Trade Credit Risk inTrade Credit Risk in Turbulent Times

RIMS Annual MeetingBoston MABoston, MA

April 28, 2010Download at: www.iii.org/presentationsRobert P. Hartwig, Ph.D., CPCU, President & Economist

Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038Tel: 212.346.5520 ♦ Cell: 917.453.1885 ♦ bobh@iii.org ♦ www.iii.org

Presentation Outline

Global Economic UpheavalFinancial Crisis, Credit Market Woes Have Continue to Impact Trade Credit

Exchange Rates, Inflation & Interest RatesInfluence on Trade Credit Risk

Political RiskPolitical RiskApart from Economics, Political Issues Remain Critical

Trade Credit Risk: Summary & OutlookTop Business Risks Influencing Trade CreditTop Business Risks Influencing Trade CreditA Look Ahead

2

Economic Volatilityy

A H lti Gl b l R iA Halting Global Recovery is Underway; Volatility Remains

3

World Economic Outlook: 2010-2011P

6 5%8%

IMF says growth in emerging and developing economies will outpace

advanced ones in 2010/11.

4.2%

2.3%

6.3%

3.1%

1.0%1.9%2.4% 2.0%1.5%

2.6%

6.5%

2.4%

4.3%

2%4%6%8%

-4.1%-2.4%

-3.2%

-0.6%

-4%-2%0%

-5.2%4.1%

-6%World Output Advanced

EconomiesEmerging

EconomiesUnited States Euro Area Japan

2009 2010P 2011P

Outlook uncertain: The world economy is recovering from the global crisis better than expected, but activity is reviving at different

d i diff t t f th ld di t th IMF Thi

4Sources: IMF, World Economic Outlook; Insurance Information Institute.

speeds in different parts of the world, according to the IMF. This means trade credit risk will vary regionally and by industry.

GDP Growth: Advanced & Emerging Economies vs. World, 1970-2011F

10 0

Emerging economies (led by China) are

expected to grow by 6 0% in 2010World output is forecast to

GDP Growth (%)

6 0

8.0

10.0 6.0% in 2010World output is forecast to grow by 3.9% in 2010,

following a -0.8% drop in 2009.

2 0

4.0

6.0

(2 0)

0.0

2.0

Advanced economies will grow slowly in 2010,

(4.0)

(2.0)

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

grow slowly in 2010, dampening energy demand

Advanced economies Emerging and developing economies World

Source: International Monetary Fund, World Economic Outlook Update, Jan. 26, 2010; Ins. Info. Institute.

Global Industrial Production Rebounds From a Tailspin; Global Trade Recovering

Annualized 3-Month Percent Change

101520

505

10

20-15-10-5

Global industrial production was down over 25% in early 2009, severelt curtailing global trade but growing at

-30-25-20

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

curtailing global trade, but growing at a 9% clip in late 2009

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: International Monetary Fund, World Economic Outlook Update, Jan. 26, 2010; Ins. Info. Institute.

Merchandise Exports Are Growingat Pre-Crisis Levels Again g

Annualized % change of 3-month moving average over previous 3-month moving average

50%

75% Advanced economiesEmerging economies

0%

25%

-25%

0%

Global trade crashed during the financial crisis. Seizure of

credit markets contributed significantly to the crash.

-75%

-50%

05 05 06 06 07 07 08 08 09 09

significantly to the crash.

7

Jan

Jul

Jan

Jul

Jan

Jul

Jan

Jul

Jan

Jul

Note: data are through November 2009Source: International Monetary Fund World Economic Outlook January 2010 update at http://www.imf.org/external/pubs/ft/weo/2010/update/01/data/figure_2.csv

Global Industrial Production and Exports: 2006 to 2011P

(Annual Percent Change of 3-Moving Average) Global trade crashed during the financial crisis. Seizure of

credit markets contributed significantly to the crash.

8Source: International Monetary Fund, January 2010; Insurance Information Institute.

