Firms are exposed to events affecting their raw materials and parts. And global supply chains are becoming more vulnerable, writes Liz Booth.

When after some 30 years in the reinsurance industry, your sector finally makes it to the front page of the UK’s Financial Times, it can be a double-edged sword. As one industry insider says: “It’s great that my children finally understand what I do, but not so great that we are getting bad press.”

And that is how it has been for credit insurers and reinsurers this spring. For the first time in many years, the sector has hit the headlines with stories of a lack of capacity and companies left uninsured. Players are quick to refute the stories, saying there is plenty of capacity, but after many benign years, the state of play was bound to change.

Almost every company has been affected by the credit crisis in some way. Even those that operate in so-called ‘recession-proof’ industries still face challenges, impacting their need for credit insurance. The entire supply chain has been affected. Any company supplying any product to an end retailer has to be concerned not just with the credit worthiness of its customers but also of its suppliers.

An unexpected event affecting the source of raw materials or parts could leave firms unable to deliver. In such a harsh climate, that may result in an immediate loss of desperately needed income – and the long-term loss of the entire contract.

A new report from broker Aon suggests global supply chains are becoming more vulnerable to

disruption. According to its Political Risk Map, the number of countries with “supply chain vulnerability” has increased from 38 to 54, because of risks ranging from government embargo or interference with a supplier through to strikes, terrorism and sabotage. Phil Bonner, responsible for the Centre of Excellence for Credit & Financial Risks at Aon Benfield, says that risk levels have increased in trade credit and surety business, and that “it is not illogical” to believe this could extend to cross-border difficulties triggering political risk events. “Any increase in the risk environment is of concern. Reinsurers are very nervous as to how results will develop across the financial risk classes. The reinsurance market has hardened for trade credit business quite dramatically, and, while the reaction has not been as extreme for the PRI market, reinsurers’ approach to the class has become more conservative. Original rates are increasing dramatically, although the impact on reinsurance pricing to this point has been less pronounced.”

He says that Ukraine is the major concern for the PRI market. “It’s limited to the bank risk rather than along supply chains, but Eastern Europe is a concern generally. There is significant potential for accumulation of losses across a number of carriers – something reinsurers are very aware of.”

Alex Hindson, head of enterprise risk management at Aon Global Risk Consulting, adds that the key to managing supply chain risk is to understand what those risks are. “Mitigation might include multiple sourcing, safety stock holding, consignment stock or business continuity plans based on rerouting manufacturing through alternative manufacturing facilities,” he says.

Commercial credit agency Graydon UK, which is jointly owned by credit insurers Coface, Atradius and Euler Hermes, has reported fewer than 10% of companies that use credit insurance have stopped buying the cover, despite premium increases of up to 40%.

But the UK government has criticised the industry following claims from unhappy customers over the widespread withdrawal of protection and suggestions that the credit insurance industry has seized up. Rating agency Moody’s warns that the industry is facing a challenging period characterised by a sharp increase in claims and a subsequent deterioration in profitability and capitalisation.

The agency expects the economic environment to remain challenging for at least the next 18 months and although it expects credit insurers to partially mitigate the effects of this crisis thanks to a high degree of flexibility in their underwriting processes, it predicts further deterioration in loss ratios in most countries.

Aon’s Bonner believes the rising cost of insurance – and of reinsurance – is part of a normal cycle. He says the economic environment is the “fundamental issue”, but believes there has been a misunderstanding about capacity.

The risk environment has changed dramatically in the past few months and insurers have reacted by increasing prices. He says that reinsurance programmes placed by his team have all been completed but, in many cases, at a higher cost for insurers – something he suspects will be passed on to clients.

“The old adage used to be five years of profits to pay for two years of claims,” he says, adding that more claims will undoubtedly filter through the system this year. Reinsurers and insurers are being especially cautious, tailoring capacity and asking more questions.

In general terms the market has been stable for a number of years. Even now Bonner reports few dramatic changes of philosophy among the major market participants; there has even been some new capacity, with two groups based out of Europe writing new reinsurance accounts from 1 January.

At one of those, Jacopo D’Antonio, president and chief underwriting officer, Aspen Re Europe, says they analysed the market carefully ahead of the first business in January. He says the decision to enter the market is consistent with the company’s diversification strategy and will offer long-term benefits.

He says that the rapid deterioration in the market in the last quarter of 2008 has increased pressure on insurers and resulted in some bad press. “But actually it is the job of the insurers to manage their exposures. What you are seeing now is a more technical approach to this product.” He says there are more claims but no increase in their severity.

The biggest risk for reinsurers and insurers is a sudden change in circumstances. Generally, he says, insurers see signs of problems and can manage themselves out of exposure but a sudden collapse of a big firm, such as KMart in the US or, to a lesser extent, Woolworths in the UK, can create large claims.

Certain countries and sectors are expected to fare worse then others. Winfried Knust, underwriting manager credit, bond & political risk for Aspen Re Europe, names Spain as a problem country, while the construction industry anywhere is also high risk. The automotive industry, particularly in the US, is another high-risk sector but problems have been identified for some time, allowing insurers to manage their exposures.

“The large credit insurers are pretty sophisticated in the way they manage increasing risks on a day-by-day basis. They know at every stage if a company has a problem.”

One positive step for the credit sector is that rising prices may help spark innovation. Aon’s Hindson points to Zurich’s recently developed supply chain solution with all-risks cover, including financial risks, regulatory issues and strikes. “The problem with the insurance market cycle is that it is quite difficult to innovate in a soft market because rates are too low,” he says. “Now it should be possible – although clients’ budgets are stretched. Timing is the key and it is an opportunity to be seen to offer more value.”

Liz Booth is a freelance journalist.