ALTERNATIVES TO TRADITIONAL CREDIT INSURANCE...and greater cross-border competition. The market situation facing many, if not most credit insurers, appeared to be that the only

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STUDIES AND PROJECTS / Alternatives to Credit Insurance / February 2007 Page 1 of 50

ALTERNATIVES TO TRADITIONAL CREDIT INSURANCE

Update

Credit Insurance Committee

1. Introduction

2. Why do new products emerge?

3. Key Findings

4. Target Audience

1. Introduction

This review aims to provide an overview of which products are currently available as an

alternative to credit insurance, by providing a summary of the instruments available, an analysis

of the way in which they operate and an assessment of their impact - current and potential, on the

credit insurance market.

For the purpose of this report, traditional credit insurance has been considered as “the provision

of protection to businesses against non-payment by their customer as part of an underlying

contract of sale related to the provision of goods and services, including the offering of full credit

insurance management services”. A fuller definition is included as Appendix 2.

It was seen as useful to focus on the instruments at three levels of competitive impact, namely:

Current competitive products; imminent competition from specified products; and, finally,

possible (but distant) competitive product challenges.

2. Why do new products emerge?

The first main driver was customer demand. It was thought that a number of factors needed to be

recognised. Firstly, as far as the trade credit risk is concerned, the differentiation between

commercial and political risks had largely become academic. Secondly, improved technical

knowledge and communications, together with the advent of global business prompted the search

for better ways of financing these ventures and a preference for “one-stop-shopping” for facilities

on competitive terms. In this context, the credit insurer had to answer a number of fundamental

strategic questions: notably whether or not to develop and offer additional products in order to

cater for the multinational corporations. These could include performance guarantees, surety and

a wide array of financially-linked products - possibly in co-operation with banks and other

financial institutions. It needs to be remembered that there is a very substantial demand for

financing and that credit insurance is but one element of this. Moreover, the multinationals do

not themselves want to become bankers. When it comes to trade credit insurance, it is clear that

whilst the multinationals still want cover, their requirements involve notable differences from

traditional cover. This includes a different attitude to risk sharing and outsourcing credit

management, in the belief that their corporate strength in dealing with both aspects is perfectly

adequate. This is assisted by the ability to obtain information more cheaply and with easier

access. An extreme expression of this belief results in deliberate ‘self-insurance’.

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The CIC observed that the credit insurance industry has made considerable strides to

accommodate these changes. This has reflected itself in both the product offered as well as in the

organisation of the industry itself. The concentration that has taken place also means that any

intending newcomers to the credit insurance market, would find a very substantial cost of entry

should they wish to compete at the multinational level. This in turn, might also lead to potential

investors which were interested in the sector, to veer towards financial products services rather

than credit insurance.

The second main driver was the demands of credit insurers’ own businesses with flat premiums

and greater cross-border competition.

The market situation facing many, if not most credit insurers, appeared to be that the only

prospect for achieving significant growth was not in the simple context of gaining increased

market share, but in doing so against a real expansion of the demand for trade credit insurance.

This also implied a real expansion of trade credit as a superior way of doing business. In this

regard, attention was drawn to the general ignorance which persisted about the risks associated

with letters of credit. The CIC agrees that there was a real opportunity for credit insurers to treat

this as a prime opportunity.

The CIC agrees that the terms of reference for the present study, did not call for its view on the

adaptation or change of the traditional credit insurance product. However, it is considered

relevant to make a few suggestions about the most important variations on the traditional product

theme.

In discussing the opportunities for credit insurers wishing to extend their existing traditional

range to include other products or services, the CIC felt that it would be realistic for each

company, at least initially, to consider direct “spin-off” from what they were equipped to handle.

Given the existing organisation of each company, and its particular constraints, the ability to

develop and provide top level service in a new product context, is not a simple matter. The CIC

agreed that real opportunities receded as operations went further away from core activity - with a

consequent loss of focus and likely organisational requirements which could impact adversely on

profitability.

3. Key Findings

In the short term, the majority of the alternatives are unlikely to be serious threats to the core of

credit insurance business. However, they are likely to limit the ease at which credit insurance

develops. The CIC therefore considered where members’ core activities could most effectively

be employed in meeting the challenge of alternative products. Immediate opportunities appeared

to be in the factoring and political risk sectors.

It is the broad field of financing that poses the biggest threat in the short, medium and longer

term. In particular, factoring and invoice discounting have shown significant growth in many

markets. The full range of credit management services, together with bad debt protection, can be

offered and can be unbundled and re-bundled to meet customer demands. The success of this

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sector is encouraging many new entrants. It was thought that the credit insurer should mention

the traditional approach of acting in the interest of the policyholder as a facilitator and not as a

separate financing operation, divorced from the cover. Accordingly, the immediate areas of

opportunity included service centred upon: debt collection; risk assessment; loss prevention; and

collateral enhancement.

The ‘risk sharing’ category is next in line with excess of loss, captives and finite programmes

where insurers other than traditional credit insurers have the easiest entry. The globalisation of

finance, the coming together of commercial and political risk insurance and the development of

longer term financing through credit insurance mechanisms will bring in general and investment

insurers and reinsurers. This will be particularly true where the underlying credit management

services are not required by the business. It was thought that there was undoubted scope for the

credit insurer to provide add-on services to captives, as well for reinsurance, excess of loss cover

and finite programmes. It was recognised that the premium for pure insurance cover might be

less than that available for whole turnover cover in these instances , but consideration could be

given to providing such ‘top up’ services on a facilities management basis.

In the ‘guarantee’ category, documentary credits and letters of credit, and the combination of

information and insurance through guaranteed status reports and the use of decision making

systems with insurance, stand out. The former are already alternatives and have been for a long

time. The latter will undoubtedly grow. Guarantees could also be considered as additional to the

services portfolio. Whereas financial guarantees are not contemplated as an acceptable product,

it is thought that ‘Information Guarantees’ and ‘Debt Collection Guarantees’ could be

considered. It was noted that ‘guaranteed information’ was de-facto already provided by policies

with a discretionary limit!

The area of Surety/Bonding was referred to as an existing complementary element of the product

range (to credit insurance) offered by a number of ICIA members. Capacity and capability to

handle this business has been achieved by vertical and horizontal integration for purposes of

having the requisite skills involved.

‘Financial instruments’ are of interest, more probably for reinsurance purposes, but are not seen

as significant threats in the short to medium term.

With regard to the ‘Threats’ identified, it is thought that the main competitors involved are:

banks, insurance companies, information agencies and specialised institutions such as factors and

shipping and confirming houses.

opportunities exist

Of course, threats are turned into opportunities and already credit insurance companies have

developed new products, alliances and marketing strategies in particular in the category of major

threat, financing and risk-sharing. Credit insurers of course can already compete at the level of

‘pure’ credit insurance cover. A key to future success is to understand the competing products

and to develop the credit risk management services where credit insurance companies have the

weapons to build an edge.

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4. Target Audience

A summary of each of the alternative products is contained in Appendix 1. While these cannot be

considered as definitive texts on the subjects, they are intended to be of use in:

Education

Strategy and Product Development

Sales Training

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APPENDIX 1

INDEX PAGE

FINANCE PRODUCTS

Factoring 6

Forfaiting 9

Invoice discounting 12

Asset backed security (securitisation) 14

Sale of overdue debts 16

Confirming 17

Leasing 24

Sale of receivables without recourse 31

Invoice centrals 33

RISK SHARING

Captives 36

Excess of loss insurance 38

Finite risk programmes 40

GUARANTEES AND SIMILAR

Guarantees, Bonds, Collateral and Securities 42

Letters of Credit 43

Debt collection enhanced with guarantee 42

Information enhanced with guarantee 45

FINANCIAL INSTRUMENTS

Credit derivatives 47

Credit options 49

Debt swops 50

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FACTORING

The acquisition of trade debts owed by one enterprise to another. These debtors will usually

be assigned to the acquiring business (the factoring company) who will also handle collection

of these debts

1. ANALYSIS OF OPERATIONS

Created by the Anglo-Saxon financial system, the classic factoring is nowadays a quite

common product which is proposed by all financial establishments. The factoring procedure

can be defined as an operation by which a company sells its invoices to a “factor”. The

originality of the factoring is to offer several services in one process as we will see.

a. Legal aspects

There is no legal text to define the factoring, so the parts sign an agreement which is a real

guide of proceedings. This agreement is a common right’s agreement and clarifies the

relations between the factor and its client. The agreement’s structure has general and specific

conditions:

General conditions: they specify the relations between the factor and the client and describe

the principle of a “current account” and the exclusive character of the agreement.

