Credit insurance, under debate

Miguel Aguirre Marzo. Professor. IE Business School

5 May 2009

It’s a catch 22 situation. There’s no trade without funding and there’s no funding without insurance. It’s time to organize incentive schemes for credit insurance.

On 11 April of this year Rafael Martínez Cortiña would have been 72 years of age. This former professor of the Complutense University of Madrid, who died in February 2007, was Vice-President of Banco Exterior de España and President of Natwest. During the many hours we spent studying finance and the risk of commercial transactions, he used to say: "There are no exports without finance and there is no finance without insurance."

In the light of events since the end of 2007, we could change the sentence slightly to "there is no trade without finance and there is no finance without insurance". As hundreds of thousands of Spanish businesses have discovered, there has been a shortage of credit insurance on our services market. Before the turbulence began, 18 months ago, bank discounts were common practice in businesses which, with debts at 90 or 120 days, turned to the financial sector for advance payments. On the international market, a significant number of orders that had to be shipped by domestic enterprises were completed thanks to the fundamental pre-finance awarded by banks and savings banks. Credit insurance replaced the real guarantees or leverage the financier required as a guarantee from the borrower.

Of long-standing tradition in Spain, credit insurance consists of cover in the event of default by the debtor/importer. The trading accounts of the businesses that provide the cover include the premiums, financial results (very important in any insurance company) and the recovery of the default payments they cover. In their debit accounts, they include their general expenses, the reinsurance cost and the indemnifications they pay.

Falling interest rates and the huge increase in default reported over the last 6 months have meant that the credit insurance market encountered loss rates of more than 150%. On average, insurance companies had to pay more than €150 for every €100 they collected.

This situation was not sustainable and the insurance companies have taken the corresponding measures. How? First of all, they have increased the price of their service (the premium), but they have limited the offer to sectors in great difficulty (construction, the car industry, etc.), a move that was unthinkable only two years ago.

The decisions taken by the government on 27 March last are designed to address this situation. The state has decided to employ two fundamental instruments: First, it will compensate the companies in the sector up to the amount of €160 M for their losses in 2009, which will improve their loss rate; And second, the Insurance Compensation Consortium will partially reinsure transactions and sectors for which the cover of the large reinsurance companies was becoming more and more costly and difficult to obtain.

These two very important measures should bring the average loss rate of 180% in 2008 down to the previous year’s level of 80%. Furthermore, the risk concessions should gradually increase and the banks will again discount commercial transactions (they have never stopped doing so) with the sole guarantee of the credit insurance. With his great knowledge of the banking and insurance sector, Rafael Martínez Cortiña knew that if there was no finance, the commercial sector would not work, and the government´s measures will ensure that the finance is backed by the great professionalism of the credit insurance sector in Spain. The results? We should see one tangible consequence, i.e. an increase in the percentage of the insured Spanish GDP, and one intangible consequence, i.e. the increase in trust in the financial and credit insurance sector.

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