The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2017

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All change

Bernard Goyder

It is a busy time to be a political risk and trade credit underwriter.

The UK is plunging out of the EU and Donald Trump is now US president. A move by countries towards greater protectionism could see trade credit losses rise. And a more isolationist US would have unpredictable consequences and push up demand for political risk cover.

David Anderson, credit and political risk head at Zurich, says he is already starting to receive Trump-related queries: "We are seeing some types of enquiries that we haven't seen before, [from] firms from outside the United States who are concerned about tariffs going up."

The problem is that it is hard to insure against a policy a politician has said they will carry out. As Anderson tells Insider Quarterly, insureds are "looking for loss of profitability coverage, in the event that the US would raise tariffs. That is not a product that we have and I'm not sure anyone has it".

Front page news
Political risk and trade credit insurers work with banks, trading houses and corporations to mitigate against the consequences of revolutions, financial crises, insolvencies and wars.

But as soon as these events actually happen, it tends to be too late for the insurance market.

"Once a risk has hit the front pages of a newspaper it's going to be difficult to find coverage for it," says Anderson.

For Jeremy Shallow, Argo Global's credit and political risks class underwriter, the Brexit referendum and Trump's election present an opportunity for the market.

"Change brings concern over risk," Shallow argues. "Ultimately, when we are selling products which people don't have to buy, if there is more fear and there is more perception that risk exists, that should be good for us to sell insurance."

Shallow thinks that Brexit will push manufacturers in the UK to look to markets outside the EU. And UK companies venturing further afield will be a "positive thing" for trade credit insurance providers, he says.

With UK exporters lacking certainty about how reliable their new customers in emerging markets will prove to be, an increase in UK trade with the developing world "may push them to make the discretionary purchase - which is buying some cover from me", says Shallow.

Different dynamics
Kade Spears, who heads The Channel Syndicate's political risk book, says he receives between 400 and 500 enquiries a month from brokers, compared to just a few a week when he started his career in the 1990s. However, he adds, in 2016 he underwrote less than 3 percent of the deals the syndicate saw.

"We are highly selective" he says. "Understanding credit is different to understanding political risk. You have to have the right models. You have to have the right support."

Underwriting capacity in the market has doubled since 2010, according to Anderson. The recent entrants include Sompo Canopius, which was reported in February to have taken on a duo of credit insurers from AIG, while three more hires to its fledgling trade credit team are said to be pending.

"A lot of people came into this market looking at the track record pre-2009, and in political risk in particular it was a very benign track record," recalls Anderson. "But, post-2010 there is much more claims activity, particularly in political violence and forced abandonment."

The Washington DC-based executive notes that pricing has been falling since 2010, but is now starting to stabilise.

Political risk and trade credit insurance has different pricing dynamics to other insurance lines, as political instability and economic turmoil push up the pricing for individual countries. In Turkey, for example, where the government survived an attempted coup in July 2016, the cost of political risk insurance is increasing.

"We have seen pricing tick up quite substantially in Turkey" says Argo's Shallow, a view echoed by other political risk underwriters Insider Quarterly spoke to.

Venezuela, meanwhile, is off risk for Argo. "It's just too hot for us," Shallow says.

Trump card
While troubled areas such as Ukraine, Libya and Yemen have been the hotspots for political violence risks in recent years, the landscape is shifting as the first "Trump era" claims start to come in.

In January this year, in response to a hike in petrol prices, rioters in Mexico took to emptying supermarkets. While Donald Trump cannot be blamed for the Mexican government's decision to cut fuel subsidies on 27 December 2016, the US president's tweets - both before and after his inauguration in January this year - have led to currency market falls in the Mexican peso, in turn increasing the cost of living for the Mexican population.

The unrest in Mexico is expected to lead to claims of between $200mn and $250mn across all markets. Walmart, for instance, is understood to have put in a claim of $60mn-$70mn following the riots against its wide-ranging global political risk policy, which is led by QBE.

