The ITFA Insurance Roundtable, held
on 7th September 2017, was discussed by ITFA’s insurance committee,
moderated by Katharine Morton. At the time of the interview, Katharine Morton
was still Editor in Chief for TFR, the Trade and Forfaiting Review.
Unfortunately, Wilmington decided to stop the edition of this magazine shortly
after the ITFA conference. Katharine was nevertheless so kind to transcript the
interview so that the readers of the ITFA Newsletter now have the benefit of
getting the insights on this important topic.
Participants:
- Geoffrey
Wynne, Partner, Sullivan & Worcester
- Huw Owen, Global
Financial Risks, Head of London Markets, Liberty Specialty Markets
- Sébastien
Heurteux, Head Trade & Insurance Syndications, BNP Paribas
- Volker
Handrich, Head Trade and Supply Chain Finance, Swiss Re Corporate Solutions
- Robert
Nijhout, Executive Director, International Credit and Surety Association
(ICISA)
- Silja
Calac, Senior Surety Underwriter, Swiss Re Corporate Solutions and ITFA Board Member,
Head of Treasury and Insurance
- Moderator, Katharine Morton
Walking the fine line
The knotty subject of differentiating and choosing between risk
participation agreements, surety and insurance as a way of mitigating credit risk
was discussed by ITFA’s insurance committee, moderated by Katharine Morton.
Katharine Morton: Where are we now in terms of insurance policies versus risk
participation agreements (RPAs) and what does everybody understand by these?
Geoffrey Wynne: We are looking at
a series of potential credit risk mitigants, and, essentially, they have to
fall into the section: guarantees. That’s the only real clue that sits in the
CRR [Capital Requirements Regulations], and the discussion, will be around
which is better – which would you prefer to have – guarantee, first demand
guarantee, and, within that, surety, risk participation and insurance.
Katharine Morton: Around the world there are different definitions of what all these
things mean. From a US audience, for example, what is possible to achieve with
them, and what is not possible?
Geoffrey Wynne: We talk in terms
of CRR, which is European, so our discussion is EU-wide. One of the strange
things is that that is everybody’s law. That is not an interpretation - that is
the law. So, credit risk mitigation is determined in accordance with article
194 up to article 225. And, of course, whether you are allowed to do any of
this is still a little bit of an issue. So, I can look at, in the UK, whether
you can be an insurer, and that’s governed by an English Insurance Act. In
Germany, it is different. And, one of the debates is: are insurers moving
outside of what their territory should be i.e. insurance, when they’re issuing
surety bonds? Can an insurer issue a guarantee? Is every guarantee issued by an
insurer ‘insurance’? And that makes a difference, because insurance law
dictates both the regulation of the entity and the interpretation of it. And,
then you get into an even more interesting area, which is: can an insurer issue
a risk participation? Is that outside the permitted requirements? We would say
no, and certainly some around this table, would say no. So, some very
interesting and intricate debates, because, as you’ll see, when you say “I
guarantee that if he doesn’t pay, I’ll pay,” and if you say, “and I insure you
that if he doesn’t pay, I’ll pay,” it may be depending on who says it as to
whether that’s insurance or not insurance.
Katharine Morton: That sets up a nice framework for where we’re at, but we’ve got the
whole market around the table. Silja, why did ITFA set up an insurance
committee?
Silja Calac: When I joined Swiss
Re three years ago, there was no insurance community within ITFA. Swiss Re was
the only member of ITFA that was from the insurance world. I knew from my previous
job that banks often have quite a few problems to find their way around these
questions. What insurance should I use? Which insurance gives me which
benefits? Because, there is not one product which is all good and another one
all bad; each product serves specific needs, and has specific advantages or
inconveniences, so that was what we wanted to clarify. That’s why ITFA set up
the insurance committee. Since then, many insurance companies and brokers have
joined ITFA. We have already achieved quite a lot in giving clarity with our insurance
guidelines and with our training efforts. One interesting question is: can an
insurance company issue surety or guarantees or risk participation? For surety
this seems quite clear because there is regulation associated with that, but Robert
will elaborate a little more on this because this is his specialty.
