Institute of Chartered Accountants of India 25 th August 2007 CREDIT INSURANCE

1. Institute of Chartered Accountants of India 25th August 2007 CREDIT INSURANCE

2. Presentation Plan • Background • The Concept • Cover and Terms • The Policy • Link to Finance • Marketing – Suggested Approach • Political Risk Insurance

3. Background • Credit Insurance Historically Facilitates International Trade • Concept more than 100 years old • Primarily developed in Europe and then spread out to other parts of the world • In India, operations first started in 2001 • Vast untapped market

4. Trade Flows • Physical Trade Flows: - Shipping Goods - INCOTERMS - Principal Documents in Trade - Marine Insurance • Financial Trade Flows: - Invoices - Secured Payments - Unsecured Payments - Negotiable Instruments

5. Risks Associated • Financial Trade Flows Secured Payments - Intra Company Transactions - Advance - Cash - Bank Guarantee - Letters of Credit Unsecured Payments - Cash Against Documents (CAD)/ Documents Against Payment (DP) - Open Account/ Clean Credit - Documents Against Acceptance (DA)

6. THE CONCEPT

7. It works but how? • Credit Insurance is not a typical insurance • product • The nature of the risk changes all the time • No blanket cover • More than pure risk transfer • Extremely interactive • Services : Prevention , Collection , Insurance

8. Prevention With or without insurance If you want to stay in business You have to avoid delivering to a company that might not be able / willing to pay ! On time…your steps:- - Identify your client - Understand his business - Gather information - Make an assessment of the credit risk you can take - Follow up on existing clients Result of this analysis: Credit limit for each of the clients Credit limit = maximum outstanding sale that is acceptable for a given client at any point of time

9. PREVENTION – Buyer Databases - 40-50 million companies worldwide - Databases - Integrated Information and Underwriting Management System - Assessment of the latest financial information, legal cases, payment behaviours - A network of risk offices - Direct contact with buyer companies generates instant, up to date and exclusive information

10. Proprietary Databases Information Past Due Date Collections Agent Knowledge & Information Claims Public Information Country Underwriters Visits Experience (Information Agency) Underwriting Database Underwriter's Trade Knowledge Information Agencies Underwriters, Client & Debtor Visits Banks Other Credit Insurers INSURANCE Group Localised Risk Management Industry & Economic Analysis

11. Information System Rating/ Grading Validation by credit underwriter Credit rating methods • Fuzzy Expert Systems • Scoring Methods Information agencies Policy- holders Banks Sales staff Risk database Internet Research Engine Debt collection agencies Economic institutes / sector forecasts External ratings Risk Units

12. Discretionary Credit Limit • Allows policyholder to place credit limit himself • Up to a certain amount, policyholders can make their own credit decision • There are agreed rules on how to do this • Of prime importance is that they follow their own rules • One of the most frequent rules is that they - follow the credit recommendation of a status agency - alternatively trade experience can be used

13. TYPICAL CASE

14. Collection Overdue and Debt Collection • Report overdue payments • Decide together who does what and the best way to proceed • Take the most appropriate action, depending on the country, the trade sector, the reason for delayed payment • amicable settlement or legal action • rescheduling of debt • recovery of stock... • Keep each other informed on the progress

15. Insurance • If insurers fail to collect 100% of the principal • Insured can file a claim • usually after 150-180 days • Debt collection expenses are insured as well • legal costs, debt collection agency…. including expenses made after the claim has been paid out • Insurers pay up to 90% of the insured debt & legal & collection expenses • depending on the contractual agreements • insurers expect you to keep part of the loss as deductibles

16. Protracted Default Insured Event Normal due date. Debt Overdue. Invoice Date Claims: Sequence of events leading to Protracted Default Claim Paid Overdue notification period Waiting Period (6 months); collections, recoveries Extended Due Date

17. Protracted Default Event of Loss Normal due date. Debt Overdue. Invoice Date Buyer insolvency: Insured Event - Claim paid within 30 days Claim Paid Overdue notification period Waiting Period (6 months); collections, recoveries Extended Due Date

18. EXAMPLE • A typical claim : • 90% indemnity • Credit Limit: USD 200,000 • Overdue Notification : USD 200,000 • Debt Collected during Waiting Period : USD 50,000 • Claim Submitted : USD 150,000 • Collection expenses : USD 7,500 • Claim payable: USD (150,000 + 7,500) * 90% • = USD 141,750

19. The Policy

20. The Policy • Normally annual policy – longer policy durations (3-5 years) can be negotiated • Invoices of credit period upto 180 days are acceptable – longer terms on exceptional basis • No restriction on goods or services • Cover provided upto the credit limit set by underwriters • Financial health of the buyer monitored on day to day basis by the underwriters • Underwriters operate with their own databases to assess the creditworthiness of buyers

21. BASIC COVER • Insurance against the risk of non-payment by their customers as a result of commercial &/or political risks • Trade receivables are an asset - deserves protection • Insurance cover helps to prevent bad debts • Insurance companies collect outstanding receivables • Cover pays up to 90% of the loss (Indemnity) • Focus: - whole turnover or a logical segment of it - short term risk - trade receivables - B2B DEBTS NEED TO BE TRADE RELATED – exports and/ or domestic & UNSECURED