Specific conditions: they indicate the price, the duration of the agreement, the guarantees....

b. Current potential market

to be updated

c. Taxes

The factoring commission is subject to the VAT

d. Mechanisms of operations

The factoring success is explained by the economic and financial process which is really

operational. Factoring is a triangular operation with a seller, a Factoring company and a

buyer.

The invoices resulting from the debt between the seller and the buyer are transferred by the

seller to the factor. In respect of the factoring agreement, this third actor can offer three

services to the seller:

the immediate finance of whole or part of the debt,

the guarantee of the good payment of the debt, and

the management of the invoices

With factoring, the seller gets three added services to optimise the management of the

turnover: Management, Guarantee and financing of the debt.

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Management:

The factor offers a complete management of the debts with the following steps: record of

debt, recover (before and after the due date) and payment.

Guarantee:

The factor can cover 100% of the amount of the invoices -VAT included. In this case, the

factor delivers an approbation, debtor per debtor. The guarantee covers the insolvency of the

debtor (official or presumed).

Financing

This service is optional but really appreciated by the clients of the factoring company, and the

first motivation of the sellers. The factoring company uses diversified methods of finance

(cheques, transfers, letter of change...).

If the factor accepts to finance with guarantee, this operation is a factoring a “without

recourse” or “non recourse”.

e. Pricing

The factoring price is a commission which represents the cost of the whole factoring services.

The factor distinguishes a factoring commission and a finance commission:

The factoring commission is a rate, a percentage calculated on the amount of the transferred

debts; in fact it’s a flat rate applied on the factored turnover .

The finance commission is the cost of the credit and is based on the monetary market.

f. Market segmentation/Possible clients

The portfolio of the factoring companies was essentially made of Small and Medium sized

businesses with an individual turnover below 200’million FF. These sellers need the factoring

services (management, guarantee and of course finance for many of them).

But these last years, the business needs have changed (for example the

outsourcing of the costs, the research of new clients ) So the factoring companies have

adjusted the initial offer and improve progressive modifications. Today, the factors offer

different formulas as services combination or services modulation (with separated services)

or new formulas ( Confidential factoring, Window dressing.. ) and propose their services to

all kinds of firms: small, medium, large and exporting firms, including very large firms.

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2. IMPACT / CURRENT POTENTIAL

a. Comparison with credit insurance

As explained here above, the factor covers 100% of the amount of the invoices (VAT

included for domestic operations) and offers two others services: management and finance.

As with the credit insurance, the approbation is revolving, and the official or presumed

insolvency is covered. Of course, the factor offers the prevention of risk.

B. Opportunities for credit insurers

Factoring offers the opportunity to optimize the customers item in the balance-sheet. The

factoring company undertakes to:

finance immediately the receivables,

prevent the risk of bad debts,

give a guarantee against bad debts

manage the customers item (follow-up of receivables, collection of debts. collection

of payments).

Factoring is actually a direct competitor for Credit Insurance, and moreover it offers

financing. Nevertheless, the prevention of bad debts risk cannot be as efficient as a Credit

Insurer’s, (shorter and more recent data base). So, the Credit Insurer can easily interfere at

two levels:

by insuring directly the factor companies

by mixing the credit insurance products with those of the factoring: a fitted factoring

policy (customers item management, control of the payment terms) and optimization of

the guarantees offered by the credit insurance policy. In this case, the right for

indemnities of the credit insurance policy is delegated to the factor company.

Additional Studies

Further reference is made to the paper drafted in 2006 by the Credit Insurance Committee

entitled “Insuring Factors Companies” (FILE 2006031)

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FORFAITING

The purchase of a series of notes representing payment of international transactions, usually

bills of exchange, promissory notes, or other freely negotiable instruments, on a non-recourse

basis.

ANALYSIS OF OPERATION

International transactions between exporters and importers are often paid by series of

notes. Forfaiting is the purchase of these series of notes, usually bills of exchange,

promissory notes, or other freely negotiable instruments, on a non-recourse basis. (This

means that there is no comeback on the exporter if the importer does not pay). The Forfaiter

deducts interest (in the form of a discount), at an agreed rate for the full credit period covered

by the notes. The debt instruments are drawn by the exporter (seller), accepted by the

importer (buyer), and will bear a backing, or unconditional guarantee of the importer’s bank.

LEGAL ASPECTS

In the contract of Forfaiting the Forfaiter undertakes to discount the amount of bills/notes

according to the assessment previously accepted by the exporter

In exchange for the payment, the Forfaiter then takes over responsibility for claiming the debt

from the importer. The Forfaiter either holds the notes until full maturity (as an investment),

or sells them to another Forfaiter, again on a non-recourse basis. The holder of the notes then

presents each receivable to the bank at which they are payable, as they fall due.

Required documents are:

1. Copy of supply contract, or of its payment terms

2. Copy of signed commercial invoice

3. Copy of shipping documents including certificates of receipt, railway bill, airway bill,

bill of lading or equivalent documents

4. Letter of Assignment and notification to the guarantor

5. Letter of guarantee, or backing. The backing is the Forfaiters preferred form of

security of payment of a bill or note. For a backing to be acceptable, the backing bank

must be internationally recognized

The most important point to remember is that any guarantee should be irrevocable,

unconditional, divisible, and assignable

CURRENT/ POTENTIAL MARKET PLAYERS

Forfaiters which are financial houses where most of the shareholders are Banks.

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TAXES

Apart from stamp duties on the notes, Forfaiting is exempt from fiscal charges.

PRICING

The Forfaiter needs to know who the buyer is and his nationality, what goods are being sold;

detail of the value and currency of the contract and the date and duration of the contract,

induding the credit period and number and timing of payments (including any interest rate

already agreed with the buyer). He also needs to know what evidence of debt will be used

(either promissory notes, bills of exchange, letters of credit), and the identity of the guarantor

of payment (or backer).

Once a Forfaiter has all this information, indications or quotations can be given immediately

by phone or fax. A commitment can be given prior to contract or delivery, and options can be

given to assist the exporter in the final negotiation of the contract

Charges depend on the level of interest rates relevant to the currency of the underlying

contract at the time of the Forfaiter’s commitment and on the Forfaiter’s assessment of the

credit risks, related to the importing country and to the backing (or guaranteeing) bank.

Briefly, the interest cost is made up of charges for the money received by the seller, which

cover the Forfaiter’s interest rate risk.

In effect, this covers the Forfaiter’s refinancing costs and is invariably based on the cost of

funds in the Euromarkets. Forfaiters calculate this charge on the LlBOR rate applicable to the

average life of the transaction. On a five year deal, for example, repayable by ten semi-

annual instalments, the average life of the transaction is 2-3/4 years. The LIBOR rate for this

period would then be used.

A charge for covering the political, commercial and transfer risks attached to the

backer/guarantor. This is referred to as the margin and it varies from country to country and

guarantor to guarantor (from 0.50% to 4.00% per year).

Additional costs (which are also included in Forfaiter’s calculations) include days of grace

charge and when necessary a commitment fee (from 0.75% to 1.50%). Days of grace are an

additional number of days’ interest charged by the Forfaiter which reflect the number of

days’ delay normally experienced with payments made from the debtor country. These range

from none to about 30 days on some countries.

MECHANISM OF OPERAT1ON

In a typical Forfait deal, the sequence is as follows:

The exporter approaches a Forfaiter who confirms that he is willing to quote on a prospective

deal, covering the export in x month’s time bearing the back of XYZ bank.

lf the deal is worth US$1million, the Forfaiter will calculate the amount of the bills/notes, so

that after discounting the exporter will receive $1M, and will quote a discount rate of ‘n’ per

cent. The Forfaiter will also charge for ‘x’ days grace and a fee for committing himself to the

deal, worth ‘y’ percent. The Forfaiter will stipulate an expiry date for his commitment (that

is, when the paper should be in his hands).

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This period will allow the exporter to get his bills/notes backed and to present them for

discounting The exporter gets immediate cash on presentation of relevant documents, and the

importer is then liable for the cost of the contract and gets credit for ‘x’ years at ‘n’ + ‘y’ per

cent interest.

Some exporters prefer to work with Forfait brokers who, because they deal with a large

number of Forfait houses, can assure the exporter of competitive rates on a timely and cost

effective basis. Such brokers typically charge a nominal 1% fee to arrange the deal. This is a

one time fee on the principal amount and frequently is added to the selling price by the

exporter.

Many houses claim tha exporters get 100 per cent finance in about two days after

presentation of the proper documents. Practices vary between houses.

