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.
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One of the most significant advantages of using a captive is the potential for cost savings. By insuring their own risks, companies can avoid the premiums charged by third-party insurers and retain underwriting profits. Furthermore, a captive allows for a better accounting, as well as reduction, of the total cost of risk.
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Captives offer a high degree of flexibility and customization. Companies can tailor their insurance coverage to meet their specific needs, which is particularly beneficial for multinational operations with diverse risk profiles. Furthermore, including trade credit insurance diversifies the captive’s risk portfolio, which is often used for property, general third-party liability and much more.
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Captives enable better risk management by allowing companies to centralize their risk assessment and claims handling processes. This can lead to more efficient and effective management of trade credit risks, including an improved management of retained risk by providing a platform to self-insure that satisfies both local and global requirements.
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Captives provide direct access to reinsurance markets, which can help companies manage large or catastrophic losses more effectively.
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By using a captive, companies can create a mechanism for their subsidiaries to pay predictable premiums over time. This reduces the volatility of loss events and protects local balance sheets, provides greater control over receivables risk among subsidiaries and better distribution in terms of premium allocations.
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Establishing a captive insurance company can be expensive and time-consuming. Companies need to invest resources in the setup and regulatory compliance processes.
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Captives are subject to regulatory oversight, which can vary significantly by jurisdiction. Navigating these regulations can be complex and may require specialized expertise.
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Captives require capital to cover potential losses. This means that companies must be willing to invest their own resources into the captive.
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While captives can provide cost savings and other benefits, they also expose companies to the risk of financial loss. If the captive experiences significant claims, the owners may need to inject additional capital to cover these losses.
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Managing a captive insurance company adds an additional layer of operational burden. Companies need to have the necessary expertise and resources to effectively manage the captive and its associated risks.
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.
WTW hopes you found the general information provided here informative and helpful. The information contained herein is not intended to constitute legal or other professional advice and should not be relied upon in lieu of consultation with your own legal advisors. In the event you would like more information regarding your insurance coverage, please do not hesitate to reach out to us. In North America, WTW offers insurance products through licensed entities, including Willis Towers Watson Northeast, Inc. (in the United States) and Willis Canada Inc. (in Canada).
