Category: Insight | Date: 28/03/2020

The future is not what it used to be

A view from Credit Insurance perspective by Mike Clark, Executive Director, Xenia

American baseball catcher and New York Yankees legend ‘Yogi’ Berra is accredited with saying, “The future ain’t what it used to be”. Famed for countless memorable phrases that made no logical sense but still contained more than an element of truth, credit risk analysts should perhaps take heed of this particular Yogi catchphrase.

To properly gauge and assess the risk of customer failure, old methods can be tried but rarely trusted. The primary reference point for credit insurance underwriters and credit managers alike continues to be publicly filed accounts, and in the past these would normally present a fairly good barometer of performance and financial strength. The danger of course is that these are historic documents and, in a period of rapid economic change, have more limited relevance. Yogi perhaps called it correctly, the future just ain’t what it used to be.

Underwriter knowledge is power

Some in our market think that artificial intelligence (AI) will at some point replace the skills of the trade credit insurance underwriter. I have my doubts. However, credit insurance underwriters must be multi-faceted individuals, and they need to do more than simply crunch numbers. Certainly an ability to rapidly dissect and understand a balance sheet is of vital importance, but in the current environment additional skills are required. In the retail sector for example an understanding of the extent to which traditional high street retailers are vulnerable to the presence of on-line competitors is essential. In the war of bricks v. clicks the on-line providers seem to be winning. Understanding when quarterly rental payments fall due is all part of the risk analysis process. Fashion retailers can be a season away from failure, if the whims of the consumer are misunderstood. Underwriters therefore need to form a view on the winners and losers – one eye on the numbers and perhaps another on the catwalk!

Learning from experience

In good times and bad the construction sector always presents us with sizeable claims. The recent demise of Carillion reinforces the view that reliance on historic accounts is dangerous. Our market is still licking its wounds from that one! The Group failed in January 2018, but in July 2016 boasted sales of £5.2bn and a market capitalisation of £1bn. To more fully understand construction risk there is a need to go beyond the balance sheet and learn about individual contracts and the margins they generate. Carillion’s failure was influenced by delays and problems with a handful of major projects.

The credit insurance market employs experienced sector specialists, who understand the risks and get to know the key managers involved. They understand the complex relationships between main and subcontractors, and make it their business to obtain the very latest information. It’s a time consuming, labour intensive and costly process, however, the underwriters who do it right provide our clients with indispensable advice and information.

The modern underwriter

The credit insurance market has done a good job in educating businesses on a need to provide them with detailed and up-to-date management accounts. This is proprietary information that companies would not ordinarily offer their suppliers. These days there is a more general acceptance that credit insurance underwriters are invisible stakeholders. Without their ongoing support lines of credit reduce with an obvious impact on working capital. There is therefore a clear incentive for most businesses to maintain a flow of financial information. As brokers we often facilitate that exchange.

The modern credit insurance underwriter therefore looks to a combination of information sources. Historic filed accounts, management accounts and payment performance will all be reviewed. Questions will be asked about banking arrangements, covenants and headroom. The nature of the customer base will also be taken into account. Is the business itself exposed to bad debt? Is there an over-reliance on a handful of key customers whose loyalty might change? Lastly, the experienced underwriter should also consider the client’s own professionalism in managing its credit exposure. If strong systems are in place that does, after all, reduce the risk of customer default and claims.

Team work is key to adapting to change.

Even with the latest financials, a keen understanding of trade sector issues, analysis of payment performance and reference to a host of additional information sources, certain failures are impossible to avoid. Disruptors - businesses who identify an opportunity to quickly acquire market share – are everywhere. Their rapid growth is inevitably at the expense of established business who fail to adapt. The recent Covid-19 event creates unprecedented and immediate risk for many businesses. In a world where components and parts are sourced globally, production lines can be halted by the absence of a single part with obvious consequences for cash flow.

Credit managers have to walk a perilous tightrope. Adopt an overly cautious approach and they are characterised as sales inhibitors. A more adventurous approach results in accusations of recklessness, particularly when a major customer fails. It’s an impossible job, but there is a solution. The answer lies in working with credit insurers, all of whom invest huge time and resource in gathering as much information as possible on the risks that sit within the sales ledgers of all companies who extend credit. The key is teamwork – client, broker and underwriter working together to better understand constantly changing trade credit risks. Even with up-to-date information, bad debts are unavoidable and when these losses occur our market is there to quickly replace lost cash flow. Many of our clients view the cover, and the information that comes with it, to be indispensable.