Exchange Rates, Inflation and Interest Ratesand Interest Rates

P f R d G tPace of Recovery and Government Monetary and Fiscal Policies

I fl E h d I fl tiInfluence Exchange and Inflation Rates, Impacting Trade Credit Risk

d C t9

and Cost

Trade Index Weighted US Dollar Exchange Rate*

115

January 2000 through March 2010Depreciation of dollar after Post-crisis

100

105

110 Tech bubble and post 9-11

depreciation of dollar

Dollar appreciates as role as global “reserve

85

90

95as global reserve

currency” affirmed during global financial crisis

70

75

80

70Jan00

Jan01

Jan02

Jan03

Jan04

Jan05

Jan06

Jan07

Jan08

Jan09

Jan10

The Global Financial Crisis Produced Significant Exchange Rate Volatility in 2008 and 2009; Despite the Fact that the Crisis Originated

*The broad index is a weighted average of the foreign exchange values of the U.S. dollar against the currencies of a large group of major U.S. trading partners. The index weights, which change over time, are derived from U.S. export shares and from U.S. and foreign import shares.Source: US Federal Reserve, Board of Governors; Insurance Information Institute.

Volatility in 2008 and 2009; Despite the Fact that the Crisis Originated in the US, it Was Other Currencies That Weakened

Inflation Rates for Largest European Economies & Euro Area, 2008-2011F

6%

4.0% 2008 2009

% Change from Prior Year Inflation is below 1.5% across major European economies and

interest rates remain low as a result obscuring tight conditions

3.3%

%

3.6

2.8%

%

3.0%

3.5%2008 20092010F 2010F

result, obscuring tight conditions in trade credit markets

2.6% 2

2.5%

2.2% 2.

4%

% % .8%

%2.0%

2.5%

1.0%

1.3%

1.1%

1.4%

1.1%

1.6%

1.6% 1

1.6%

1.4%

1 0%

1.5%

2.0%

0.3%

0.3%

0.1%

0 0%

0.5%

1.0%

0.0%Euro Area Germany UK France Netherlands

Source: Blue Chip Economic Indicators, 3/10/10 edition.

3-Month Interest Rates forMajor Global Economies, 2008-2011F

5 0% 2008 2009Interest rates remain generally low in much of the world, depressing insurer

4.0%

4.4%

4.0%4.5%5.0%

2010F 2011Finvestment earnings. But rates are often

held low by government action and lingering economic weakness, obscuring tight conditions in trade credit markets

%

2.6%

2.5%

2 5%3.0%3.5%

2.0%

1.4%

1.8% 2.

1 %

1.3%

1.2% .2%

2

1.7%

1.5%2.0%2.5%

0.7%

0.3%

0.7%

0.6%

1

0.2%

1

0.4%

1

0.4%0.5%

0.5%1.0%

0.0%Euro Area Japan UK China US

Source: Blue Chip Economic Indicators, 3/10/10 edition.

Internationally, Most Short-termInterest Rates Are Still Quite Low

Central Bank Current Interest Rate

Last Changedg

Bank of Canada 0.25% April 21, 2009Bank of England 0.50% March 5, 2009Bank of Japan 0 10% Dec 19 2008Bank of Japan 0.10% Dec 19, 2008European Central Bank 1.00% May 7, 2009U.S. Federal Reserve 0.25% Dec 16, 2008The Reserve Bank of Australia 4.25% April 6, 2010China 5.31% Dec 22,2008Hong Kong SAR 0 50% Dec 17 2008Hong Kong SAR 0.50% Dec 17, 2008Korea, Republic of 2.00% Feb 16, 2009Hungary 5.50%* Mar 29, 2010

*reduced from 5.75%Source: http://www.fxstreet.com/fundamental/interest-rates-table/

Political Risk

M N ti S ff f P liti lMany Nations Suffer from Political Instability, Fundamentally

I fl i T d C dit Ri kInfluencing Trade Credit Risk

14

Aon: 2010 Political Risk Map

Political and financial instability remain a feature of the business landscape in 2010 due to the recession, according to Aon.

15Source: Aon

Aon 2010 Political Risk Map: FindingsElevated Political Risk Levels to Continue in 2010

Significant volume of credit and political risk claims in international insurance markets have driven many of the 18 country downgrades in this year’s map.Aon believes 2010 will see elevated political risk levels continue before an overallAon believes 2010 will see elevated political risk levels continue before an overall tendency for improving global business conditions becomes established. For many companies and across different sectors, including credit and political risk insurance, the business environment remains uncertain when trading with or investing in politically or economically unstable countries.politically or economically unstable countries.

