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.

Take Debenhams and House of Fraser, let's say, you have a small supplier, a fashion brand, and they have £60 million turnover for this example. They're selling £5 million to Debenhams and £5 million to House of Fraser. They approach the credit insurer and say they want to underwrite some of this risk for the receivables of each, what is the process then and what are the typical terms of a contract or policy?

Let's go back to the new business stage. They'd look at the top 15 buyers. Normally speaking, they would be looking to insure around about between 65 to 85% of those top credits. That's the sort of normal level that you would expect at a new business stage.

Yes, the top buyers. What that then means is that anything below this discretionary level that I mentioned, the other 40 buyers, are covered in full, subject to them complying to the policy terms and conditions. For those top buyers, they are being constantly monitored by the credit insurance companies, in the same way as a bank would be monitoring their risk profile.

Just to be clear: the supplier gets the smaller buyers insured completely because the top buyers are only insured up to a certain indemnity level previously disclosed?

The indemnity level still applies. The normal structure would be that 90% would be covered. I'm talking about a company with a £60 million turnover, it would be 90% coverage of all debts. There would be a first loss, in the same way as you would have a first loss on your car insurance, to take out all the attritional small losses. There are other technical first losses they can include or tier losses they can include in there. But normally speaking, for a company of that level, you're talking 90% indemnity level. When you start to get above £100 million, companies can start to negotiate for 95% indemnity level. In some circumstances, you can get 100% indemnity, but again, that only tends to be for losses that happen when they're buying the policy, and also 100% applies when someone is normally taking a catastrophe type policy.

No, it's 90% of the claim amount. So, let's say for example that the top buyer, buyer A, has a credit limit that's been written of £100,000, and a claim comes in. Let's say the claim is £100,000. It can be more than that, which I'll explain in a minute. Then, the underwriter will send a cheque, if everything is in order for £90,000. Now, of course, that credit limit that's been requested, that is the invoice value so it includes any profit margin

So when credit insurance started back in 1918, the maximum indemnity level at that point in time was always deemed to be 75% and no higher because no insurer wanted to cover the profit of the supplier. Those levels have changed over time. So you need to build in the fact that you are covering all the invoices, which includes the profit margin. And it's paying out 90% of the total invoices that are insured.

It could be that, because it's a strategic account or whatever, it could be that the supplier says, "Thanks credit insurer, thank you for your £100,000, but I'm still going to go and supply them £500,000." In that instance, the credit insurer will pay out the 90% of the £100,000 limit that is agreed.

You have two policy types, mainly. Firstly, you have the losses occurring. Let's say that the policy period is 1st January to 31st December, if the loss happens in the policy period, then the supplier can claim for the insolvency. That tends to be an insolvency only policy. The vast majority of policies are losses attaching and they include insolvency and protracted default. So, even though a policy might be for a one-year period, the policy also covers any trade that's undertaken on the last day of the policy period. So if you've got 90 days credit, what an insurer tends to do is say, "Right, you've got 90 days credit, you've then got 30 days where you can negotiate an extension of the credit within your own powers and you've then got 180 days to make a claim." So the risk window of the insurer is actually not just that 1-year period but it's actually 1 year and 9 months. It could even be 1 year and 10 months.

Also, policies generally tend to cover what are called binding orders or they cover something that is called a delayed effect of cancelation. So, in all this time, these limits are dynamic. There is a period of grace where the supplier can continue to use that limit, if they can prove that they've got transactions that are binding or they can prove that there's a continuous order of transactions. This is where sometimes it gets confused, when there is a suggestion that insurers have cancelled cover on somebody and are not writing new cover, it could either mean they're continuing to keep the cover they had or they're in the run-off situation. So the suppliers continue to supply, insured for whatever period they have agreed within their contracts.

So when you see the news about Debenhams or insurers are cutting coverage, it doesn't mean that they're stopping all coverage to the retailers. Typically what does that mean, if you take the case of Debenhams and House of Fraser?

I don't know the specifics of those two cases at the moment.

