." Obviously, that isn't the most advantageous business relationship for both parties but it's the most secure. Or, I could decide, because I'm happy with what I perceive the risk to be, to say, "Sure, I'll allow you to have those goods and you can pay me in 120 days time, giving you the time to go and sell those goods yourself and I trust that you are going to pay me and that there will be no problems in that 120 Days." Obviously, there is a whole heap of working capital decisions that you need to take into consideration during that time scale. If you go for the cash option then brilliant, but you're not going to get much of a margin. If you go for the risk one, you're probably going to get a better margin but you are going to have to arrange to cover that transaction with financing or with your own assets or whatever. Hopefully that gives you an idea.

If you don't do that, if you do go open credit and you are waiting 120 days and the money doesn't turn up, what do you do next? Credit insurance gives you the ability to actually claim.

Looking at the business model, let's take an example, there's a supply worth £100, for example, an OEM is supplying a retailer. What is typically the premium that the supplier pays on this?

You've got all sorts of options here, which is why this is a difficult one to answer quickly. You could cover a single transaction, you could cover just that one transaction and go into the market with a single risk credit insurance policy. The normal pricing of that, for a single risk, you would potentially get an indemnification level of 90%. You can get an indemnification level of 100%, the difference between the two is that one of them would be: you could only claim for losses that effectively happened during the policy period - the 90% one tends to cover what is called the losses attaching, risks attaching, which effectively means that there is a run-off of risk for whatever the trade credit period is for those last deliveries made on the last day of the policy. With the credit insurance on a single risk, they assess the risk in exactly the same way as a bank does, the only difference really is that they are fundamentally deciding whether or not that company is going to be good for that risk, up to a year from now. Whereas a bank has the benefits of the bank, it will have security, other assets and whatever, other rights of redress and probably has a longer banking relationship than just the 12-month period that most of the short-term credit insurance people are writing their policies for.

The credit insurer will grade that risk on a scale of 1 to 10. Normally, 1 would be potentially triple A, and 10 tends to be technically insolvent or otherwise ceased to trade or something like that. But, to get a single risk, there is a fundamental difference because not many trade credit insurance companies will insure any risk that is graded 6 or higher. So they will only provide single risk policies from grade 1 to 5.

If we just take Debenhams and House of Fraser and those retailers in question of late, what is typically the relationship then between the credit insurer and these retailers?

There could have been some single risk support for these particular retailers. But, fundamentally, it's the other way round. What you generally tend to get is a company, because that particular form of insurance is highly selective and very expensive and the insurers themselves tend to shy away from concentrated risk situations, so most of the insurers in the market will turn around and say that it is actually more economically viable for both parties - we get a better spread of risk, you get a better pricing - if you give us your whole turnover, not concentrating just on one single risk.

So, if we take the example of Debenhams and House of Fraser, there are obviously multiple supplies, everything from electronics to clothing to whatever. They've probably got hundreds of suppliers. Let's take a company that manufactures towels and bathroom stuff, and let's say they've got a turnover of £20 million or something like that. They've probably got on their trade debtor list something like 50 to 60 companies buying from them. So, what the underwriter then says to them is, "Bring us all of those 60 buyers, we'll set you a level where we are happy with your collections, happy with your internal systems on setting credit levels. But, anything above that, you have to come in to us for a limit." The underwriter then assesses those risks. Let's say, out of those 60, 15 fall outside of 20,000 credit limit. This company is supplying 45 companies, that are below 20,000 credit limit. Anything above that, the insurer will look at those limits and say whether or not they are happy to write them or not.

Let's say you've got Debenhams, House of Fraser and 3 other top buyers, subject to its appetite, the credit insurer will come back and say I'm happy with 100,000 on company A, 100,000 on company B, 50,000 on company C, et cetera. The company insuring their debtors will then say, "My total turnover is £60 million," or whatever figure, and then the underwriter will charge them a rate against that 60 million turnover level. Now, if you want to know the rough ideal levels, an SME say up to £1 million turnover, can expect to pay anything up from about 0.25% on turnover, subject to their bad debt record and also their risk appetite. A company with a turnover of £10 million to 50 million can probably expect to pay something round about 0.2% on turnover, a company from £50 to 100 million we're looking at paying 0.15% on turnover, over £100 million and you'll be looking at something around about 0.09% on turnover. When you start to get up to the multinational companies, they're looking at, depending on turnover, anything between 0.25 to 0.09% on turnover.

So, a way of looking at it, let's say there's a company with 60 million turnover, let's say that's a rate of 0.2%, so they'll pay £120,000 of premium. Then the credit insurers will then apply a maximum liability to that premium level, which is roughly in the regions of about 25 times up to 100 times the premiums for an SME. So let's say this one sits in the middle somewhere. So they would get 50 times the premium they pay, so 50 times the £120,000. That's the maximum they can claim under that policy.

So you don't ensure the full amount of the receivables for the supplier, there is a certain limit to that based on the premium size?

Yes, indeed. Generally speaking, it will be more than the top two limits or something like that.

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Retail Credit Insurance

November 5, 2019

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