As American exporters look toward a recovery in 2010, many will be asking the same question: Should I invest in credit insurance?

It’s not a simple question. On the one hand, the depth, length and global nature of the recession forced hundreds of overseas buyers into bankruptcy, leaving countless U.S. firms out cold; had they purchased credit insurance, they could have recovered up to 95 percent of their losses.

But the unprecedented size of the recession also forced insurers to pare back their coverage limits and even cut off clients completely, sometimes with little or no warning. Some experts expect up to a 20 percent reduction in capacity during 2010.

“We made every effort to proactively contact customers,” says Anthony Barrett, vice president and senior manager of risks services at Atradius, a major credit insurer. “But we have to acknowledge that the depth and rate of decline in the economy was such that we couldn’t hope to aspire to same level of communication that we like to provide.”

Indeed, in early 2009 the credit insurance market found itself in an uncomfortable situation: Exporters from across the economy were rushing to find an insurer willing to cover them, even as insurers were refusing to cover all but the safest of risks.

The result, says Bryan Squibb, president of Chicago-based insurance broker AU North America, is a paradox: The hypothetical case for credit insurance is stronger than ever, but for many potential customers, that case was significantly damaged by the insurers’ rush to safety during height of the recession.

“A year ago,” Squibb says, “as we really entered this recession, there was knee-jerk reaction from the big three” insurers-Atradius, Coface, and Euler Hermes, which collectively cover about 90 percent of the market-“and so we’re fighting a little bit against disappointed clients and prospects over what’s happened.”

The real question, then, is this: What happened over the last year, what can American exporters expect out of the credit insurance market in 2010-and how can they best position themselves to take advantage of it?

An overview of the market

Trade credit insurance, until recently a rarely purchased product in the United States, has gone big time-it generated almost $800 million in annual premiums last year in the U.S. market alone. And, that market has a lot of room to grow: In Europe, an economy of comparable size but with a much more mature insurance market, premiums bring in about $4 billion, with annual growth of about two percent. “Credit insurance is a lot larger in Europe,” says Squibb. “There, I have people who have been buying it for twenty years, whereas [in the United States], eight times out of ten I’m talking to a brand new buyer.”

Credit insurance emerged as a product in late nineteenth-century Europe, but it didn’t reach widespread use until after World War I. It blossomed during the economic booms of postwar Europe, when peace and rapid rebuilding saw cross-border trade reach epic proportions. Today, worldwide trade credit insurance is an $8 billion a year business, with 87 percent of that captured by just three firms: Euler Hermes (36 percent), Atradius (31 percent), and Coface (20 percent).

“In the States you are lucky enough to have a huge country, so when a small company thinks of expanding itself, it thinks of domestic expansion,” says Jean-Claude de Lassée, chairman and managing director of the French broker Assurance Universelle. “In Europe, that firm immediately thinks of exporting.”

American interest in credit insurance blossomed over the last decade, particularly from U.S. exporters that sell to developing markets. And, at least at first, customers found great deals-the big three found themselves forced by intense competition and low interest rates to keep reducing their premiums. This made sense in a growing economy where every new client meant more money and a relatively small risk of having to pay out a claim.

But in retrospect, this cycle wasn’t sustainable; once buyers started to fail, clients’ claims began to mount, and insurers feared that claims payouts could soon top premium income. According to a report by Marsh, a major credit insurance broker, 2008 saw loss ratios-or the percentage of each dollar earned that gets paid out in claims-reach catastrophic proportions: Coface saw 73 percent, Euler Hermes 78 percent, and Atradius an astounding 99 percent. (Loss ratios usually hover between 50 and 65 percent.) And though complete 2009 numbers are not yet available, the first part of last year saw even worse results, including an 88 percent loss ratio at Euler Hermes.

Claims volume tripled between mid-2008 and mid-2009, with a comparable rise in the dollar amount of losses. In the UK market, for instance, the Association of British Insurers reported that the claims value increased 166 percent between the first quarter of 2008 and the first quarter of 2009, to $509.4 million. The U.S. market saw comparable numbers. While the final numbers were not available at press time, some experts estimated that total worldwide claims for 2009 would total $4 billion.

The big three saw their party turn into a panic, and they began slashing limits, raising premiums, and even cutting off some clients completely. In a 2009 report, Marsh noted an “unprecedented reduction in available credit limits,” while some buyers “are not being offered renewal rates at any price.” In early April 2009, insurance customers were seeing renewal rates jump by as much as 30 percent.