The claim demonstrates the depth of cover available for political events in the specialty insurance market. Cover for political violence, including strikes, riots and civil commotion, is often taken on by political risk underwriters, despite being the mainstay of the standalone political violence market.

Regulatory push
More than half of the clients that use the global political risk and trade credit insurance market are banks. Since the financial crisis, there have been lending constraints imposed on banks, with the industry's version of Solvency II, known as Basel III, forcing firms to set a certain amount of capital aside for a rainy day.

Sophisticated lenders, such as HSBC and JP Morgan, have the option of buying insurance to get capital relief. The regulatory changes imposed after the 2008 financial crisis pushed bankers, especially those in the world of trade finance and emerging market lending, into the arms of the political risk and trade credit insurance sector.

Business is also coming to the political risk and trade credit market from export credit agencies (ECAs). Zurich's Anderson says he has seen more of these government agencies turning to the insurance market. According to Anderson, state-run export finance lenders, such as UK Export Finance, are under pressure from governments to be more autonomous in managing their portfolios prudently for taxpayers. The ECAs buy big chunks of treaty reinsurance, as well as purchasing trade credit insurance for specific deals.

Other big customers include the commodity trading houses - companies like Glencore, Trafigura and Vitol. These big traders are now acting like banks themselves, using their vast balance sheets to finance commodity purchases.

The banks and trading houses are buyers of single situation trade credit. These are big ticket transactions that the insurance market gobbles up on a case by case basis.

For instance, if a company is buying all of the oil in Angola one month to sell to the export market, or is financing a power station in Tunisia, it might tap into this market to alleviate the risk.

Major claims
Companies with long supply chains are more likely to purchase a different kind of trade credit cover: insurance against suppliers not paying up, often due to insolvency.

Insurers are particularly worried about so-called "torpedo claims", where insolvencies come out of the blue. As Tim Fisher, managing director at AJ Gallagher, says, these claims concern "companies where one day they are creditworthy and they just fall over the next day".

After the mobile phone retailer Phones4U went bust in September 2014, for example, insurers had to cough up between £30mn and £35mn in claims.

And the collapse of Hanjin Shipping Co in 2016 is an example of where things can go wrong on a bigger scale. It isn't clear yet what the tab for the trade credit insurers will be following the shipping company's demise, but as one broker puts it: "Hanjin is huge."

The South Korean shipping firm was officially declared bankrupt on 17 February 2017 and trade credit insurers will now have to cover the losses to banks that financed the goods currently stuck on Hanjin vessels waylaid by the company's collapse.

Banks use letters of credit and extend trade receivables - ultra-short-term loans - to support trade around the world, which in turn are insured by carriers such as Euler Hermes, Coface and Atradius.

Trade finance defaults are rare, but costly. One spectacular example came in 2014, when metal that had been put up as collateral in Qingdao, China, for millions of dollars of lending was found not to exist. Banks and trading firms were hit hard by the resulting $3bn fraud.

And insolvencies are on the rise. Euler Hermes, the massive Allianz-owned trade credit carrier, said it expects global bankruptcies to increase by 1 percent in 2017. An increase in insolvencies could lead to more trade credit claims, and put pressure on pricing.

Prices for both political risk and trade credit insurance are already starting to edge upwards. As Zurich's Anderson says: "With some of the dislocation we've seen recently in the market, you're starting to perceive a hardening of pricing, but on individual risks I think underwriters can still be quite aggressive." Shallow agrees that pricing is getting more disciplined in the political risk market.

As Trump's presidency gathers momentum, and the UK formulates its plans for leaving the EU, the political risk book presents a conundrum for carriers.

Should insurers invest resources in what promises to be a growth area? Or do they hold back, taking the hardening price environment and the chaotic geopolitical landscape as a signal to proceed with caution?


This article was published as part of issue Spring 2017

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