The ITFA (International Trade and Forfaiting Association) recently released a new initiative in the form of a Basel III-compliant trade credit insurance policy form. Designed to assist insurers and financial institutions to negotiate new deals and help establish a standardized Basel III policy, the IFTA’s initiative also represents an effort to help trade credit insurers in an era where insurance companies are seriously re-evaluating how they operate.
Trade credit insurers, and the insurance industry as a whole, have been greatly challenged by the economic fallout created by the pandemic and the lockdowns. The frequency of insolvencies from commercial customers due to financial difficulty has risen greatly. Normally, credit insurers would cancel (or at least limit) coverage for buyers who display signs of being unable to pay.
But due to the serious economic situation created by the pandemic, there is now the dramatically increased risk of trade credit being withdrawn across the board. In this article, we’ll cover why insurance plans including TCIs have become more relevant since the start of the pandemic, how the IFTA’s new policy should help trade insurers, and then what we can expect the near future to look like for the insurance industry overall.
What is trade credit insurance?
Trade credit insurance, or TCI, protects businesses against the inability of commercial customers to pay for services or products. The inability of customers to pay may result from financial woes, bankruptcy, societal upheaval, or other factors. The purpose of a TCI plan is therefore to help businesses ensure they still receive proper cash flow as a result of doing business with a customer who won’t or can’t pay. Banks, in particular, utilize trade credit insurance for capital relief and to reduce financial risk when conducting transactions.
In many industries, it’s common for customers to take out a line of credit in order to make a large purchase. Of course, any business that lends money to customers is taking a risk that the total amount lent (in addition to any interest) will not be repaid. It’s even a greater risk when the debt is unsecured and there is no collateral to reinforce the loan.
A comprehensive TCI plan will compensate a business for any unpaid debt, depending on what the coverage limits and other details of the plan are. Since most lines of credit that businesses give for large purchases are unsecured, having a TCI plan in place will mitigate much of the risk. In other words, businesses with a TCI plan at the very least should be more comfortable with extending lines of credit to customers, and they will have a backup plan in the event that the entire debt is not paid.
Why the pandemic has demonstrated a need for insurance
Due to greater financial uncertainty since the pandemic began, there has been a drastic increase in the number of businesses and individuals alike applying for insurance coverage. It’s not just TCI plans either. The number of business owners applying for life insurance coverage, for instance, has increased dramatically as a means to protect their financial assets in the event that the worse happens.
It’s not hard to see why. Covid has proven to be deadly for patients who are older and/or have existing health issues. That’s most likely why the number of adults who have purchased a life insurance plan has increased to 50% of adults in Canada and 52% of adults in the United States.
If anything, the pandemic has demonstrated that there is a very real need for businesses and organizations to have an insurance plan (or plans) in place to help ensure financial stability in an increasingly volatile era. It’s also demonstrated a greatly increased demand for insurance coverage across a number of different policies and plans. Other insurance plans that are in greatly increased demand from business owners include general liability insurance, worker’s compensation insurance, and commercial property insurance.
And now that insurance companies (in general) are experiencing much higher demand since the start of the pandemic, there is much more uncertainty in regards to the timing and extent of claims, as well as the fact that most insurance agencies are being forced to increase premiums and raise additional capital to help reverse the decrease in return on equity. Like the businesses they are insuring, insurance companies themselves are likewise at increased risk.
Even though the policy by the ITFA is in regards to trade credit specifically, it may provide us with a blueprint on how risks and costs may be reduced for insurance companies overall as well as the financial institutions they work with.
What does the ITFA’s new policy form do?
Basel III is an international regulatory framework that was made as a response to the 2008 financial crisis. The new ‘harmonized’ Basel III-compliant policy form that was released is designed to help insurance companies and banks negotiate new deals as well as standardize a trade credit policy.
The new form covers receivables policies and is intended to generate more insurable opportunities while keeping costs and time spent to a minimum. As noted previously, banks and financial institutions often rely on TCIs for capital relief and to keep risk to a minimum. The issue, however, is that banks and TCI agencies often each possess their own Basel III policy forms.
When a bank and TCI agency attempt to work together, many hours or even days are spent on negotiating forms. This is difficult because all forms being negotiated are kept confidential and much work goes into settling on similar wording. Needless to say, negotiations can be extended and expensive.
The goal of the ITFA’s form is to ‘harmonize’ wording during negotiations between banks and insurance companies so that two primary goals are accomplished: one, that insurance carriers can more clearly based on their services provided and the details of their policies versus policy wordings, and so that banks can focus more on their pricing. To put it into simpler terms, it aims to standardize how insurance policies are worded.
As Sean Edwards, the CEO and Chairman of ITFA stated at the 2021 ITFA conference, “Consistency, predictability and a reliable form is paramount to regulatory bodies further recognizing trade credit insurance as a viable risk transfer mechanism for capital substitution. We need all banks, insurance companies, law firms, and brokers moving in the same direction if we are to grow the overall industry.”
Streamlining policy negotiations between banks and insurance companies with standardized wording is certainly one way to provide relief to insurance companies, and one that could be applied to other insurance companies outside of TCI carriers as well.
Other actions include governments offering their support to insurance markets by guaranteeing transactions made by insurance companies through reinsurance agreements and, in the case of the European Union, having export credit agencies ensure short-term trading risks instead of private insurance companies.
As the world starts to emerge out of the economic crisis generated by the pandemic, private businesses, banks, and insurance companies are all at greater risk than they were before. Insurance companies including TCIs are in a position where their services are in much greater demand than before, and they need to minimize financial losses. The move by the ITFA to standardize language and streamline negotiations between banks and insurers is one-way costs can be reduced.