Trade credit insurance is a vital tool for organizations to protect against the risk of non-payment by their customers. This includes not only insolvency risk on goods delivered and simple non-payment, but also pre-delivery costs, the non-honoring of letters of credit, or non-delivery of pre-paid goods. A challenging macroeconomic and political situation (that several geographies are currently experiencing) can increase the risk of insolvency and/or default and trade credit insurance, as part of an overall risk management program, can assist companies in navigating these critical business exposures by providing protection.
The last couple of years have seen a remarkably benign claims environment for trade credit insurance globally. However, the outlook for the next year or two is pointing to a more difficult time for corporates, with insolvencies and payment delays expected to grow dramatically. Trade credit underwriters are becoming more cautious as losses begin to climb. This could see insurers pull back on trade credit capacity and tighten their underwriting standards, making it more difficult for businesses to obtain coverage. This could push organizations to explore alternative ways of securing trade credit insurance.
One innovative approach to managing this risk is using a captive insurance company. This is an insurance company that is wholly owned and controlled by its insureds, with the primary purpose of insuring the risks of its owners. It is an ideal tool to manage the volatility brought by the insurance marketplace as well as to enhance control on their trade credit programs. Indeed, we see an increased number of companies utilizing conventional whole turnover credit insurers to front on behalf of their captives. The captive, which typically is a single-parent or a cell captive, provides a layer of reinsurance support to disrupt and improve market capacity reducing the total cost of risk.
Captives can be used in trade credit insurance either as direct insurers (with reinsurance as needed), or as reinsurers for a fronting insurer. The structure depends on the group's needs, licensing authority, domicile, and loss history. A captive could cover trade credit risks up to an annual deductible, then reinsure above this level. Alternatively, a fronting insurer could set a policy limit and purchase reinsurance from the captive. Risks may be insured by whole portfolio or specific per buyer deductibles, providing financial and operational benefits to both parent companies and subsidiaries.
Using a captive in a trade credit insurance program offers several advantages, including cost savings, customization, and improved risk management. Companies considering this approach should carefully weigh the positives and negatives to determine if a captive is the right solution for their trade credit insurance needs. We suggest that the company undertake a captive feasibility study, as a first step, to determine the expected financial outcomes of a captive involvement in their trade credit insurance program.
This requires a determination of the amount of risk that the company is willing and able to take in the captive, and the retentions and limits desired (or required) to be purchased from a commercial trade credit insurer. The study provides a qualitative and quantitative analysis for the parent company to use as the basis for making an informed decision on whether to proceed with the implementation of a captive insurance company for their trade credit insurance program. A broker can also support an organization with the implementation, reducing the complexity of transitioning from a more traditional trade credit insurance program to one using a captive insurance company.
For more information on trade credit solutions for multinationals, please contact our team.
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