Robert Nijhout: There is a bit of
a thin line between what insurance is and what bank guarantees are. The determining
factor is how it is regulated. Insurers are regulated by the insurance
regulator, which arguably in many countries is the same as the bank regulators,
in the same buildings, often in central banks. But, perhaps more importantly, insurance
is reinsured and that is usually the reason why some conditions need to be
applied in an insurance product because reinsurers don't like certain risks
such as nuclear risk or five great power war or financial guarantees and such.
Surety, unlike credit insurance, is legislated as well as, regulated
by the regulator. You can start a credit insurance company without having to
comply with a certain law. But surety is legislated and regulated on a national
level. If there is no surety legislation, you cannot sell a surety bond. It
depends on the country on how they define it, but in Europe it is almost always
defined as an insurance product, therefore regulated by the insurance regulator
and subject to Solvency II in Europe and similar regimes in jurisdictions
around the world. But, of course, insurers will do as much as they can to satisfy
the clients' demands. If a client wants an on-demand product which is
unconditional, then insurers will try to issue that. Another big difference
between banks and insurers is that insurers don't have collateral, they just
have underwriting. So, if they issue an unconditional on-demand guarantee to
just anyone, you don't have any security and you're also in breach of your Solvency
II regulations, etc. So, surety companies are very selective to whom they issue
these types of products, but they are available. That’s perhaps the attraction
for a lot of clients despite the conditions that some surety products have, vis-à-vis
bank guarantees; the fact that they don't have to collateralise it and don't
have to block credit lines or other ways of guaranteeing the collateral, gives
them a lot more freedom. It’s horses for
courses, as Silja said.
Katharine Morton: Where
do banks sit on this? Are you using insurance products as a way of just getting
away from Basel II considerations?
Sébastien Heurteux: Risk Participation Agreements [RPAs] are a dream product, it is
on-demand and it is simple to explain internally and to credit committees. The
wording is simple. It limits scope for wording negotiations. I would say RPAs
are more automated in their way of working. Now to simplify the product to such
extent, such cover will only works between two parties which have a high level of
trust. The RPA is a dream product but it is not accessible or offered to
everyone. At the industry level, Should there be a default by the Insurer in a
situation of claim, this would taint the reputation of the product. In the
wording of an insurance policy, terms and conditions are detailed in a greater
manner. .
As far as BNP Paribas is concerned, we use both products – RPA and
insurance policies – in a very “fungible” manner. The RPA is a more efficient
and user-friendly insurance policy, but at the end of the day, we contract an
RPA in a similar way we contract an insurance policy.
A point raised was the RPA’s jurisdiction-specific feature. What many
banks want is a single tool used worldwide to cover its risks and/ or get
capital relief. Insurance Policies have more of a worldwide reach in their
availability across jurisdictions. The more the covers are differentiated in
their nature or form between business lines, regions or territories, the more
banks will be exposed to operational risk. The key risk for an Insured to lose
the benefits of an insurance policy is often assimilated to the Insurer going
burst ie a Credit Risk. We should not underestimate the risk of the Insured not
fulfilling correctly his obligations viz. the Insurer: an Operational Risk.
I would say there’s a sense of uniformity that we need to have in a
Global Organisations to make the risk cover work optimally. Today RPA remains
very specific to certain Insurers, to certain underlying asset class, to
certain geographies. Until RPAs are offered in a more widespread manner, it
will only be used in an opportunistic manner.
Katharine Morton:
So, is that an issue of documentation, is this an issue of just different types
of risks that are covered, or different jurisdictions in terms of doing things
on a one-to-one basis?