MARKET SEGMENTATION/POSSIBLE CLIENTS

Clients of Forfaiters are exporters, especially those who sell in very risky countries where

political risk is carefully evaluated. Normally, transactions are not worth less than US

$100,000 and their duration can range between 180 days and ten years, depending upon the

country/importer financed and the guarantor.

CURRENT MARKET SIZE

to be updated

MARKET SEGMENT OF RISK

Exporters occasionally supplying high-risk countries, covered sometimes by public credit

insurers.

OPPORTUNITIES FOR CREDIT INSURERS

The risk is very high due to single transactions in high-risk countries. Spreading of risk

cannot occur. Provided that most of exporters’ sales are towards the above-mentioned

countries, it even appears very risky to cover the whole turnover. It is the opinion of exporters

that Forfaiting is much more profitable than credit insurance. A solution could be to create

and offer a global policy to Forfaiters which undertake to submit to cover all the discounts of

the backed notes by paying a very low premium rate.

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INVOICE DISCOUNTING

Sale by a business of trade debts owed to that business, usually without informing the debtor.

The selling business will normally retain responsibility for collecting the debts.

1. OPERATION ANALYSIS

Legal Aspects

Invoice discounting is an assignment contract with recourse whose subjects are the following:

suppliers-assignors, credit institutions-assignees and purchasers-assigned

CURRENT/POTENTIAL MARKET PLAYERS

Banks, credit institutions or financial companies.

TAXES

Invoice discounting is exempt from fiscal charges.

PRICING

Operation costs are determined according to different factors: in the case of operations on

domestic credits, interests and a commission determined on the basis of purchaser evaluations

will be detracted by the Bank from the advance payment; in the case of operations on export

credits and assignments with recourse, evaluation will include currency, political and

commercial risks according to which commissions will be increased or further guarantees

wil1 be requested from exporters. Interests will be calculated according to the Euromarket

quotations.

OPERATION MECHANISM

Operations may concern domestic or export credits.

After having delivered goods and issued an invoice, a supplier may suddenly need liquid

assets. It may therefore decide to assign one or several invoices to a credit institution which

after having evaluated the purchaser advances the amount, net of interests and commissions.

The purchaser is then notified that assignment has taken place.

The assignment formula is generally-speaking with recourse therefore, credit institutions, in

the absence of further guarantees such as promissory notes or bills of exchange, are protected

by their right to claim repayment to suppliers of the amounts advanced.

MARKET SEGMENTATION/POSSIBLE CLIENTS

Suppliers selling to national and international clients with or without the use of credit

instruments.

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CURRENT /POTENTIAL IMPACT

COMPARISON WITH CREDIT INSURANCE

The main difference with credit insurance is that the supplier receives the advanced payment

of the invoice, net of interests and commissions, though it also risks having to repay 100% of

the advanced amount in the event of a claim, instead, in the case of an insurance, risks

decrease to 10-20% of the operation and an 80-90% indemnification is ensured on the unpaid

amount.

From a supplier’s point of view, invoice discounting has the advantage of being a single

operation while in the case of insurance, a series of operations are necessarily submitted to

cover, thus affecting the final cost of each operation.

MARKET SEGMENT OF RISK

Invoice discounting involves minimal risk, owing to its mostly with recourse formula, though

such operations are occasional.

OPPORTUNITIES FOR CREDIT INSURERS

A valid product could be an insurance contract drawn up directly with credit institutions,

encouraging the latter to submit to cover all the INVOICE DISCOUNTING operations

bearing certain characteristics. Risk spreading would therefore be valid on operations

guaranteed twofold, thus ensuring low premium rates to the clear advantage of credit

institutions.

To be excluded: insurance contracts with suppliers on any of their Invoice discounting

operations.

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ASSET BACKED SECURITY (SECURITISATION)

The repackaging of assets (e.g. accounts receivable) as securities for sale to outside bond

investors

1. ANALYSIS OF OPERATIONS

Securitisation of receivables is a financing technique allowing corporates and financial

institutions to raise on an off -balance sheet basis committed medium to long term funding at

attractive spreads. Securitisation is a mature technique with a large number of transactions

taking place in the USA and Latin America but also in France, Germany, Italy and the UK.

b. Current/Potential Market

to be updated

c. Taxes void

d. Mechanism of Operations

Securitisation is most attractive for industrial or business corporations which generally raise

money on the basis of their business, products, cash - flows, management... as opposed to the

value of their assets. The process takes out the trade receivables from the assets, but only

those which are linked to the actual industrial or commercial process, and finances them

separately with assets based lenders while leaving the overall business enterprise funded by

traditional cash-flow lenders. In a securitisation, the receivables and debts provided by the

assets lenders are removed from the originator’s balance sheet.

Sale (transfer) of the receivables to the “special purpose vehicle”

Sale of certificates by a Trust, with assignment a rating of credit (for example AAA)

or an insurance policy cover. So securitisation is not only a source of credit but also a

balance sheet instrument. In France, only banks can securitise, so that business firms

are forced to call on bank services which weighs on the operation cost, or to call on

off-shore companies. Furthermore, the securitisation cover is going to be extended

very soon to other ranges of accounts receivable such as leasing and business bad

debts.

e. Pricing

Rate according to each country market.

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f. Market segmentation/Possible clients

Only big firms are able to securitise and only firms having a large customers item are

interested.

IMPACT CURRENT/POTENTIAL

a. Current market size

to be updated

b. Comparison with credit insurance

Credit insurance is not a direct competitor to securitisation, contrary to factoring. It is above

all an original financing with risks transfer for the benefit of the Special Purpose Vehicle

(SPV) and also an off-balance sheet instrument.

c. Opportunities for credit insurers

The credit insurer could improve tile rating and bring a better risk assessment.

If the seller is credit insured, the securitisation procedure is all the easier as the ceded

debts are already selected by its credit insurer.

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SALE OF OVERDUE DEBTS/BAD DEBTS

Sale of debts that are past due or are claims arising on an insolvency of a business, e.g. where

it has entered an administration process but has not been liquidated.

Sale of claims unpaid (invoices or commercial paper past due) to companies specialising in

the collection of debts. Generally the acquisition is firm with a discount that varies in each

case and may reach 80% of the amount owed.

The buyer company examines the debtor to assess its situation and determine the discount

rate it is willing to offer.

The purchase of unpaid claims is practised in some countries.

In Spain, it is done on a small scale. Reliable data regarding the value of the claims purchased

are not available, neither for domestic nor for international business.

It is practiced outside the usual banking and financing circuits. The market is insignificant

and opaque.

The seller obtains cash (small amounts) for claims unpaid still in the process of collection, or

for claims in some cases already considered as bad debts.

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CONFIRMING

Confirming is an administrative-financial service that a financing entity renders its client with

the aim to handle his payments and to offer his suppliers the possibility to assign in advance

(without recourse) their receivables drawing on the bank discount lines of the buyer.

OPERATION

Confirming originates from the buyer’s need to find alternatives to the traditional ways of

handling supplier payments. Its aim is to eliminate the administrative and fiscal expenses,

improve purchase conditions and make cash management easier.

Confirming was introduced in Spain in 1994 upon the initiative of one of Spain’s most

important financial institutions, the Banco de Santander.

The nature of confirming is two-fold, administrative and financial, in as much as it

offers the supplier financing and risk coverage;

helps the debtor to improve its cash management;

provides for notice and notification of payments to suppliers;

provides for the execution of payment orders, as well as for the issue of cheques

and instruction of transfers.

As the supplier makes use of the option to exercise his right to advance collection, confirming

turns into a form of factoring. The credit is assigned without recourse, and the confirming

entity assumes the risk of insolvency of the buyer.

The paying client achieves cost savings as regards the confirmation of drafts, issuance of

promissory notes and related correspondence. The supplier easily obtains advance payment,

and does not run the risk of non-payment or draw on his credit limit with the bank, while the

soundness of his balance sheet improves (reducing receivables and bank indebtment).

There are several versions of confirming on offer, under different names such as confirmed

payments, flexible payment scheme, etc.

The main sectors which employ confirming techniques are:

Building and construction

Distribution (large surfaces)

Large industrial enterprises.

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Confirming is subject to the different laws that govern and regulate commercial practice in

each country.

In Spain, the activities of credit institutions (who practice confirming) are regulated by the

Law on Discipline and Intervention of Credit Entities. As confirming experience is reduced,

there is hardly any related jurisprudence, giving rise to differing interpretations of questions

deriving from practice.