22. The premium rate depends to a large extent on. . . • Insurable turnover • Quality of the risk / historical losses • Credit terms • Sector of the buyers • Countries covered • Quality of the credit management • Spread of the risk • Amount of work expected for servicing • Level of self retention ( % covered, NQL, EEFL, AFL) • Discretionary limit requested • Maximum liability • ..... competition

23. Most important features of the policy • Risk covered (whole turnover concept) • Premium rate • Deductibles • Indemnity • Maximum Liability • Discretionary limit • Reporting of overdues • Credit limit fees • Additional Covers

24. Policy Structure • General Conditions of Insurance • Schedule • Defintions • Special Conditions - No Claims Bonus ` - Low Claims Bonus - Profit Sharing - Reverse No Claims Bonus - Political Risks - Work In Progress - Consignment Stock - Cover for Associated Companies

25. What is not Credit Insurance • Single buyers, selected buyers • L/C business • Loans • Leasing • Project finance • Guarantees • Bonds • Performance risk • Non-acceptance • Pure political risk • Currency exchange risk • Risk on private persons

26. Marketing Approach

27. WHY DO COMPANIES PAY FOR CREDIT INSURANCE? • Protection against bad debts • Balance sheet protection • Corporate governance • New markets • Debt collection • Information, screening of clients • Avoidance of internal conflicts • Reduction of the fixed overheads • Relax existing credit conditions • Financing

28. The commercial process • A contact • The prospect provides underwriting information • The credit team delivers a non binding indication (NBI) • The NBI is delivered, explained, discussed, reviewed as often as necessary • (prechecks) • Audit of credit management • (on risk letter) • Policy issuance • Risk underwriting of all the buyers

29. Credit Insurance – World Market

30. Credit insurance in the world World Market 2003 ICISA members (credit insurance) Total Market appr. EUR 4.2 bn Credito y Caucion QBE Insurance Others AIG 7.3% 1.7% 9.5% Atradius 2.5% 23.1% Mapfre 2.2% CESCE 2.2% Euler Hermes Coface 34.2% 17.4% Source: ICISA 2003

31. Credit insurance market by region Credit insurance market by regions in % and Mio. € direct earned premium

32. Distribution channels

33. Sectors covered

34. THE LINK TO FINANCE

35. FINANCIAL INSTITUTIONS • Financial Institutions (FI) have been collaborating with insurers for more than100 years • FI that lend money to corporate clients look for guarantees and collaterals • Trade receivables are among the most liquid and most secure assets • Trade receivables pledged to the FI help the FI to take more risk and/or reduce cost of borrowing • Insurance improves the quality of receivables • There are different variations on this theme • Loss payee clause • FI as Joint Insured • Factoring

36. The company takes up credit insurance The company pledges the receivables to the Financial Institution (FI) The company instructs Ins co to pay out any claim directly to the FI So the insurance claim replaces the receivable that was not collected LOSS PAYEE CLAUSE

37. LINK TO BANKS : LOSS PAYEE CLAUSE

38. Same as Assignment Clause The Financial Institution (FI) gets a copy of each credit decision The FI can pay the premium if it wants to The FI can file a claim JOINT INSURED

39. LINK TO BANKS : BANK AS JOINT INSURED

40. The Financial Institution (FI) buys the invoices without recourse The FI takes insurance Usually the FI buys invoices only to the extent that there is a credit limit The FI is responsible for the credit management (sometimes subcontracting it ) Receivable purchase agreements and assigning of debt mechanisms FACTORING / INVOICE DISCOUNTING

41. LINK TO BANKS : FACTORING & INVOICE DISCOUNTING

42. TO CONCLUDE • Banks are increasingly interested to use credit insurance • Credit insurance can help to increase the amount of financing • Credit insurance may reduce the financing cost

43. Political Risk Insurance

44. Actions or Inactions of Foreign Governments or macroeconomic Problems which Interfere with Contracts or Investments What Are Political Risks

45. The Products Political and Credit Risks • Contracts: In that - Trade Credit Insurance - Contract Frustration • Assets/ Investments: In that - Confiscation

46. Contract Frustration: Government Action Resulting in the Failure or Refusal of a Contracting Party, Including a Financial or Performance Guarantor to Honour their Obligations under a contract Has to be Trade Related and Cross Border

47. Contract Frustration: Perils Insured - Private Obligor non-performance due to government action - Government Obligor non-performance - Arbitration Default - Import Restrictions - Export Restrictions - War (except war of five super powers) - Transfer Delays/ Currency Inconvertibility - Fair and Unfair Calling of Bonds

48. Transactions Typically Facilitated by Contract Frustration Insurance • Pre-export Finance • Import Finance • Barter/ Counter Trade • Sales Contract • Service contract • Purchase Contract • Letter of Credit • On Demand Bonds Since risk are different for each, policies are bespoke

49. Policy Features – Contract Frustration Coinsurance Waiting Period Average: Where an assured underinsures, underwriters apply a percentage by which the actual exposure was in excess of the insured limit to the amount of the claim

50. Limit of Liability Either • Full Value • Excess of Loss (Recoveries are often top down) • First Loss