Silja Calac: What Sebastien said is important. Risk participation does not give
the same level of comfort to the insurance company as a traditional insurance
policy does. Therefore, with a traditional insurance policy, an insurer would cover
up to 90%, 95%, sometimes even 98% of a risk while under a RPA, one would usually
not cover such a large share.
Volker Handrich: I agree. Our main product is risk participation. What does the
client want? In the EU, for CRR compliance, capital relief is a big topic. RPA is
a great product because it’s unconditional hence it gives the capital relief
and it’s a very simple approach. If there’s a non-payment, we come in. There
are some challenges, one is on the underwriting side, and this is where there
is a place for both insurance as well as RPA.
Because we give this broad cover, this guarantee type of cover, we
would not do 90-95% of a transaction. It’s a question of ‘‘skin in the game’’.
Thorough underwriting is much more important. On the retention side, we are
much more selective and usually would like to go for 50/50 risk sharing - we want
to see a lot of ‘’skin in the game.’’
The other challenge is that whereas usually the RPA is based on
English law, as Geoff pointed out, from a regulatory perspective, and from a tax
perspective, you still have to respect local rules, and there the treatment can
go in your favour or against it. The UK Insurance Act is another question. The
regulatory question is ‘’can we use the same wording in every country?’’ And
the answer is ‘no’. In the EU, yes we can, typically, but in the US for example,
we cannot. In Singapore, we have to adjust it. In other countries, like China,
you have to get every word change approved by the regulators.
So it can become a challenge from a tax perspective too. Sometimes
it’s an advantage in so far that IPT [Insurance Premium Tax] is not applicable
under the RPA in certain countries, but again, you have to check in every country.
Katharine Morton: What
is Liberty’s view on these products?
Huw Owen: I’d just like to pick up on a couple of points. From our
perspective, we’d make a distinction between the two RPA products we’ve been talking about. The RPA that’s issued by the
bank is one type of product that’s probably underpinned by contract law. Some
of the RPAs that are issued by insurance companies, we feel that they are insurance
policies.
This is probably the underlying topic of conversation: what is an
insurance policy and when is an insurance policy an insurance policy? I
appreciate that this is a tricky area due to there being no specific definition
of a contract of insurance under UK/EU law but arguably from an English law
perspective, if the product is issued by an entity that’s an insurance company,
and it has the characteristics that common law has shown to define an insurance
policy [consideration, insurable interest, fortuity then it probably is an
insurance policy.
Katharine Morton:
If it walks like a duck, and quacks like a duck, maybe it’s a duck. Why is it
important?
Huw Owen: Potentially this is semantics because it’s just arguing about what
you call it. But it also goes to what the underlying law is and any disclosure obligations
there might be. So, in the absence of anything specific in the policy that
strips away some form of duty of disclosure then arguably there is a duty to
disclosure by proxy because it’s an insurance policy to the provisions of the
Insurance Act.
I agree that there is a place for the different products and
ultimately what we’re all focused on is giving a client the best product – the
product that they want. So, the question is – ‘’does it work for the client?’’
And, if we think that both products can qualify as a guarantee under CRM [credit
risk mitigation], then maybe that’s doing what it needs to for the client.
One potential area of improvement of insurance is its usability. There
are two aspects to the usability in terms of understanding some of the
conditionality in the document. We’ve come an awful long way. Geoff might
disagree, but I spend a lot of time renegotiating with our clients – in a way
negotiating with Geoff and his team – and I think those wordings are very good,
and they’re very good from a client’s perspective, and we’ve really narrowed
down the operational risk that banks are running. I know Geoff might probably
would go a little further, but they are good templates.
The other issue where insurance probably needs to focus and really
where the insurance RPA’s strength lies, is on the claim payment. The potential
concern for banks is when they come to claim, they could be facing an entirely
different team within the insurance company who are making a determination on
the claim often using external loss adjusters. In this context I can understand
why any insurance RPA’s self-certification claims process and payment in 10
days, ask-questions-later type of approach, can look more attractive as a
product.