In spite of legal restrictions, the advantages of confirming move large distribution enterprises

(with enormous negotiating power in front of their suppliers) to use it as a means to manage

their supplier payables.

In countries such as Spain, the use of confirming saves you the Tax on Documents under

Seal, since no documents whatsoever are issued. This saving may be equivalent to 3 to 5 per

mil of the nominal amount invoiced.

The confirming contract is a contract on services to be rendered, whereby the confirming

entity undertakes to handle the payments of its client pursuant to the terms and conditions

agreed (notification of payment/financing proposal/ execution of order upon maturity), and

the client undertakes to pay the order issued. Exceptionally, and provided the supplier has not

assigned the title to the credits to the financing entity, some entities accept revocability.

The contracts usually vary according to the financing entity, and even among the clients of

the same entity, depending on the special conditions established for the service. It is not a

custom to specify volumes, restrictions for the client (exclusiveness), execution expenses or a

date of expiry.

Upon the perfection of the confirming contract, the financing entity provides the suppliers

with the following information:

List of invoices ready to be settled with detail of reference numbers, amounts and

maturity dates;

Offer of advance payment, either specific (certain invoices that the client wishes to be

discounted), or automatic (all invoices the client sends for confirming are discounted);

Request of all data needed to carry out the assignment (proxy, bank and account of the

beneficiary);

Special conditioning of the credit assignment contract. This kind of contract has the

following characteristics:

o Assignment without recourse of the credits,

o Possibility to select invoices and dates,

o Possible financing at a fixed or variable rate.

The client provides the confirming entity with detail of the payments to effect. A commercial

paper is no longer a physical document but turns into a computer entry. The financing entity

will debit its clients account upon maturity, either with a single entry or per remittance,

invoice or supplier.

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1. Credit sale of goods

2. Client informs the bank of commitments assumed

3. Advance collection by the supplier (discount of the corresponding amount)

Pricing

The cost for the supplier of small or medium size, on strength of his client’s guarantee

(normally a large enterprise), will probably be more competitive than that of direct

discounting of commercial paper. The confirming entity can offer lower discount rates, as

bankers’ fees for the management of receivables and stamp duties disappear.

In practice, the discount rates applied are the same as everywhere; on the Spanish market they

vary between 5% and 8%.

The large enterprises, fundamentally the giants of distribution with their huge power of

negotiation, making use of their position of strength, drive bank confirming costs to the

supplier, while they in turn obtain a financing edge with the bank.

The buyer may obtain commissions from the bank as he forces the supplier to decide between

bringing collection forward paying a discount rate or waiting for maturity, in which case the

estimated delay of collection is 7 to 12 days.

Impact on credit insurance market

The banks and financing entities make up the supply side of the international confirming

market. They operate through their respective leasing and factoring companies.

The entities that manage payments via confirming must count on a structure sufficient to

satisfy the technical and logistical needs of this system of handling payments. These needs

are: computer capacities, speedy communication with the suppliers and a customer service

department.

The confirming entities do not measure the risk on the basis of the financial statements of the

supplier, but of those of the client, so that instead of many small risks, risk is concentrated in

a few large clients.

Suppliers’ use of advance payments accessible through confirming is a means of capturing

bank business. The financing entity manages to concentrate and control the payment orders of

its client and, having at its disposal his supplier data base, is in a position to establish

business relations with these, e.g.: to open accounts, to acquire the rights of collection

deriving from their relation with the client, to offer other financing facilities, etc.

Discounting supplier receivables by way of confirming, the financing entities reap a snug

profit.

In the last few years, the confirming market worldwide has experienced a significant increase

of offering entities. Potential new players are those banks and financing institutions that as

yet do not count on this service among the range of products on offer to their clients.

FILE 2007013


Requisites essential for the introduction of confirming in companies are:

Deferment of payment for purchases;

Adequate creditworthiness;

Capacity to validate invoices in a secure and speedy manner;

A certain volume of sales and an important number of suppliers. The greater the

amount of payments and suppliers, the greater the potential reduction of expenses

(paper movements, signatures, mail, conciliations).

This is the profile of the major part of large enterprises, independently from their sector of

activity. The banks accept to use this technique only in their dealings with clients that are

financially very sound, as this allows them to extend their financing business and their

services assuming very low risks,. and quite often they capture the suppliers for their

customer portfolio.

At present, the demand for confirming comes from large enterprises or from multinationals of

excellent solvency and economic stability, who pay their suppliers on credit terms.

The Administration and other public entities are a potential market for confirming,

considering its consistency as a technique to settle accounts with suppliers, the savings of

administrative expenses and the new possibilities for the regulation of cash flows.

These days, the confirming entities target sectors where supplier payments are governed by

specific regulations and which may require certain modifications of the traditional service,

such as the search for new formulas to effect massive payments to residents abroad.

FILE 2007013


1. Comparison with Credit Insurance

Confirming Credit Insurance

Insurable risks There are no risks. There

is a guarantee from the

bank/ confirming house

Commercial

Political (not always)

Payment of transaction In advance (by discount) As agreed under the

supply contract

Indemnity after insolvency None. Bank /confirming

house assume risks

70/85% 3-6 months from

insolvency

Supplier’s risk No risk in case of early

collection (less discount

rate)

15%-30% of the contract

amount

Minimum number of

transactions

Depends on each entity.

(normally at least 50

suppliers)

Possibility to exclude

sales.

Minimum amount Total invoicing of Pta.

1,000 mill. (depends on

each entity)

No

Scope Domestic market (possibly

international, in specific

cases, with difficulties)

Practically worldwide

Market sectors Construction

Distribution

Large industries

Practically all kinds of

goods.

2. Present Size of the Market

To be updated

FILE 2007013


Growth is mainly due to two circumstances:

The companies’ interest in outsourcing administrative work associated with the

management of payments;

The suppliers’ need to substitute the traditional methods of handling payments

proposed by financing entities (bank cheques, promissory notes) for others such as

confirming, that come with a greater number of services.

The system has advantages and disadvantages for each of the intervening parties:

1. The buyer:

Advantages:

Greater consistency in the handling of supplier payments;

Regulation of cash management (unifies flows of payment);

Possible automatic financing of suppliers.

Disadvantages:

The confirming lines limit his borrowing capacity.

2. The supplier:

Advantages:

Agile and speedy collection;

Speedy and easy financing system;

Receivables disappear from the balance sheet.

Disadvantages:

The amount collected is lower than the amount invoiced.

3. Financing entities:

Advantages:

Concentration of total flows of payment of large enterprises;

Possible access to business with suppliers, as part of their income is channeled

through their accounts with the bank.

Disadvantages:

Risk associated with high credit lines.

FILE 2007013


We have no reliable data regarding the size of the confirming market worldwide

Repercussions on the Market of Credit Insurance

At present confirming is employed solely as regards receivables of the suppliers of large

enterprises; therefore, its impact on credit insurance is limited. The risk of non-payment

being totally eliminated with certain clients (discount without recourse), the credit insured

suppliers exclude buyers paying by means of confirming from coverage.

The extension of this service to smaller companies could translate into a decrease of credit

insurers’ market share.

Credit insurers will see the repercussions of this technique when collecting premium from

insured that employ confirming as a means of payment of their suppliers (of goods as well as

services), because, whether they decide to discount their receivables or whether they wait till

maturity, they will have to bear with the financial expenses.

Opportunities for Credit Insurers

Credit insurance may combine with confirming by offering the financing entities a taylor-

made policy for the coverage of credit lines they grant to draw on for the payments to be

made on account of their clients.

The confirming entities bear the risk of insolvency deriving from the buyer’s discount lines.

The premium would be very low.

Expected Timing

In a large number of countries, confirming is a product not yet consolidated; development

expected for the next few years will maintain the present growth rates and be sustained by the

ample market potential within its reach, due to the less exacting criteria currently applied by

financing entities when drafting their offer.

Presently, its a technique offered only to enterprises of renowned solvency, which limits its

possibilities of expansion. The greater the experience of the offering entities, and in as much

as this is positive, the greater the possibilities for expansion of the market to include

companies of lesser size, which will help to accelerate its development.

FILE 2007013


LEASING

The leasing contract is an agreement whereby goods (assets) are rented for a certain period of

time and the lessee is obliged to pay irrevocably a series of periodical quotas, insurances,

taxes and maintenance and other expenses for the goods/assets subject to the contract.

OPERATION

The lessee has the use of the asset during the period stipulated for the transaction, at the end

of which he may either:

purchase the asset for a previously agreed amount, called residual value, or

return the asset to the leasing company.