In which situations would the insurer cut? Would they be looking at net leverage or EBITDA  generation? What exactly would cause them to do that?

The fundamental reason for cutting, considering that they assess the risk more or less on the same basis as a bank will, the first trigger tends to be a delay in payment.

So the delay in payables increasing for the retailer?

It could just be, yes. In 90-95% of the credit insurance policies that are in existence, there is a reporting requirement. When an account goes beyond a certain period, as I say, normally it's the terms of payment plus a period where there's a flexibility for the supplier to negotiate something with the buyer. When it goes beyond that, the supplier is required to submit a return to the underwriter showing the delinquent accounts. Obviously, that always tends to prompt a conversation between the underwriter and the supplier to find out why. It could be a dispute if the goods were no good, so they have to indicate that. In addition to that, the underwriters have massive databases, huge databases of information they receive. There's the payment side of it but they will still continue to get all of the information that you would expect them to get, whether or not it's monthly reporting, quarterly reporting, et cetera.

They're basically analysing like a credit analyst would at a fund or a bank.

At what stage does it get to where credit insurers say, "I've had enough and I'm cutting coverage or I'm cutting complete coverage for Debenhams going forward"? Does it work on a supplier by supplier basis?

First things first, it's very rare that an underwriter will cut cover on any buyer, without consulting the supplier and having a full discussion with the supplier. And, in many cases, also then having a discussion with the buyer as well. I think it's hard to contemplate the number of credit limits that the underwriters are writing each day. It's enormous and the speed that they do it as well.

I think the final nail in the coffin for some of these retailers is typically the kind of insurance coverage for suppliers. How should we look at that, what are the signals to the credit insurer that tell them when to cut coverage?

It would be that the insurer didn't believe that the buyer is going to be able to meet their obligations as and when they are due.

So that would come from the analysis of the type of debt they have?

Absolutely. It's literally that. I can remember discussions with a high profile distributor into the food and beverage sector and our analyst had received the management pack. We had indicated for a while that we weren't comfortable with the amount of exposure and the performance of the company. The company provided full cash flow and full forecasts and we were monitoring the performance of the company against the forecasts. This particular one was constantly falling behind its forecasts but was still showing a level profitability. Clearly, the conversation was along the lines of: "We know, we are in the middle of a refinancing." So there was an enormous amount of discussion between this company and its bankers and the insurers. Our analysts would always go along to the various meetings, as well as receiving the pack. We'd have regular buyer meetings. Eventually, it got to the stage where, in the same way  as it does in any credit assessment, the view was that this company wasn't able to continue to perform its liabilities.

When we say 'cutting coverage,' does that mean the insurer is no longer underwriting the receivables from the retailer or that the coverage is now costing more?

There isn't normally a mechanism to charge more. There are a couple of top-up products, which the suppliers can take advantage of where they can pay more, but that's not in a potential default scenario.

What do suppliers do from there then? Let's take that example of Debenhams and House of Fraser again, if I'm the supplier, £50-60 million top line and I've got a big line of business at Debenhams. Euler Hermes comes to me and says, "We're cutting coverage and not underwriting this risk anymore," does the supplier then have a decision to take on that risk or not?

I think the supplier has a number of  options they can go to. They could take the risk themselves, they could tighten their credit payment period that they're using, or they can seek some additional support security for the transaction, which can all be done.

So you put greater stress on the retailer i.e. cash up front or security or you potentially look for alternative financing options?

I think again the important thing to understand here is that for most credit insurers, it is the last decision they take not to cover a buyer. At the point that they turn around and say that they are not covering that buy any more, they don't receive any income. That whole turnover element, the supplier doesn't pay anything anymore going forward for any future supplies that they might make. But there would have been an enormous amount of assessment before they would have made that decision to stop cover.

Do you see any other insurers picking up that coverage if they do lose it it? All risk has a price right. I'm curious if the credit insurers compete in that manner?

It's always the choice of other underwriters if they want to take that risk or not.

It doesn't always work that way. There might be someone who's happy to take that risk for a particular reason. Some of the underwriters are more embedded in certain sectors,  so have greater information in certain sectors. There's one underwriter that is very very much an expert in the construction industry for example, and they will take risks that the other underwriters won't take.