Movements on the 2010 MapA total of 18 countries have seen conditions worsen leading to a downgrade: Algeria, Argentina, El Salvador, Equatorial Guinea, Ghana, Honduras, Kazakhstan, Latvia, M d M it i Phili i P t Ri S h ll S d U it d A bMadagascar, Mauritania, Philippines, Puerto Rico, Seychelles, Sudan, United Arab Emirates, Ukraine, Venezuela and Yemen.Sudan, Venezuela and Yemen have been added to the Very High category, joining Afghanistan, Congo DRC, Iran, Iraq, North Korea, Somalia and Zimbabwe.

/Eight countries/territories have been upgraded to a lower risk level - Albania, Myanmar/Burma, Colombia, South Africa, Sri Lanka, East Timor, Vanuatu, Vietnam and the Hong Kong Special Administrative Region of the People's Republic of China.

Bottom Line: Political and financial instability remain a feature of the

16Source: Aon

Bottom Line: Political and financial instability remain a feature of the business landscape in 2010 as a result of the recession.

A.M. Best: Country Risk Evaluation*

18

16

1818

20 10 of the 76 countries evaluated by A.M. Best are in the most at-risk

category. Country risk is factored into all A.M. Best ratings.16

14

12

14

16g

10

6

8

10

C t i th t th t i k d th f t t h ll t

2

4

6 Countries that pose the most risk and therefore greatest challenge to an insurer’s financial stability, strength and performance (CRT-5) are: Belarus,

Bosnia and Herzegovina, Dominican Republic, Ghana, Jamaica, Kenya, Lebanon, Nigeria, Ukraine and Vietnam, according to A.M. Best.

0CRT-1 CRT-2 CRT-3 CRT-4 CRT-5

*A.M. Best defines country risk as the risk that country-specific factors could adversely affect an insurer’s ability to meet

Source: A.M. Best., AMB Country Risk Report, Sept. 2009.

y y p y yits financial obligations. Countries are placed into one of five tiers, ranging from Country Risk Tier 1 (CRT-1) denoting a stable environment with the least amount of risk, to Country Risk Tier 5 (CRT-5) for countries that pose the most risk and greatest challenge to an insurer’s financial stability, strength and performance

Countries by Risk Tier RatingCRT 2CRT-1 CRT-3 CRT-4 CRT-5CRT-2

Barbados*BelgiumBermuda

AustraliaAustriaCanada

Bahamas*BahrainChina

CRT 4Antigua & Barbuda*

Brunei Darussalam

BelarusBosnia and

HerzegovinaD i iBermuda

British Virgin Islands*Cayman Islands*

DenmarkFinlandFrance

G

CyprusIsrael

Kuwait

DarussalamEgyptIndia

Indonesia

Dominican Republic

GhanaJamaicaIslands

Hong KongIreland

Italy

GermanyGibraltar*Guernsey*Isle of Man*

MalaysiaMalta

MexicoNetherlands Antilles*

JordanKazakhstan

Mauritius

KenyaLebanonNigeria

JapanLiechtenstein*

Macau

Isle of ManLuxembourgNetherlands

Norway

Netherlands AntillesOmanPolandQatar

MoroccoPanama

PhilippinesR ssia

UkraineVietnam

New ZealandSlovenia

South KoreaSpain

SingaporeSweden

Switzerland

Saudi ArabiaSouth Africa

Thailand

RussiaTunisiaTurkey

18

*Denotes countries to be considered “Special Cases” by A.M. BestSource: A.M. Best., as of 4/13/10

SpainTaiwan

United KingdomUnited States

Trinidad and TobagoUnited Arab Emirates

Trade Credit Risk: Summary & OutlookSummary & Outlook

C l A f E iComplex Array of Economic, Financial and Political Factors Will

B ff t T d C dit M k t fBuffet Trade Credit Markets for Years to Come

19

Top 10 Risks & Reported Readiness and Losses: Many Impact Trade Credit Risk*

Rank Top 10 Risks – All Industries

Reported Readiness – All Industries

Loss of Income in Last 12 Months – All IndustriesIndustries Industries

1 Economic slowdown 60% 57%2 Regulatory/legislative

changes65% 24%

g3 Business interruption 79% 30%4 Increasing competition 71% 39%5 Commodity price risk 77% 57%5 Commodity price risk 77% 57%6 Damage to reputation 58% 9%7 Cash flow/liquidity risk 75% 25%8 Distribution or supply 70% 20%8 Distribution or supply

chain failure70% 20%

9 Third party liability 81% 40%10 Failure to attract or retain 68% 16%10 Failure to attract or retain

top talent68% 16%

*Yellow shading denotes risks with greater impact to trade credit risk.

