Aon’s Matt Tuckey – Claims Director and Carley Chaplin – Head of Business Development, warn that a rise in insolvencies, coupled with changes in insolvency legislation introduced during the pandemic mean businesses need to take advantage of the trade credit insurance market now while premiums are still competitive.
Insolvencies are on the rise according to the Office for National Statistics which reported that total company insolvencies in England and Wales have reached their highest level since 2009. This is supported by Insolvency Service figures. In contrast, insurers who provide trade credit insurance for businesses to help protect them from bad debt have seen their claims ratios fall substantially over the last two years – largely due to the pandemic, reduced trade and the intervention of governments – which means it is still a competitive market in terms of premium costs and coverage offered.
Insurers are, however, starting to recognise the growth in insolvencies. The trade credit market is deteriorating in some sectors like construction and metals, which means businesses should consider taking out trade credit insurance now – or renewing early if they already have cover – to protect themselves, particularly given the requirements of government insolvency legislation whose purpose is to enhance recovery prospects for struggling businesses. However, achieving that objective could increase suppliers’ exposure to the costs involved in bad debts.
Economic Situation Deteriorates
As the economic situation deteriorates globally – exacerbated by the war in Ukraine – increasing inflation, rising interest rates, volatile foreign exchange rates and supply chain issues are beginning to bite hard. For businesses, this uncertainty is a backdrop to other difficulties such as the withdrawal of government support and restricted funding following the pandemic, as well as the need to start re-paying bounce back loans and meet deferred tax commitments.
The impact of Brexit can’t be overlooked either. The Office for Budget Responsibility estimates that Brexit will ultimately make the UK 4 percent worse off than it would have been, with the FT writing “We've seen in all areas, in prices, in terms of investment, and in terms of trade, we're seeing negative effects due to Brexit, which we can now pinpoint as a Brexit effect, not a pandemic effect, not an energy crisis effect. These are very clearly Brexit effects.”
Add to all these factors the spiralling operational cost of doing business in areas like energy use and it is no surprise that more companies have simply stopped trading and liquidated their assets, with Creditors Voluntary Liquidations (CVLs) back to pre-pandemic levels. The Office for National Statistics reported 5,629 insolvencies for the second quarter 2022 – the highest since the third quarter of 2009. It also said, “More than 1 in 10 UK businesses reported a moderate-to-severe risk of insolvency in August 2022.”
New Insolvency Legislation
While CVLs present a challenge to creditors, so does the expectation that other types of insolvency such as Company Voluntary Arrangements (CVAs) and Administration orders to allow troubled businesses to restructure and continue trading will also start to creep up, following the introduction of the Corporate Insolvency and Governance Act (CIGA) 2020; widely reported as the biggest shake up of insolvency legislation since 1986. The Act put in place protective measures for debtors (i.e., insolvent businesses), potentially to the detriment of their creditors and means that more distressed businesses can continue to trade with protection from their existing creditors. Given that CIGA prohibits suppliers from enforcing their rights, any securities or imposing conditions on the insolvent customer and, if required to do so by the insolvency practitioner, having to continue to supply to the insolvent business on the same terms (with exceptions only being granted by the creditor’s application to the court), it could expose businesses to more losses with no guarantee that they will be able to recover their arrears.
In turn, trade credit insurers historically sought to vary the terms of ongoing supplies – such as increasing pricing to contribute to mitigation of the loss – as a pre-condition to issuing salvage waivers. Now, insureds are faced with the prospect of either breaking the law by refusing to supply when requested to do so, or forfeiting revenue in order to satisfy insurers’ requirements because they cannot increase prices - therefore being forced to retain the insurer’s proportion of the salvage to their own account, whilst also reducing the value of their insurance claim.
Another potential hurdle for creditors seeking to get their money back is the reinstatement of HMRC as a preferential creditor from 1 December 2020 which puts them above unsecured creditors – typically trade suppliers – when it comes to recovering debt from the failed business.
Be Better Informed
If you’re a trade supplier you’ve always been close to the bottom of the pile of creditors when it comes to making a recovery, but with the changes in law and broad economic issues you need to take steps to protect what is probably your largest single asset – the debts owed to the business – from turning into bad debt. Trade credit insurance has a key role to play here, not just in bad debt protection but also in terms of helping businesses enhance their management of the risk of who they trade with. When businesses look at trade partners, the information they have in terms of how those businesses are trading to assess the payment risk is generally limited to historic publicly available information sources like Companies House. One way they can get better intelligence is to work with their trade credit insurers who are speaking to these customers regularly, getting more up to date management information, and speaking to other policyholders as to how these customers are behaving.
As well as helping to better inform trade suppliers around the credit worthiness of their existing (and prospective) clients, getting all this up-to-date information also gives businesses the confidence to trade with new customers in new countries. In addition, if they encounter payment problems from these customers, some of the key trade credit insurers also have operations in those countries, which will help them to collect that debt or take them through the legal process.
How to Present a Claim
Buying trade credit insurance is just one step however, and it’s also important that businesses take time to consider how they will present any claims to ensure they receive the payment they expect from their policy. Claims that are rejected tend to be due to issues around credit limits; reporting of adverse information; late recovery action; late claims submission or uninsured contract terms. It’s key that when making a claim, insureds present a clear submission that summarises the circumstances surrounding the loss and supporting documentation provided. Insurers can be challenged, but it’s important that preparation is thorough, and any appeals are lodged promptly.
Given the deteriorating economic picture, every business – whether it has insurance protection or not – should review their processes and credit management risk profiles, to ensure they are robust and can respond appropriately as and when the situation develops. Alongside that, trade credit insurance can play an invaluable role. While premiums are still competitive, it’s an ideal time to buy, before claims volumes escalate and insurers react by raising prices and restricting levels of cover. Businesses will need to work closely with a specialist broker to make sure they are not subject to the problems with conditions such as full salvage waivers, for example. In addition, your broker should actively assist with the presentation of any claims and be your advocate, to optimise the likelihood of a settlement.
For more information, visit https://www.aon.com/unitedkingdom/commercial-risk/credit-solutions/default.jsp