What happened? On the surface, it was the same story as everywhere else in the economy: The crisis hit so quickly, and so severely, that no one knew what to do. “Two thousand nine was a significant year, unlike anything previous,” says Keith Dunford, vice president and worldwide underwriting manager for political risk at Chubb, which provides specialized mid-term credit coverage. “Most people haven’t been around long enough to recognize anything like this.”

But the problem was especially acute in credit insurance because for too long the decisions over whom to cover and at what rates were driven overwhelmingly by assessments of the client’s reliability and experience, rather than the markets into which they were selling.

Then, when buyers in those markets started collapsing and claims began pouring in, the situation reversed itself-suddenly even the most trustworthy clients couldn’t get sufficient coverage, simply because they traded in risky markets. “I think their risk management departments got ahead of themselves,” says Squibb.

The result was to torpedo the reputation of a product that was just beginning to win over buyers in the American market.

“I think they just cut and ran and forgot about communicating with clients,” says Evan Freely, head of the Global Political Risk and Trade Credit Practice at Marsh. “They were in survival mode, though never in danger of going bankrupt. They said, ‘We had to cut our limits, to do what we need to do.’ But as a result the reputation of their product suffered.”

ECAs Cushion the Blow

Some relief was provided by export credit agencies (ECAs), government-run or –sponsored institutions, like the Ex-Im Bank in the United States, that provide financing for exporters. In the face of dried up credit and scarce insurance, Ex-Im and others stepped into the breach. “Particularly for small businesses, there was a real retrenchment in credit and insurance, a real pull back,” says Ex-Im President Fred Hochburg.

In 2009, Ex-Im reached an all-time high for export financing, providing $21 billion in total financing, a 46 percent increase over 2008. It also offered insurance coverage for small- and medium-sized companies, with up to $5 million in annual export sales (along with discounted premiums and waived deductibles on first losses), a limit it increased to $7.5 million in November. “The private sector does not want to do transactions of that size,” says Hochburg. “The private sector walked away.”

Ex-Im’s performance was generally welcome and applauded by the private insurers and their customers. But not all ECAs were as successful. Though ECAs in Canada and Scandinavia won plaudits for their rapid and efficient response, the United Kingdom’s efforts were deemed an utter failure.

In May 2009, the British government introduced a “top up” insurance program that would provide supplemental coverage to customers who had seen their insurance limits reduced by private-sector insurers. As British Business Secretary Lord Mandelson said at the time, “This scheme will provide a much-needed breathing space for businesses suffering as a result of the reduction in trade credit insurance.”

The problem was that, wary of crowding out the private sector, the government plan offered unattractive rates and only covered firms that already had coverage, leaving those that had seen their coverage withdrawn out in the cold. “We will not prop up bad businesses or take unacceptably high risks,” said Mandelson. But in erring on the side of caution the UK government threw many babies out with the bathwater, denying coverage to viable, experienced firms that happened to sell to what the private sector suddenly believed were unacceptably risky markets.

     The result was predictable. By the first of December, only 18 million pounds, out of a total of 5 billion pounds available, had been claimed, despite the fact that the government reduced the premium rate from two to one percent in August to encourage interest.

Overall, the industry’s assessment of the ECAs’ performance is mixed. “The jury’s still out, but they did seem to have a calming effect on the marketplace, they did fill some niches,” says Mike Ferrante, chairman and CEO of Coface North America.

ECAs also present a dilemma for a recovering market, a question everyone will be chewing over in 2010. They are there to act when the private sector withdraws, but in doing so they run the risk of distorting the market. After all, when a private insurer decides to withdraw coverage from a certain exporter, is it over-reacting, or is it sending an informed signal to investors to keep away?

“One obvious issue is whether a government should ‘second guess’ private sector insurers experienced in underwriting trade credit risk,” argued a recent report by Marsh.

That, of course, assumes that the market always responds correctly. “There is a tremendous amount of imperfection in the insurance market, especially when we have a crisis,” said economist Gary Clyde Hufbauer, a former Treasury official and now a senior fellow at the Peterson Institute for International Economics. “A kind a panic situation can ripple right across it, especially when you have a crisis, and unless public agencies are ready to step in, you’ll have yet another additional problem.”

The issue, Hufbauer adds, is not the intentions of the ECAs, but their capabilities. “The problem is that they collectively are too small to really tune the corner. They just don’t have the financial muscle to do it.”