Let's take a situation where an insurer cuts coverage, what would make an insurer take a risk again for the same line of business? For example, you cut coverage for Debenhams, would you then underwrite Debenhams' business in 6 months time or a year's time? Is it possible to win back the business?

It is possible, yes. This is just a hypothetical situation but let's say a company was continually saying that they were going to get a refinancing package, but the refinancing package didn't happen and everything looked towards the fact that the company would cease to trade. But then, suddenly, at the last minute, there's a white knight investor who comes in and pumps all the money in the world into the business that it needs to survive. There's no reason why a credit insurer wouldn't come back on risk on that particular buyer. Obviously, there would have to be a discussion and proof that the funding was in place. So, yes, it is possible, but it has to be understood: is it that we're not taking anymore cover, or is it scaling down the amount of cover that we have already had, or is it we are not providing cover to any supplies going forward. We've got our run-off of risk, we believe that this is a terminal situation and we want to get out of the risk now - and this is the important thing again - we're advising our suppliers that we are not covering. We'll probably turn around and say to them that we will only cover it in the following situation, if these things were to happen. But the advice is from the underwriter to the supplier: "Only trade with this company if you can get some form of security," or in short terms "If you can get cash."

Does the supplier only have one credit insurer for the whole business?

Generally, because most of the policies are whole turnover, a lot of the smaller companies will only have one. But, there is quite an active broking market. So let's say for example, that you're that company with the three top buyers and after 6 months the underwriter turns around and says, "I don't like one of these anymore, I've got signs of payment default, I've got signs that the cash flow forecast is not there, no funding, I believe it's going to fail. I'm not going to write any cover going forward." That company can then go into the market and see if there is somebody out there with the appetite to take that risk. That is absolutely possible and in that particular situation you can get further cover. There are situations also where you can get top-up cover. For example, for those three limits, rather than completely taking the limit away they go from 150 down to 75. It's possible to get that other 75 from somewhere else. There is an active top-up market. So then you could have two insurers on the same risk. Or you could have a nil covered by somebody else who just has a better appetite in that particular sector. As I mentioned before, there's an underwriter that's an expert in the construction market that will take risks that others don't take and each of the underwriters tend to have a specialism in a particular area.

If you look at the credit insurance business as a whole, what are the pressures or types of environment that could define some of the coverage they offer to suppliers? Are there macro environments or whatever it may be that would make them tighter on coverage?

I think you've got a big one at the moment, you've got Brexit. Again, from a risk perspective, the underwriters will start with an economic review of a country, they would then look at the individual sectors within that country and then there is the individual review of the buyers within that sector. This information is always being monitored continually. So, yes, something like Brexit will affect that. Obviously, we all know in terms of the high street retailer space at the moment, it's struggling. There are some successful companies, I think Dunelm reported good results today. So there are still winners there, clearly. I think if you were to look at the amount of exposure still being written by the credit insurers, it probably has been adjusted for department stores and that sort of business, but they would still be covering a whole heap of other retailers in different spaces.

So they don't adjust by sector, it's more of a risk by risk, bottom up process?

Absolutely, yes. That's fundamental. Their perception of a particular country and their perception of a particular sector might change colour. It might go from a green / green to an amber or yellow. But, fundamentally, that decision about a particular buyer is made on an individual, case by case assessment.

You mentioned a days payable, days outstanding of a balance from the buyer to the supplier, are there any other specific metrics you would look at, say for analysing House of Fraser or Debenhams?

I guess the big thing is that there are a lot of things going on in that particular sector at the moment, which will influence an underwriter's decision. There's been a big move, as we know, recently, for retailers to use CVAs,

Is that an insolvency event in the contract?

So that would trigger the policy[inaudible 50:39]?

Chapter 11. They're all insolvency events. CVA: insolvency event. It's quite a factor to consider at the moment. I think, if you look across the retailer space in particular, some of the companies in the retailer space are probably going through their fourth or fifth iteration of CVA.