Usually, there are three parties who intervene in a leasing operation: the supplier, the user

(lessee) and the leasing company (lessor).

The use of leasing as a means of financing sales is very extended, not only in the

industrialised world, but increasingly in the developing countries.

The main sectors where leasing is employed are

Capital Goods

Automotion

Real Estate

Information Technology.

The main types of leasing operations are:

Financial leases: (Financing of the purchase of goods): The user of the goods chooses the

product and the supplier, the leasing company buys the goods under the conditions indicated

by the user who then rents them, with a purchase option.

Operating leases: (Financing of the use of goods): The lessor of the goods may be either a

leasing company or the manufacturer or distributor himself. The lessor retains title to the

goods, but the lessee has the right to consider the contract terminated at any time, so as to

avoid the risk of obsolescence.

Lease-Back: Comes into play when an enterprise is in need of financing. In this case, it sells

one of its assets, generally real estate, to the leasing company, which in turn leases it back to

the seller. As a consequence, the user obtains cash and, once finished the period established,

has the option to repurchase the asset.

Cross-border leasing: Transaction where a leasing company finances the export of goods

manufactured in its country of residence, signing a leasing contract with a non-resident

FILE 2007013


lessee. This is a significant financial means to boost exports; interest in it has increased due to

the growing importance of the financial component in international transactions.

Tax lease: Special leasing category, very common in international transactions, used to

finance capital goods as aircrafts, ships, trains and large projects. The main purpose of such

operations is to take advantage of the countries’ differing tax legislations. Often this results in

tax relief or benefits obtained simultaneously in two different countries (double-dip lease

transactions).

1. Legal Aspects

Applicable legislation varies according to each country. Consequently, certain leasing

techniques that are very common in the Anglo-Saxon sphere of influence experience

restrictions under, e.g., the Spanish legislation.

The laws that in general regulate leasing operations in Spain are:

The Law on Discipline and Intervention of Credit Institutions establishing:

Minimum duration of the transaction according to type of goods;

Breakdown of quotas according to interest and recovery of the goods’ cost;

Quota structuring with implicit payment of non-diminishing values;

Restrictions regarding the legal form of the lessee.

The Law on Company Tax (fiscal regulations).

Pursuant to an EU directive, as from Jan. 1, 1997 it is mandatory that all leasing companies

throughout the European Union be credit institutions. This has led these companies to

broaden their range of activities which gives them the opportunity to balance their

commitments thanks to the possibility of diversification.

Cross-border leasing operations must be structured in such a way as to match their

commercial-financial characteristics with the legislation of the relevant country. Often, there

are several intervening jurisdictions: the manufacturer’s, the final user’s, the leasing

company’s financing the operation, plus the jurisdiction corresponding to the other investors

that may intervene one way or another in the transaction, so as to make the most of it from

the fiscal point of view.

Anglo-Saxon finance legislation is more flexible than its Spanish counterpart, as it but

establishes a series of rules with the aim to ensure the solvency of the credit entities operating

as lessors and the transparency of the transactions.

2. Actual/Potential Players (Offerers)

An analysis of the companies presently operating on the leasing market requires a roundtrip

through the banking sector. The banks and financial entities have companies that specialise in

the handling of this type of transactions.

FILE 2007013


In the past few years, leasing has experienced a gradual decline in the number of offering

entities in all countries, due to

the excessive number of companies compared to the size of the market

the Authorities’ greater and stricter requirements as regards companies wanting to

operate on the leasing market;

the recession at the beginning of the 90’s.

In a sector such as leasing, that stands out for its merger processes bringing forward stronger

and sounder enterprises, capable to offer services at international level, the possibilities that

new players apart from those already present might make their appearance, is practically nil.

3. Taxes

Leasing quotas bear VAT or the tax levied on rental services. The Spanish authorities apply

the general rate of 16% (7% on sanitary equipment). It may be deducted by the lessee as he is

the one who bears it.

For leasing operations to be tax deductible, they have to comply with the requisits established

by the legislative framework of the respective country.

Normally, it is the leasing company who receives the fiscal benefits from the operation, who

in turn passes them on to its client through pricing, by way of quotas inferior to those of an

equivalent loan. On occasions it is the other way around, as in Spain, where the fiscal benefits

go directly to the client.

Leasing as a financing tool is not neutral as regards its fiscal treatment. It allows for the long

term financing of 100% of the investment. Fiscal advantages refer to how these operations

are dealt with as regards company tax levied in the different countries.

Generally, these allow for the accelerated amortization of the production equipment financed

and consider quotas as deductible expenses, thereby reducing the tax assessment basis of the

lessee.

Certain leasing operations must not show on the lessee company’s balance sheet.

Consequently, the debt represented by future quotas to be paid by the lessee doesn’t appear

either.

The double-tax agreements significantly improve the possibilities of leasing as an instrument

to finance exports, because certain countries, in addition to lower retentions on payments for

services rendered by non-residents to local entities, establish the possibility that the company

bearing the retention may compensate the amount withheld using it as payment on account

when settling company tax.

In practice, the agreements establish numerous conditions for compensation, which often

makes it unfeasable. One way to avoid the problem is to structure the operation through a

third country that has a more favourable bilateral agreement with the country of destination.

You then instrument a company of that country to act as the importer of the goods subject of

the operation.

FILE 2007013


4. Operating Mechanism

The leasing contract is set forth in writing according to general models establishing the

general conditions which may be extended and supplemented by means of annexes.

The contract must adjust to the useful life of the goods.

The sequence of a typical leasing operation is as follows:

The leasing company acquires the goods its client wants from the manufacturer. Then,

the leasing company, in its new capacity as titleholder of the goods, forwards them to the

client who starts paying the corresponding quotas.

Once the leasing period is over, the client either buys or returns the goods.

In a cross-border leasing operation, the “real” exporter still is the manufacturer who has

found the opportunity to sell and who usually continues the business relationship with the

client after the transaction.

Under a tax-lease, a company other than the lessor or the lessee is instrumented to act as the

“investor”. Thereby you make use of that company’s fiscal capacity, that is, its capacity to

delay the payment of a certain amount of taxes for some time.

The Japanese leasing companies have been carrying out this type of operation more often.

They also employed Japanese enterprises as “investors”. Furthermore, it is customary to

make this kind of arrangements with Swedish, French, Belgian, Northamerican or other

“investors”. In the latter cases, the goods to be financed are usually manufactured in the

country of the “investing” company.

5. Pricing

The nature of leasing is basically financial, that is, there is a clear relation between the value

of the initial disbursement of the leasing company, the periodic quotas it expects to collect

and the interest rates prevailing on the market. The financial margin is somewhat higher than

that commonly applied to credit and loan transactions of similar amount and conditions.

Depending on the value and term of the investment, the rate normally is that of reference in

each country plus a spread (for example Spain: MIBOR + 2%). This rate is usually higher

than that of other term financing. The amount of the periodic quotas payable by the lessee is

governed by the specific characteristics of each operation.

In the case of an operating lease, the lessor retains title to the goods, but the lessee has the

right to terminate the rental contract. Therefore, the periodic quota are higher than in a

financial lease.

FILE 2007013


The activities of a company offering operating leases focus less on the financial aspects of the

business: the risk of non-payment is reduced due to the fact that the quotas for the same

equipment are lower than those of a financial lease with the same initial investment. In

exchange, there is the risk of residual value. As a result, the solvency and average

creditworthiness/quality of its normal clientele may be worse than what is normal for a credit

entity. Nevertheless, this does not jeopardize the economic viability of the leasing companies.

It allows these enterprises to cover segments of demand which are off limits for traditional

credit institutions.

6. Segmentation of Markets/Potential Clients

The leasing market originally focused on medium and long term financing of important

transactions for the acquisition of assets for production, so its main employers were the large

enterprises intervening in these operations.

Later legislative treatment converted leasing into a financing instrument, the financial-fiscal

costs of which were very competitive with the conventional credit facilities of the banks.

As a consequence of the above, in the past few years the leasing companies have established

ties especially with the small and medium sized enterprise. Fiscal benefits deriving from

leasing concentrate on this kind of company, so on many occasions this financial instrument

appears as the only possibility to make investments.

On markets as in Spain, the average leasing contract with this type of company amounts to

Pta.3 - 4 million, with 250,000 contracts signed per year.

Presently, the leasing companies make efforts to capture new clients targeting private

individuals (under legislations such as ours, only self-employed professionals may enter a

leasing contract), and to increase income generated by products deriving from leasing (as is

renting).

