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Taking a closer look at the perils of credit insurance


Given the current downturn, credit insurance can sometimes be useful as an early warning system—even when you don't receive a check.

"We weren't caught by Aleris at all," said one scrapyard executive, referring to the February bankruptcy filing by Aleris International Inc., Beachwood, Ohio. He tipped his hat to the German-based underwriter that provides his coverage against unpaid bills caused by financial woes. "They're tightening up on the amount that they're willing to insure, but they are good in the sense that they will notify you," he said.

"They cut the amount of Aleris coverage in half back in December.," he added. "We were very cautious after that because Aleris was so slow with payments. Once we got paid (by Aleris) we decided to wait and see, even though we had some open orders with them in January. After the insurance was canceled, we didn't ship."

Another recycler, though he buys such coverage, perceives credit insurers as likely to add undesirable momentum to the upswings and downswings of the economy—and secondary smelting in particular. "(Lenders') credit lines aren't available even for viable, strong companies," he said, "so the credit insurers are listing almost nobody these days" among consumers of aluminum scrap.

Even the first executive, grateful for the cue to drop Aleris, is unsure whether the arithmetic of credit insurance will continue working in his favor. He cites a $40,000 deductible each year plus a 95-percent cap on reimbursements, so there's no net reimbursement unless a year's defaulted bills approach $100,000. At current aluminum prices, no single customer will owe $100,000 unless they're receiving shipments daily, he said. "A lot of people would have to go" downhill for the policy to pay for itself.

One sales pitch from credit insurers is that their product can offset the concentration risk of selling into an industry with a shrinking number of players.

The 2007 acquisition of Wabash Alloys LLC, Wabash, Ind., by Aleris prompted some scrapyards to cultivate the lesser smelters buying secondary aluminum. That strategy would prove to be a wise move, given Aleris' financial trajectory.

For brokers selling credit insurance, a narrow policy focused on a company's top two or three customers is portrayed as an alternative response to industry consolidation. "Clients can deal with concentration risk by sharing some of their larger exposures with credit insurers in order to sell more to such customers," said one brokerage executive chatting with recyclers in an off-the-record conference call organized by the Institute of Scrap Recycling Industries, Inc. "Accounts receivable can represent 35 to 40 percent of a company's current assets. To leave those uninsured while other issues are insured—property, equipment and inventory—isn't prudent."

He described U.S.-based underwriters of trade credit as tending to focus on worst-case coverage, with limited interest on broad policies covering large numbers of customers. Where the debtor company is already known to be in trouble, a policy might have a large deductible but be non-cancelable for a 12-month or 18-month period. This contrasts with the approach of European-based underwriters, which offer much wider coverage for receivables but on terms that are adjustable on short notice, deleting particular customers of an insurance client or reducing the customer's covered debt limit.

Some U.S. customers find that disconcerting during an economic downturn, brokers acknowledge. "We've had some clients who are uncomfortable with the ability of the insurers to move away from some of the coverage," said one of the conference call's participants. The clients "have actually turned to us to move into more of a catastrophic or non-cancelable type of policy."

The broker said the traditional credit insurers are typically based out of Europe Atradius NV, based in the Netherlands; France's Compagnie Française d'Assurance pour le Commerce Extérieur (Coface); and Germany's Euler Hermes Kreditversicherungs-AG.

"We saw rates fall to some of their lowest points in 2007. Now they are increasing. Insurers are taking more and more losses," he said.

Another conference call participant supplied greater detail on 1997 to 2007. "Their loss history was good," the brokerage executive said. "This made them compete for business by decreasing rates. They also became a lot more aggressive in approving buyer limits—which was good while times were good. Rates got so low that some insurers were complaining they didn't get enough return on their capital."

Even now, credit insurance hasn't dried up, according to one of the conference call's speakers. "There are plenty of underwriters out there that still haven't really had a large number of losses. Some have been hit with a lot of low-value losses, but the market hasn't been hit with any large-value losses yet," he said. "Underwriting capacity is still out there, but it's just a little bit tougher than it's been in the last couple of years."

Suppliers of trade credit can get fancy when a potentially dicey vendor is a publicly traded company with transparent financials.

A die caster recalled buying 18 months of credit protection on General Motors Corp., Detroit. He said the deal was arranged through a bank and was based on financial derivatives involving GM's equity and debt securities. In crude terms, the provider of that 18 months of trade credit had shorted GM. If the company took a turn for the worse, the derivatives investment would yield a payoff from which to reimburse the unlucky trade creditor. However, the credit provider chose not to re-up. "When it ran out, after the 18 months, they said 'we don't write any, at any price,' so I couldn't get any more."

And he's not interested in conventional credit insurance. "If they can say 'we're no longer covering General Motors after 90 days' and I've got a one-year contract, I've just wasted my money." PAUL SCHAFFER

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