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Economic Barometer: Trade Credit Market Reflects Challenges

The global economy is once again at inflection point. The world is, at best, facing a slow recovery or, at worst, is in a second recession. It appears Europe is on the brink of an economic downturn, and the structure of the European Union (EU) is making change slow and complicated. The U.S. environment is in election mode with little material change likely to occur until after the elections; perhaps the President will succeed in getting a jobs bill passed. In some emerging markets, central banks are trying to manage growth and contain inflation to head off potential blossoming bubbles in consumer credit and real estate. Credit insurance markets are excellent barometers of things to come in the global economy.

Trade credit insurance provides protection against default. Simply stated, when a customer fails to pay for a trade receivable, due to bankruptcy or slow payment, trade credit insurance can indemnify the organization and provide claim payment for the covered portion of the receivable. It is cash flow protection, plain and simple.

On a daily basis, these markets underwrite the payment trends of companies in every industrialized nation in the world. While we cannot overlook the macro economic indicators of jobs and GDP, consider for a moment the experience of the credit insurer.

In 2008 and 2009, most credit insurance markets experienced significant losses. Several markets had the unlucky combination of having severe losses and a high frequency of losses.

Prior to that time, credit insurance was perhaps underpriced; particularly in the U.S., the markets were in a positive credit cycle, as we all were. Pricing competition was fierce in an environment of higher sales growth in the insured base. Optimism among insureds created a bubble of exposure written on what in hindsight was not the true exposure base.

During the crisis, insurers had to pull back on coverage, eliminate coverage for certain industries, and in many cases strain their relationship with the insured in an effort to save their balance sheet. In hindsight, these actions not only saved the industry but made it stronger.

As the economy began to improve in 2010, the credit insurance industry saw new entrants as primary carriers as well as new capacity for reinsurance. The result has been a significant softening in rates and very aggressive competition for coverage in growth markets like the U.S. and Latin America. As the global economy teeters on the edge, what signs are we seeing from credit insurers about the future—mixed signals? The insurers have shown a ravenous appetite for new premium, resulting in soft pricing that favors buyers during 2011. As we move into the final stretch of this year, the markets are once again reviewing the risks on their books with an eye to proactively managing exposures.

First the good news: from a credit insurer perspective, all the underwriters have solid balance sheets. Each knows the risk they are sitting on, and they have processes actively in place to manage exposure changes down to the geographic and sector and buyer level. This is excellent news, not just for their shareholders but for policyholders. The policy you receive today comes with a much deeper understanding of the risks protected and a better service model than ever before.

The potential bad news is we are not out of the woods yet. Credit insurers are seeing slow payments from buyers in specific sectors and in places like Spain, Italy, and, of course, Greece. Most markets were avoiding Greek buyers except where commercially important to an insured. Now, most markets are avoiding Greek buyers period. It is not too far off to assume that as the contagion spreads to Italy and Spain, so will the lack of coverage on buyers in those countries.

An additional cause to give one pause is the financial situation in Europe. The Troika (EU, ECB and IMF) is painstakingly solidifying plans to support European banks. All around, we are seeing bank and country downgrades, cash withdrawals from major institutions, and a run on bank stocks. Does any of this sound familiar? October 2008, too big to fail European style. While a Lehman-like collapse may likely be averted, it will require a large consensus-style democracy in the EU to move quickly. It has never moved quickly.

A few glimmering rays are on the horizon. First, this is not 2008; the U.S. financial system is well- capitalized and, barring a run on a bank or its stock, the system should weather the storm. It may not be pretty, but it is not going to be the end of the world. In the U.S., we still have to get jobs growing, and that will not happen until the housing issues are resolved, which will take years.

As for the credit insurers, many of whom are domiciled in Europe, they stand ready to support policyholders now more than ever. Every day, the headlines prove the value of the insurance proposition, and the credit insurance markets not only have weathered a historic crisis but improved their product to support policyholders.

Taking a lesson from the last credit crises, organizations need to manage their cash positions proactively. Finance teams regularly use hedging tools to manage volatility in their business. But hedging strategies are not just for oil, other commodities, and foreign currency. Credit insurance is a tool that credit and risk managers can use to hedge risks to their cash flow and growth.

Now, more than ever, is the time to consider protecting your growth and your cash assets with a product that performs.