Source: Aon Analytics; Global Risk Management Survey; Insurance Information Institute commentary of trade credit risk.

Financial Crisis Increases Demand for Trade Credit Insurance

Financial crisis has led to significant increased demand for trade credit insurance cover

Banks and other trade financiers had to take measures during the crisis which resulted in increased pressure on suppliers’ credit terms and high risk scenariosresulted in increased pressure on suppliers credit terms and high risk scenariosTrade credit insurers continued to support their customers during the crisis, illustrated by: 20 million running credit limits; insured exposures at EUR 1.8 trillion; claims ratio before costs of around 84 percent for 2009 (pre-crisis 40-60 percent)Available capacity not affected by the crisis but pre crisis terms no longer availableAvailable capacity not affected by the crisis, but pre-crisis terms no longer available

Insurers increase information sharing and transparencyHigh policy renewals of around 80-90 percent confirm customer satisfaction with their insurance partnerspIncreased information sharing and transparency will be provided to customers. Emphasis on “added value” of insurers’ risk management role and higher transparency re credit limit decisions

OutlookOutlookContinued availability of trade credit insurance cover gives confidence and security during fragile economic recoveryCost of capital and tightened risk environment continues to challenge industry, l di t hi h i t d t i t diti

21Source: International Credit Insurance & Surety Association, April 2010

leading to higher premium rates and stricter conditions

Bottom Line: Market now stable, but still challenging situation

Trade Credit Insurance MarketplaceTrade credit insurance market is concentrated in the hands of a few

Total global annual premium income was over $8 billion in 2008Three major monoline credit insurers account for nearly 90 percent of market: Euler Hermes (36%); Atradius (31%); Coface (20%) Backed by reinsurersHermes (36%); Atradius (31%); Coface (20%). Backed by reinsurersOther companies involved include: Chartis, QBE, various Lloyd’s syndicates and ACE, as well as govt-backed export credit agencies

Exposures rise, but premium growth lagsExposures rise, but premium growth lagsIn past five years exposure levels of major credit insurers saw massive growth as they competed for market sharePremium income has not grown at same rate because of price competition and increased writing of marginal risks by insurersincreased writing of marginal risks by insurersRisk/reward imbalance

Economic downturn takes its tollPersistent economic downturn with retrenchment of bank credit, drying up of letters , y g pof credit results in significant rise in payment defaults and corporate failuresThese conditions have led to significant increase in claims and record high loss ratios for major three insurers in 2009A capacity problem could follow in 2010 if reinsurance capacity shrinks or becomes

22

A capacity problem could follow in 2010 if reinsurance capacity shrinks or becomes price prohibitive

Source: Marsh: Trade Credit Insurance and the Global Credit Crisis, 2009; Insurance Information Institute (I.I.I.)

Trade Credit Insurance MarketplaceInsurers refocus on risk quality

Credit insurers review and reduce exposures/limits on certain industry sectors and countries of concernIndustry sectors considered difficult by most credit insurers include: constructionIndustry sectors considered difficult by most credit insurers include: construction, retail, commodities, electronic consumer goods, automobiles and transportDramatic premium increases for loss-making policies. Some not renewed at any price.Insurers will not take on risk deemed to be volatile or unprofitable

Alternatives for insurance buyersTop-up cover, other insurers, accounts receivable purchase agreements and govt support some of the alternatives buyers are exploringSmall market for top up cover but not in all regionsSmall market for top-up cover, but not in all regionsInsureds with strong credit and ability to retain risk exploring increased use of captive insurersGovernment-backed options offer limited support in some countries, but at a cost

Bottom Line: In 2010 challenging conditions remain, but receding recession should improve loss situation for trade credit insurers

23Source: Marsh: Trade Credit Insurance and the Global Credit Crisis, 2009; Insurance Information Institute (I.I.I.)

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