And few expect that, after almost eighteen months of public-sector money being pumped into the global economy, governments will be willing to step up their support for exports much further. Which means that in 2010, the focus is almost exclusively on what the private sector does next.

Turning the Corner

The bad news is that no one seems to know exactly what the private sector will do. “There’s so many different opinions,” says Freely. “Each carrier, each underwriter has a different strategy right now. One may be really high on retail, while another may say staying away. Some may say we’re shut out of an entire country.”

John Pontin, senior vice president in charge of sales an marketing at Euler Hermes, says the market is slowly turning a corner and will open up slightly in 2010. “The market is pulling itself out of the recession of the last few years. It’s on an upward swing. But it’s definitely in the infancy stage of that process.”

De Lassée, of Assurance Universelle, agrees. “The prospect for 2010 is that we will see new limits of guaranty being increased, because we think the worst of the crisis is behind us.”

Others say that even if limits increase, credit insurance rates are likely to stay high, settling into a new equilibrium-after all, they say, the pre-crash years saw rates driven to unsustainable lows by interest rates and intense competition.

Nevertheless, Marsh reports, 2009 demand was up by 18 percent over the previous year, indicating that for all the frustration with insurance providers, the underlying value of the product is still compelling. Adds Pontin, “Interesting enough, we’re a 119-year-old company, and 2009 was the highest demand we’ve ever had.”

And, some brokers say they are starting to see some flexibility on price returning to the market. Solid companies with low-risk exports can often renegotiate rates, says Freely. “We’re seeing some of the private market carriers getting more aggressive in underwriting risk and pricing, and we’re seeing some of carriers being more flexible in pricing; you can now negotiate on price, whereas three to four months ago you couldn’t.”

Indeed, many insurers see 2009, for all its difficulties, as a validating year. The big three firms continued to pay claims on time, demonstrating the core value of their product. And while they may not reduce their prices, they are learning to communicate and expand the value-added components of their products.

“There’s a lot of value we can deliver for what the customer is paying,” says Atradius’ Barrett. “Not just the coverage that the dollar buys, but the intellectual capital and the data that surrounds that,” including early warnings on buyers and economic forecasting. And, some firms are learning use credit insurance to indemnify their entire accounts receivable-up to 40 percent of a firm’s assets-and then borrow against them or even sell them to a bank.

Still, no insurer has illusions about the challenges that the last year and a half uncovered. The problem is how to determine which were the result of this once-in-a-lifetime economic crisis, and which are challenges that will appear in even a mild recession.

For example, though insurers were able to pay most claims on time, they found their back office operations pushed to the limit, at times impacting their customer relationships. But how much excess capacity should they build into their back offices, knowing that it might not be used for another decade?

Others are trying to make sure they don’t get caught unawares again.

We’re gaining much greater financial optics, particularly in the U.S.,” says Barrett. “We’ve made it our MO to roll our sleeves up and work through our organizational chain from the guys doing the selling to the underwriters, so we can gain financial information from our customers’ buyers more easily and we can look at risk on a more factual basis and make a call based on that risk.”

And all the insurers interviewed for this article said that a primary goal in 2010 would be to refocus on their clients, not only rebuilding relationships frayed during the crisis but also rewriting the terms of the insurer-client relationship. Ferrante, of Coface North America, says his company’s focus will be to try to raise its clients’ awareness of risk, in part by building it more explicitly into the firm’s rates.

So what can insurance customers do in this new, post-crisis market? Freely, of Marsh, says he tells his clients to be proactive about risk, especially by investing in risk-management systems.

“One thing I think that is going to be more important than ever is systems to help clients assess credit risk and not rely solely on credit companies,” he says. “A lot of limit cuts are being driven by capacity issues, not risk issues, so if you’re relying on your carrier to provide you with risk information, that’s not going to work.”

Squibb says he’s telling his clients much the same, adding that they also need to be realistic in what they can get in the market. “What I’m advising clients to do is to anticipate reasonable coverage, then to get top-up cover from other markets,” he says.

In other words, the days of low-premium plans that cover 95 percent of losses are probably over. But used correctly, credit insurance can still be a great investment for an export-oriented firm, particularly one trying to navigate the still-stormy seas of the 2010 global economy. wt



Clay Risen is an assistant editor at The New York Times op-ed page. He has written for The New Republic, Smithsonian, and Inc., among other magazines.