III. PRESENT/POTENTIAL MARKET IMPACT


Leasing Credit Insurance

Risks insured There are no risks for the

supplier. Guarantees from

the leasing company

Commercial

Political (Not always)

Payment of the transaction As agreed under the

contract between supplier

and leasing company

As agreed under the supply

contract

Indemnity in case of default None. Leasing company

assumes the risk.

70/85% 3-6 months from

default

FILE 2007013


Supplier’s risk

Depending on the solvency

of the leasing company

15%-30% of contract value

Minimum no. of

transactions

Individual contracts Possibility to exclude sales

Minimum amount

Depends on each firm None

Countries covered

All Practically all

Market sectors Capital goods, Automotion,

Real state

Practically any kind of

goods.

2. Present size of the market

To be updated

3. New Market Segments

As a consequence of the sectors and terms common to leasing operations, these basically

focus on medium and long term financing.

In the case of cross-border leasing, the rules governing export transactions in different

countries allow for the natural development of the activity. Moreover, it benefits from the

whole range of Government policies and support measures aimed at the fostering of exports.

Analysing the main terms and sectors subject to leasing, we find that the sectors of consumer

goods or semi-finished products, the main markets of short term credit insurance, are very

little affected by this activity.

4. Opportunities for Credit Insurers

Leasing operations, domestic as well as international, combine very well with credit

insurance, as the leasing company acting formally as the supplier may benefit from all the

advantages or services that credit insurance offers this kind of enterprise (transactions would

enter under buyer credit).

International leasing operations can profit from the official support granted to export credit

transactions in each country.

Credit insurers may intervene in leasing operations offering the lessor coverage for

the risk of the lessee’s default on the periodic quota established under the contract.

the risk of non-recovery of the goods under contract at the end of the stipulated

term, in case of an operating lease.

5. Expected timing

FILE 2007013


In the last decade, leasing has become one of the main sources of industrial financing.

We are dealing with a completely consolidated product on the international financial market

showing great potential for growth.

Its growth is directly related to that of industrial investment and therefore subject to cyclical

development, with downturns, such as in the 90’s (result of the weak investment activity all

over Europe at the time), or upturns (due to the satisfactory development of the economy and

gross capital formation).

Additional Studies

Further reference is made to the paper drafted in 2006 by the Credit Insurance Committee

entitled “Insuring Leasing Contracts” (FILE 2006026).

FILE 2007013


SALE OF RECEIVABLES WITHOUT RECOURSE

Transaction that provides the client with financing in exchange for the sale without recourse

of his receivables to a financing entity who advances the agreed percentage and assumes the

risk of non-payment. The client is in charge of collection. Very similar to the so-called

“secret” factoring (undisclosed factoring).

1. Legal Aspects

Legislation applicable to these operations is that governing the assignment of corporate

receivables, core of the contract, regulated in Spain by the Law of Commerce. The

regulations of the main European countries are essentially the same as those in Spain.

2. Current/Potential Players (Offerers)

Fundamentally, an activity of banks and factoring companies; in certain countries, it is also

carried out by other financial institutions.

Traditionally a product of the banks and factoring entities, other financing institutions do not

seem to be interested in offering this kind of service.

3. Taxes

These operations could be subject to VAT. Contingent on applicable legislation, the

operations may be subject or exempt from VAT, depending on whether they are considered

as payments on account of assigned receivables or funds actually advanced in settlement of a

firm purchase of receivables.

4. Mechanism of Operation

In order to obtain cash, the client sells his receivables without recourse to the financing

entity. The latter acquires the receivables, while collection remains the responsibility of the

client; the debtor is not notified of the transaction.

5. Pricing

Usually, the price or cost of the sale of receivables without recourse varies in terms of the

financial market situation, the quality of the risks assigned and the actual credit term granted

the client.

FILE 2007013


6. Market Segmentation/Potential Clients

Generally, the clients for this kind of guaranteed financing are medium or large sized

enterprises with a sound customer portfolio.

III. CURRENT/POTENTIAL IMPACT ON OUR MARKET


Credit insurance offers differentiated services, as are:

Assumption of credit limits

Action for recovery

2. Present Size of the Market

Apparently, we are dealing with a tight market with a limited volume of operations.

3. Repercussions on the Credit Insurance Market

On principle, it seems that the product will not have much impact on credit insurance

business, as the service is normally limited to medium and large enterprises with buyers of

excellent solvency.


Under certain circumstances, it might be interesting to offer coverage to the financing entities

selling the product, following similar lines as coverage credit insurers have designed for

factoring.

5. Expected timing

No significant medium term developments are expected, as possibilities for employment are

limited.

FILE 2007013


INVOICE CENTRALS

Organisations to ensure total or partial supplies of one or several distributors, offering

optimum prices and terms of payment and, possibly, additional services.

1. Legal Aspects

As you will have observed, in Europe we have a very important tendency towards

globalisation , affecting invoice centrals as much as large distribution groups.

2. Current/Potential Players (Offerers)

To be updated

The top seven invoice centrals in Europe in 1996:

EMD, integrated by Markant (Austria), Markant (Germany), Superköb (Denmark),Selex

(Spain), Nisa Today’s (Great Britain), Selex (Italy), Musgrave (Ireland), Markant

(Netherlands) and Uniarme (Portugal).

DEURO / MIAG, integrated by Metro (Austria), Makro (Belgium), Metro Reichelt

(Germany), Metro (Denmark), Pryca (Spain), Makro (Spain), Carrefour (France), Metro

(France), Makro (Great Britain), Metro (Italy), Makro (Netherlands), Carrefour (Portugal)

and Makro (Portugal).

AMS, participated by Allkauf (Germany), Mecadona (Spain), Casino (France), Argyll (Great

Britain), Rinascente ((Italy), Superquinn Ireland), Hakon (Norway), Ahold (Netherlands),

JMR (Portugal), ICA (Sweden) and Kesko (Finland).

EUROGROUP, formed by the GIB group (Belgium), Coop (Switzerland), Rewe Zentrale

(Germany), Paridoc (France) and Vendex Food (Netherlands).

C.E.M., including Edeka (Germany), Uda (Spain), Booker (Great Britain), Conad (Italy) and

Crai (Italy).

N.A.F., joined by Konsum (Austria), FDB Coop (Denmark), CWS (Great Britain), Coop

(Italy), NKL (Norway), KF (Sweden), EKA (Finland) and SOK (Finland).

BIGS, composed of Spar (Austria), Unigrobal (Belgium), Bernag Ovag (Switzerland), Spar

(Germany), Dagrofa (Denmark), Spar (Great Britain), Hellespar (Greece), Despar (Italy),

BWG (Ireland), Unil (Norway), Unigro (Netherlands), Dagab (Sweden) and Tukospar

(Finland).

FILE 2007013


3. Taxes

Tax applicable: VAT

4. Mechanism of Operation

There are different types of invoice centrals, depending on the activities assigned them by

their associates:

Centrals for the negotiation of purchases. They are authorised to analyse, make the

selection, establish tariffs and criteria for discounts and rebates, but have no executive

powers.

Centrals for the negotiation and execution of purchases. The central negotiates and

places the orders, and usually even settles payment directly with the suppliers.

Service centrals. They render services other than the purchase of supplies, for example

information, market studies, training of personnel, import management, etc.

5. Pricing

Consists in a commission , e.g. a percentage on purchase volume handled. The commission

percentage varies in terms of the intensity and scope of the activities assigned by the

associates, that is, in terms of services rendered.

6. Market Segmentation/Potential Clients

Basically, the clients of invoice centrals are supermarkets and supermarket chains not

belonging to large distribution groups.

III. CURRENT/POTENTIAL IMPACT ON OUR MARKET


The invoice centrals do not offer their suppliers any payment guarantees. They operate as

intermediaries and, in some cases, as payment centrals, without guarantee. Their services

mainly focus on the purchaser, not on the supplier.

2. Present size of the market

There are presently four invoice centrals in Spain (the top two control a market share of

92%), which in 1996 represented a turnover of Pta. 2,592,587 million.

3. Repercussions on the Credit Insurance Market

They have a special impact on the companies of the food sector and on those who channel

their sales through large distributors. It is clear that the turnover affected is enormous and,

hence, so is premium.

FILE 2007013



Given the present situation, where invoice centrals lack capacity sufficient to guarantee the

payment of suppliers, but nevertheless are interested in offering some sort of guarantee to

increase their purchasing and negotiating power, credit insurers might examine the ways of

covering the suppliers’ final buyer risk.

A second possibility might be to cover the default/insolvency of the central.

We highlight the appearance of special cover schemes for invoice centrals, designed taking

into account the model of the so-called finit insurance policies.