It's the same old story. That's an interesting point in terms of the CVAs. Do you look at that risk differently again after the CVA and analyse bottom up again in terms of underwriting the buyer?

Well, it's effectively a new entity isn't it. I'd like to say it's a clean page, but in some of these situations, it's not is it. You'd like someone to come along and say, "Yeah, we were £100 million short previously, that's all we needed to get through. And we've actually got £100 million of free cash in the business."

The key thing that I've found is that it's not very clear, particularly if we use a retail example, on the dynamics between supplier/ retailer/ insurer and how the system works, how they fit in, when coverage is cut and the impact on that line of business. Is there anything specific that we should be looking at?

I think it's all about communication. It's always made a bit more difficult when companies then turn around and the buyers, in particular, are insisting on the use of [inaudible 53:10], which we all know are far more prevalent than they used to be. And that example I used earlier about the company that was continuing to provide financial information to the underwriters on a regular basis, it was a full pack and everything else, and it suddenly stopped one day. They just suddenly decided, "No we're not sending that information anymore." Shortly afterwards, one of their biggest suppliers then just pulled the rug.

Do suppliers normally pull the rug or no? Let's say you cut coverage, obviously it's on a case by case basis whether the suppliers take that risk, but in your experience have you found that suppliers often follow the insurers and say, "Okay, I'm out, it's too risky"?

Not every time. Of course, one of the other things that I think is important to build in to any discussions is that, in terms of the sectors, an underwriter doesn't feel comfortable if they've got too much of the supply to that one buyer, because it then doesn't give them the ability to work with their suppliers to get out of the risk. In this particular example, it was actually one of the biggest suppliers to the buyer, much to everyone's shock, who wasn't insured, who pulled the rug. Some underwriters were out completely, some special situations were still in place. I don't think this particular buyer saw this as even the remotest potential, but it happened. At the same time, that supplier was negotiating other contracts and not telling this particular buyer. So it eventually got to the situation where they could replace this buyer in their supply chain and then cut this buyer loose and then it failed. That's probably another important thing to say is that when an insurer starts giving 'nils,' they are happy to look at new risks that the suppliers have. So they are happy to assess whether company A is better than company C.

Is there anything else in this topic that you think is important?

One of the important things I think at the moment, certainly in the retail space for me, is the question: "What's the strategy?" What is the strategy of these companies? Can they convince us? It's not just for insurance, it's for the whole market. Can they convince their own board? Can they convince their own shareholders, stakeholders and the market that they've got a viable model to operate in a changing environment? For me, I think that has to be one of the most fundamental things here. With all that's changing, what are their plans? Are they happy to share those plans with the underwriters, as they would the other players?

And they should always consider that the bank is most likely secured, the bond holders are most likely secured and then they've got their trade creditors sitting there unsecured and in there is this trade credit insurance market and the buyers probably realise too late how important the role that that trade credit insurance has in their business. And then that is something that I think they need to put a bit further forward.

Is that changing? How do they view insurers? Obviously, there's a signed secured debt holder effectively in the capital structure. Is that changing are they treating them more as secured?

I think there have been some situations where there has been additional support given to the credit insurer to make them more comfortable with the risk. That is possible and there are some difficult discussions that maybe need to be considered more frequently. Discussions where the bondholders and the banks sit down with the credit insurers and make sure that they all understand what direction they're going in. Again, you only need to hear that example of that company where their major supplier decided that they were going to pull out to see the importance of that. You need to ask: Has everyone got a common strategy? Because the moment that anything goes a little bit awry, suspicious gets in and people start taking decisions.

Do you see retailers willing to communicate more with credit insurers and involve them more in securing bondholder conversations?

Retail Credit Insurance

Former Head of Commercial Underwriting, Euler Hermes UK

inpractise.com/articles/retail-credit-insurance

Why is this interview interesting?

Executive Bio

Stephen Birmingham

Former Head of Commercial Underwriting, Euler Hermes UK

Interview Transcript

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Retail Credit Insurance(November 5, 2019)

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