Some of the big insurance providers engage their claims function throughout
the underwriting and wording negotiation process, so that there’s no risk of
reunderwriting when you get to a claim situation. When we are assessing a claim, we can respond
very quickly and are focused on making timely payments on valid claims, so that
we meet all of our obligations. Because, the worst thing we can do is make a
mess of paying a valid claim, that is not good for anyone.
There are clearly some advantages to the private credit insurance market’s
willingness to consider up to 90% indemnity and its risk appetite both in terms of structures (very
little that the market won’t consider) and jurisdictions. But the willingness
to offer high indemnities came about from a partnership with clients where
insurers were relying on material information provided to by clients.
Geoffrey Wynne: I agree. Insurance has now come a long way and is a lot better. Under
the Insurance Act the concept of the insured being able to discharge its
liability on disclosure by making a fair presentation of facts, does make a lot
of difference. But, they’re different creatures. Insurance is insuring against designated
risks, it so happens that when you’re dealing with credit insurance,
non-payment insurance, that that’s the same risk that the other products cover
with the guarantee and the RPA. What’s interesting is that there’s a waiting
period for payment with insurance. We have accepted that 180 days, the
conventional waiting period, is still timely for regulatory purposes, for CRR
purposes.
The requirement to act as if uninsured in that period, to keep working
at it, has a slightly different relationship, and I was interested that Volker
used the phrase “skin in the game”. It is quite interesting because whilst the
insurer says, “you’ve got to have a bit of skin in the game,” actually what the
insurer says is “you’ve got to work to get this money back, even though you’ve
insured it. I’m looking to you, the insured, to offer me something I can
understand that I can assess.” So, I’ll assess the risk based on what you’ve
told me. And it just so happens that I’m quite likely to have a bigger and
better appetite for risk because my view, cynically, if you like, is that if I
charge premiums of 10%, so long as I don’t have to pay out more than 10%, I
make a profit. A bank looks at every single loan it makes and expects it to be
repaid. So, it can’t go to its credit committee and say, “let’s do these 100
deals but I’m certain that 10 of them are going to fail.” The credit committee
would say “which of the 10 are going to fail? We’ll get rid of those.” The
balance, the skin in the game point in risk participation is essentially that the
guarantor and the insured will work together.
Silja Calac: I fear we’re starting to mix things up. When you say that you
believe that when insurance do risk participation this might be insurance, I’d
say of course it is all insurance, but there are different insurance products. When Swiss Re does risk participation, we
actually do it under the surety regulation [Class 15 as per SI No 359 of 1994 -European Communities (Non-Life
Insurance) Framework Regulations, 1994]. This is
clearly a product which is separate from the comprehensive non-payment
insurance product which we are comparing here, and it is not regulated by the
UK Insurance Act, for instance. But, it is a product which insurance companies
are allowed to do, and which is regulated as such. Both these products have
their specificities and can be of advantage to a bank or not. I would like to
avoid confusing readers here, not that they end up thinking it’s all the same, and
some insurance companies are just twisting regulations.
Volker Handrich: The thing is do we talk about the law dimension? Is it a regulatory
dimension? Is it a tax dimension? That’s where the difficulties start. The credit
insurance product, on a global level, is the more standardised product, because
there is a more established market, whereas RPA works very well in certain
countries or regions where you have the capital relief, but in other countries
you have to adjust on a local basis and that’s where the challenge lies -
standardisation versus a better product.
We’re all within insurance regulation and we all have a value
proposition. Ultimately as a bank you have to decide for which client and which
situation is the right product. Insurance and RPA are both unfunded. If a bank
has very high funding costs they might go for funded syndication instead. They
might opt for a very different route if capital relief is the big driver. Then
it depends on the bank’s internal capital model. Most follow the advanced
approach, some follow the standard approach, and depending on the model they
use, maybe RPAs are better but then maybe in a different situation you have a US
bank that has sufficient capital which may prefer the lower retention or maybe
even a better price from credit insurance.