5. Expected Timing

The big invoice centrals confront the large distributions groups. At present, it seems that there

is a move for consolidation of the vertical groups of distribution. It is to be expected that the

big invoice centrals will have to follow the tendency of concentration.

FILE 2007013


CAPTIVES

A captive company is set up and owned by a company to insure or reinsure certain risks of

that company. It will never (re) insure risks of other companies.

A captive will make it possible for a company to:

insure risks that are difficult to insure on the market.

use the captive for its cash flow rnanagement,

protect the balance sheet (the risk is spread over 5 to 10 years),

have access to the reinsurance market (through retrocession).

A captive should not be created for tax purposes only.

Most captives will be reinsurance companies because it can be created without having to be

submitted to any controlling authority. An insurance captive will have to comply with the

legislation and control existing for other insurance companies.

A reinsurance captive will require a “fronting” insurer. This fronter will insure the risks and

reinsure itself with the captive. For this a fee will be charged, normally between 5% and 8%.

In addition the fronter will require a retention of 2.5% to 5 %.

The premium asked for in the policy of the fronting company will have to be market related.

The captive company will not have enough assets to assume all the risks. Therefore the

fronting company will require a “letter of comfort” of the company in order to be protected

against the possibility that the captive company would not respect its obligations. The

fronting company will also only pay claims after it has bcen paid by the captive.

The captive will be managed by a professional, never by the fronter. This professional can for

instance be a broker. On average, a fee of 750.000 BEF will be asked for.

A captive can also be rented. In this case a reinsurer will open a “captive account” This

structure , however, is a solution due to disappear because the legal framework is not

completely waterproof.

Features or points for potential competition:

Captives can reinsure risks that were previously completely reinsured by the

professional insurers. Therefore it takes premium away from tbe traditional insurance

market.

Captives have access to the reinsurance market (through retrocession).

Tendency for the future (next 5 years) concerning competition:

Due to the control of the official authorities that is supposed to become more and more strict,

captive solutions can be considered as a niche market.

Potential competitors:

FILE 2007013


Reinsurance companies.

Proposals for resistance:

Members might consider the necessity to be able to participate in programmes with captives,

as fronting company and reinsurer of the captive.

In case price is an important element during a negotiation it might be considered to touch

upon the possibilities of a captive.

CONCLUSION

Programmes with captives will remain a niche product. However, ability to participate in

such programmes should be considered.

FILE 2007013


EXCESS OF LOSS INSURANCE

Insurance cover for aggregate losses exceeding a limit (the aggregate first loss) usually up to

a maximum limit.

Purpose and principles of operation

The purpose of Excess of Loss insurance is to cover the losses of a policyholder caused by

customers’ failure to pay outstanding amounts due in the policy period.

Losses are covered by an Excess of Loss insurer, provided the cumulate amount of losses for

the insurance year exceeds a limit set by the policy (Aggregate First Loss), and remain under

a ceiling also specified by the policy.

The causes of loss are, in most cases, restricted to the court adjudicated insolvency of debtors,

but some Excess of Loss insurers also cover political risk (AIG, SUN ALLLANCE). and

protracted default default (AIG).

The premium is fixed amount for each insurance year and is often expressed as a percentage

of turnover. Premiums are generally between of 5 % and 10 % of the rnaximum liability of

the insurer.

Excess of Loss is a mixed financial and insurance product. The value of the product depends

on the quality of the insured’s credit management team, and requires an analysis of the losses

borne in the five previous years.

Potential competition.

Excess of Loss insurance does not involve either service, or assistance in the analysis of

customer risk. Competition with credit insurance therefore occurs only in the technical

coverage of financial risk.

This competition may be substantial when the target policyholders are major companies

generating annual turnovers of rnore than FRS 100 rnillion and who do not wish to outsource

customer risk management.

A major advantage which Excess of Loss insurance offers over credit insurance is the

extremely low Excess of Loss insurers’ cost ratio (around 5%). The Excess of Loss insurer

can offer an attractive premium rate, from 1 pro mille to 3promille of turnover.

Another problem arises from some Excess of Loss insurers’ practice of offering new policy

holders settlement of existing losses, provided the policyholder undertakes to refund the

insurer over a number of years, in addition to paying tbe Excess of Loss insurance premium.

Future trends.

FILE 2007013


Competition will remain limited, as long as Excess of Loss insurers do not offer

supplementary services.

Even so, there is clearly a market demand for Excess of Loss financial cover, provided the

potential policyholders also have access to customer credit-worthiness information and debt

recovery services

Competition might also develop from the bank insurance sector, which might be ready to

back new entrants working on a partnership basis with a service provider.

Who are the likely competitors ?

General insurers who aim to extend their business to the corporate sector.

New entrants formed from partnerships between the banking and insurance industries.

What can credit insurance do ?

On a defensive basis, develop Excess of Loss products with underwriting of major

risks and major accounts.

Develop a broader services offering, and in particular offer customner risk analysis,

and advisory and debt recovery service.

Examine all possibilities of partnership with Excess of Loss insurers, so as to make

best use of complimentary, rather than narrowly competitive business opportunities.

C O N C L U S I O N

Excess of Loss policies are similar to reinsurance contracts, and when associated with a

captive insurer, provide competition for classic credit insurers.

Credit insurance needs to insert more sophisticated clauses into its contracts, in order to meet

the requirements of the major companies. It is essential that we offer an outstanding level of

customer service quality, as this is the best means of ensuring customer loyalty.

FILE 2007013


FINITE RISK PROGRAMMES

Finite Risk originally meant financial reinsurance and could today be defined as a financial

transfer of limited risk over several years with a potential profit-sharing on every contract.

Points for potential competition:

Multinational companies with operating captives can transfer to their “blended”

risk, including credit , risk to reinsurance companies through finite risk solutions. There is

even a possibility to use the risk bearing capacity of the capital markets by introducing finite

risk programs.

??lile tax authorities have looked into the matter and stated the following criteria : The

assuming company should have a “significant insurance risk” under the reinsurance portions

of the underlying insurance contract and it is “reasonably possible” that the assuming

company may realise a “significant loss” from transactions.

So the following elements have to be involved:

a) The presence of insurance risk.

b) Risk shifting and risk distribution and

c) commonly accepted notion of insurance.

Tendency for the future:

More and more, finite products are being combined with traditional reinsurancc solutions in

blended covers.

Blended covers can be written to include risk which have traditionally been considered

uninsurable for example, political risk and financial risk,

At the same time the finite products:

help to accentuate cyclical trends in the insurance market,

provide reinsurance capacity even for hard-to-insure risks,

promote the establishment of long-term relationships between primary reinsurers and

reinsurance and,

facilitate insurers’ access to equity and borrowed capital.

Who could be the potential competitor :

Captives in co-operation with reinsurance companies such as Zurich-group (Centre Re),

Swiss Re and Sirius (ABB). financial companies like GE Capital and investment banks.

What can wc do about it:

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The products will not interfere with traditonal credit insurance products but we have to be

able to co-operate with captives and providers of finite risk programs to be able include our

expertise in underwriting the product.

The demand for the“product” wıll in the future be requested among multinational companies

with operating captives that would like to have long term policies with a possibility for profit

sharing on tbe upside and to have finite products as capacity suppliers. This will give mutual

benefit to both buyer and seller.

C O N C L U S I O N

Long term policies are now being structured to meet thc exclusive needs of individual

customers,

Tbe future will belong to the providers which have a superior underwriting, know how,

excellent financial standing and the ability to blend finite solutions with traditional

reinsurance covers and completely new products. Such products would include especially the

transfer of risk to the capital markets and also to protect the insurer not only against

catastrophe losses, but also against losses on the assets side of the balance sheet which are

incurred when, for example, increased loss payments make it necessary to sell assets while

the financial market is in a weak phase.

FILE 2007013


GUARANTEES, COLLATERAL, AND SECURITIES

Promise by one person to make good any failure by a second person to meet financial

obligations owed to a third person. Assets held for the account of the third person.

Guarantees and other kinds of securities can be replaced by traditional credit insurance if

potential or new clients demand selection of buyers.

As for performance bonds, tender bonds, advance payment bonds etc. (e.g. for the

construction sector) this special line of bonds has grown in competition with banks and is

now among the main product lines additional to credit insurance. Depending on the local

market it is an attractive additional for credit insurers as well as for other insurance

companies - and banks, naturally. The products and their qualities are well known.

This category of security instruments is predominant in two major segments: the domestic

and the export construction market.

