Trade credit insurance is seldom used in asset finance (more so in invoice finance) but can play a valuable role by facilitating increased sales, reduced capital requirements and higher profitability, as well as mitigating downside risk either on a single large transaction (or customer) or at a portfolio level.
Here are some ways you could use insurance to improve business performance:
Whether it's a large single transaction or repeated borrowing from an important multi-hirer customer, all finance companies find they reach their limits with good customers with whom they would like to write more business.
An appropriate insurance policy protects against single name exposure and allows an increase in the volume of profitable, attractive lending to that counterparty. Where this is applied to your largest customers, the increase in volumes can be significant.
In so doing, you increase sales and are more likely to achieve preferred lender status (with the customer and/or broker), reduce any requirement for deal syndication and keep competitors at bay.
Imminent guidance from the PRA on Basel 3.1 bank capital regulation is likely to force banks to substantially increase their capital requirement for SME business (with the corresponding reduction in return on capital performance measures).
A suitable insurance structure has the potential to transfer the counterparty risk to the insurer, which can reduce the level of capital required.
For example, if, as previously indicated under Basel 3.1, the SME Support Factor for Standardised Banks is removed, the risk weighting for SME lending would rise from 57.14% to 75%. By comparison, we're working with the AA-rated insurer Allianz Trade, which would be treated by the bank as a 20% risk-weighted counterpart, resulting in a significant reduction in bank capital requirement and, as a result, a much stronger RoE performance.
The expected implementation timetable for Basel 3.1 is 1/7/2025, which is likely to stimulate significant short-term interest in finding effective solutions for the issue.
There are a number of scenarios where taking out credit insurance at a portfolio level can be beneficial.
Investors may be seeking a smoothed, low-risk return. Alternatively, the motive for a fast-growing lender may be to build a track record of smoothed financial performance, ahead of a potential sale of the business.
For a captive finance company, credit insurance may be attractive if it is encouraged to take on lending situations that are outside of its preferred appetite in order to support sales by its OEM parent.
Finance companies looking to enter a new asset market or expand internationally may also wish to protect against downside risk.
Subject to your specific business requirements, credit insurance can play an important role in protecting your business, increasing sales, managing capital and improving profitability.
For more information, please contact Peter Hunt.