Sébastien Heurteux: If we put aside law, legislation, regulations etc, and we take a
very operational approach. In both cases whether it is Liberty issuing
Insurance Policies or Swiss Re issuing RPAs, we are facing Insurers. An Insured
should have the exact same approach in terms of disclosure and answering
questions when presenting a file. Similarly Insurers seem to go through similar
underwriting processes. So, regardless of the type of cover, an RPA or an
insurance policy, the placement process and interaction between the Insured and
the Insurer look very similar.
Going one step further in the situation of a claim, the willingness of
an Insurer to pay overrides the type of cover. In the examples that we have
experienced or that we know of, I would say insurance policies and RPAs have
always been timely paid indistinctively from their nature. As a track record,
in terms of the efficiency of the product, we are all good.
At the end of the day, what we want is the cake. If we have the cherry
on the cake, it’s not the cherry that will feed us, it’s the cake. Now, the
cherry will always look good….
What I hear is that between an RPA and an Insurance Policy each bank
has a sensitivity of its own. It is often ruled by their own internal systems,
understanding of the products, methodology and/or applicable regulation.
The bank regulators have not tackled the insurance product per se when
laying out the regulation. Now the Credit Insurance is commonly treated as an
extension of what the regulator defines as Guarantee when tackling Credit Risk
Mitigants. This somehow can blur the picture or set undue constraints to the
efficiency of Credit Insurance. That is why I don’t think there is a right or
wrong.
Katharine Morton: Where
are we at with the Insurance Act, what’s changed and what will change?
Geoffrey Wynne: The Insurance Act presented a very good opportunity. It essentially
rewrote insurance law, which had been more than 100 years, very insurer-biased
was the perception of the market. Therefore, there were lots of reasons why
insurers were able to escape liability. The new Act tried to close loads of
those gaps. It did not remove the responsibility from the insured to tell the
story properly but said you could do it at the beginning in one presentation.
The problem has been two fold. One, the Act allowed opting out of certain
clauses which we believed the insurance market was using a little bit too much
and one might say abusing, in other words they didn’t have to think about the
point, they opted out to go back to where the old law was. And the second
thing, where ITFA in fact was trying to step in, was saying, “Given the fact
that we have a really good Act, why have we not got some standardised wording
in the policies, or indeed, why don’t we have standard policies, a bit like the
BAFT risk participation agreement?” In other words, why are insurance companies
still issuing their own policies?
Katharine Morton:
Maybe Rob would like to make a comment from the ICISA perspective.
Robert Nijhout: First of all, the insurance market is an open marketplace, subject
to antitrust regulations. So if insurance companies all collude to draft one
policy wording, and the market had to swallow that, that’s unacceptable. But
perhaps more important is we have a fiercely competitive market, the market is
extremely soft, and the underwriters have to compete very hard for their business.
With this soft open market, there is downwards pressure on price. And if you
don’t want to compete on rates, on premium rates – and I wish we could charge
the 10% that Geoff mentioned earlier – you have to compete on something else,
which is the quality of your product.
Quality is defined in the policy wording, in a way that the customer
likes to see, and whether that’s a global wording for a multinational or
whether that is a very specialised wording for a particular deal with
structured finance and a long tenor. So, the market wants that difference.
Having said all that, it’s in the interest of the insurers who are dealing with
banks with a symbiotic relationship, and we depend on one another to come up
with a product that is recognisable for banks. So, you could think of creating
guidelines or parameters or something in that realm where you say, “if the
policy complies with these characteristics, then it’s more acceptable for banks,”
but then we would say, “can the banks also have a single opinion on what they
think of insurance companies?” And that doesn’t happen either. So, the first
thing we need to do is educate one another, because I don’t think insurers
appreciate the limitations or the specificalities that banks have to deal with
and vice versa, so it would be good to have a bit more openness on both sides.
Katharine Morton:
That’s what IFTA’s up to, isn’t it?
Silja Calac: As Geoff mentioned, we have thought about drafting a non-payment standard
policy. At least in the insurance committee, we think you could standardise a non-payment
insurance policy to some extent, and that’s also our aim. The guidelines were a
start. The time isn’t yet ripe to go too far, but Huw would you agree in the
longer term we should aim to come to more standardisation?
Huw Owen: If you could reduce the amount of time we spend on conference calls
with the lawyers that would be a bonus! Potentially the biggest losers of a
standardised product will be the brokers. This is their leverage on what they
sell, and maybe some clients have got themselves in a position where they’ve been
using the market for a very long time and they have a very good wording
themselves, so maybe they wouldn’t be that keen to use a more standard product.
But maybe, it’s inevitable. It’s a bit controversial but certainly we
still spend a lot of time on wording negotiations. Most banks are moving to the
point where they have one policy template, but there are 50-odd markets now, so
to get the approval of 50 markets takes quite a long time. The point about the
opt-outs and carve outs – yes, I think that insurers have had the use of carve
outs and we have narrowed it down to a couple of clauses that we feel that if
we didn’t have the carve outs the clause would be more or less toothless. I’m
talking specifically about Section 11 – causation – but the Insurance Act work
was very welcomed, it definitely redressed the balance more in favour of the
client. It was long overdue. The market responded relatively well and we got
there in the end. We came to a very good landing, again with some lawyers’ help
on certain issues, like defining what constitutes a reasonable search and
knowledge for our banking clients. Arguably we all could have reacted slightly
better, but we got there in the end. And one thing it did demonstrate is that
you’ve got 50-odd markets, but they are relatively collaborative, and that’s
one of the defining positives around our market.
Geoffrey Wynne: What’s interesting was that there was a long gap from when the Act
came into effect and from when the Act was passed, and that time was not used
well, and that’s been a criticism. The point is, there was no real meeting of
the minds. And, it was interesting that the RPA, the risk participation market,
having gone for years with lots of different forms, finally woke up in
2006/2007 to the idea that it would work to have a standard form of wording,
and therefore it was collaborative in a way that you would probably have said
five years before then that banks would never have agreed. What banks have done
is, they all have their little idiosyncrasies and, 10 years down the road, the
idea is to re-tread where we’ve got to. And in some ways, Huw you’re right that,
in the insurance market, the combination of a lot of insurance companies a,
lot, lot more Lloyds underwriters and a lot of brokers has meant that nobody
saw it really in his interest not to put in his two pennies worth on the
wording. Whereas the banks in RPA terms said, “actually, we don’t want to waste
time on those long phone calls,” and now on many risk participation that we’re
involved in there might be one or two exchanges about one or two tiny issues in
the drafting. The lawyers would actually like the insurance market to get to
that point. We’re not saying “standardise totally”, but we are saying, “Why do
we have to rewrite this? Why isn’t Clause 1 the same? Why have I got to look and
see whether Clause 2 has been put into Clause 12 and is also in Clause 8?” And
I think that the RPA has sort of overcame that.
Sébastien Heurteux: In the past, the policy wordings for credit insurance were
worked-out on a bilateral basis between the Insured and the Insurer. One party
was proposing a template that was amended to reach an acceptable format to
both. At that time, there were a limited number of insurance companies and
Insureds. Over the past few years, the market has grown very rapidly with now
over 60 insurance companies. At the same time lawyers have started to be used
for the drafting of insurance policies.
With the new Insurance Act (and CRR requirements), the involvement of
external law firms has increased even more rapidly. . With a rather small
number of lawyers truly knowledgeable about credit insurance, these very few
law firms came out to be instrumental in setting, common ground between
Insureds and Insurers on policy wordings.
Because of both the credit insurance market growth and the legal and
regulatory environment changes, the role of law firms has suddenly become
essential. The limited number of knowledgeable law firms advising Insureds and
Insurers has resulted in more uniform templates used throughout the credit
insurance market.