As for the domestic market segment, collateral has always been the standard instrument. In

periods of growth and good economic conditions, collateral has been well accepted by the

beneficiaries. However, in recession periods there is a demand of increasingly better

securities in form of unconditional guarantees for periods of up to 5 or 10 years. This attitude

is especially taken by the public sector whose buying power enables it to exercise enormous

pressure on the market thus creating a great deal of problems to many construction companies

not being financially solid enough to find a guarantor. In their turn, banks and insurance

companies are faced increasingly with these excessive demands.

In the export market segment, the unconditional guarantee is the dominating instrument, as

the collateral is difficult to realise in cross-border business transactions. Historically, the

insurance and bank industries have strictly separated their activities: all financial matters,

including securities, relating to exports were the bank’s business - and they still are.

Therefore, the bank would in any case be the first partner to be approached by the exporter

for such questions. This enables the banks to select the risks they want to underwrite and for

the insurance industry, the risk is anti selection.

FILE 2007013


LETTERS OF CREDIT

Arrangements between banks and businesses whereby debts of the businesses with named

third parties are assured for payment

This instrument is mainly used in the export sector. It is used as a payment guarantee of

foreign customers to domestic suppliers. It is treated as an additional credit facility beside to

the normal overdraft bank facilities.

Letters of credit are an efficient instrument both for short-term and medium turn shipments to

non-OECD countries, because banks can offer cover for transfer and political risks at the

same time, and in the same product.

On a short-term basis, many sectors have been working traditionally on credit terms with

OECD countries, as these are traditionally the fields for credit insurers. In short-term export

business, letters of credit are normally used for shipments to non-OECD countries only.

Letters of credit are particularly common for medium and long-term export business, e.g.

investment goods, as plants and machinery, both to OECD countries and non-OECD

countries.

Currently, the situation seems to be that credit insurers have only little chance - and only little

interest, too - to induce exporters to replace the letters of credit by a credit insurance policy,

mainly, because the exporters would not get an equivalent product (uninsured percentage)

and secondly, because the credit insurer cannot be interested in underwriting buyers and/or

countries that will normally represent higher risks (often insufficient

creditworthiness/development countries).

On the other side, if banks request additional security through credit insurers and/or general

insurers, there might be some possibility for insurers to facilitate the bankers and ease their

own credit facilities.

Till now, the demand from banks has been very limited, and it has been directed towards

countries as for which the banks are having capacity problems with regard to high risk

countries (political risks).

If the demand comes from the market, credit insurers could easily facilitate the banking

industry accordingly.

FILE 2007013


DEBT COLLECTION ENHANCED WITH GUARANTEE

A service offered by a debt collection company whereby if a debt passed to them for

collection is not collected by a certain date, they will purchase that debt.

Collection agencies are contacted by creditors in a moment only, when existing receivables

are much overdue and thus already jeopardized. In these situations, it is normal for traditional

credit insurers to cancel their credit limits.

Therefore, it is difficult to imagine to do the contrary on a bigger scale, e.g. systematically,

with good chances to make profit.

In some cases, receivables are sold to a collection agency, but not as a scheme and definitely

on a very selective basis or maybe as a mediator.

Apart from factoring, there does not seem to be a market that would allow a company to sell

even their sound receivables to collection agencies.

According to the domestic law situation in some countries (e.g. Germany), it is for the time

being not possible as a credit insurer to handle also the debt collection. Many credit insurers

have own subsidiaries or have influence in debt collection agencies. Currently, there does not

seem to be any direct competitive product available for credit insurers in the next future.

FILE 2007013


INFORMATION ENHANCED WITH GUARANTEE

Commitment of a ‘buyer information provider’ to compensate any losses arising from

complying with the credit recommendations

This can be defined as amount payable in case of insolvency to a client through information

agencies.

Credit insurers usually cover the discretionary limits by contract as well as the limits to be

applied for by policyholders.

In the eyes of clients, the combination of information and guarantee would be an ideal

instrument to replace costly WTO credit insurance policies. They could practise self-

insurance to a higher degree and buy cover, only where they think it is necessary.

This could be realised in two ways: either the information agencies enhance their information

with a guarantee or credit insurers back-up their credit limits with information.

If guaranteed information through information agencies to clients come on the local market

this certainly would mean an entry into the selected portfolio cover similar to coverage

through products obtainable on the credit insurance market.

An agency would have to overcome the following obstacles, if they want to have a chance to

be successful:

Scoring/rating system:

It can be assumed that their scoring/rating systems are not sophisticated and efficient as

those of the credit insurers, they would have to find methods, means, and ways to

improve it. According to the scoring/rating systems known so far, the systems of

commercial information agencies do not allow quotations of bigger amounts.

Anti-selection:

Since credit reports are sold on a free choice basis, e.g. the clients are absolutely free to

decide when and for which of their customers they want to buy a report, this boils down

to an extreme anti-selection. A supplier would normally never ask for a report on his

existing customers with whom he has positive experience; so only reports on potential

customers that are unknown could contribute to a spread of risk for the agency. Yearly

subscriptions or minimum packages are merely a pricing tool with no positive impact on

anti-selection.

Product:

Who is offering this combined product to the market? If it is the agency, it is bound to get

a licence as credit insurer; otherwise, it must have a credit insurer at hand. How to assess

the premiums in a case-to-case product?

Corporate culture:

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It would be a mega-change in corporate culture for a report agency to take on the role of

an insurer. It would possibly even mean to run two different philosophies in the same

house, with the same staff!

After-sale service:

Whereas a report does not entail particular services after sale, it would mean to follow-up

the insured cases (collection and claims handling). This means additional, highly

specialized staff.

Distribution channel/IT:

In order to avoid the necessity to establish new and expensive distribution channels,

clients must be offered easy access on electronic IT-links from the agency data base to the

insurance data base.

Conclusion:

The barriers for information agencies to enter the market of credit insurance with guaranteed

information on big scale and to remain there successfully seem to be rather high, however

possible to overcome. Only agencies being an affiliated company of a credit insurer or having

a close co-operation (back-up) with a credit insurer, as well as possessing a highly

sophisticated IT-infrastructure and know-how will be in a position to expand in this direction.

Geographically, their activities will be restricted to the area covered by the agency’s data

base or the coverage provided by an insurance company.

The best way for a credit insurer of meeting such competition is to offer an even better

product. Furthermore it simply means to credit insurers that they have to offer competitive

(quality and price) products in their own range of products to keep this quite substantial

market share in their own portfolio.

Credit insurers have to offer on-line and machine based analyses systems to compete with

this potential product on the respective markets. It will be a matter of quality and handling as

to what extend information agencies are able to come into this special market.

There is a quite big market share available which covers the security of small amount

business and it certainly influences the relationship between information agencies and credit

insurers. If not, which is quite common, substantial shares of credit information agencies are

held by credit insurers themselves.

The competition is between all major information agencies on the local and international

markets. The clients are the same as for credit insurers for small policies.

FILE 2007013


CREDIT DERIVATIVES

Derivatives are financial instruments stipulating the payment as a function of the value of a

certain underlying asset or index.

In the case of credit derivatives this index is generally a single or aggregate credit status or

bond price. If in such a contract one party commits itself to a second party to pay a

predefined amount for the change (generally deterioration) of the credit rating (incl. default

status) within a predefined period of time in exchange for a risk premium, this contract is

referred to as a credit option. Unlike standard credit insurance

single risk may be “insured”

not only default but also other credit stati trigger the compensation

the “insured” need not proof a loss but only the “status”.

In spite of the underlying insurance logic it is far from being certain whether these contracts

are actually insurance or not for tax, regulatory and accounting purposes. These seem to be an

argument (supported by the banking industry) that this is actually not the case (see appendix).

This implies inter alia

that premiums for credit derivatives are not subject to IPT

that the transactions are supervised by banking authorities and are subject to cooke-

regulatives

that the “insureds” may have to activate these contracts as “risky assets”

that the “insured”: being a professional insurer attemptimg to reinsure himself may

not net this coverage with his gross commitments.

This market is generally regarded very fast growing, fairly large (ca. 50 - 100 billion US$

nominal coverage), very innovative, and rather untransparant. However, it is clearly

dominated by bankers both being buyers and sellers, with an increasing interest

of other large (financial) institutions, trying to hedge their credit risks; i.e. being

buyers

and most likely a number of non-bank “cowboys”, attemptimg to earn an extra

margin as the risk taker; i.e. seller.

While these products may be both traded via official exchanges and “over the counter” the

number of underlying indices is clearly expanding, e.g.

new indices

weighted indices to hedge portfolios.

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In any case, the indices may be limited to rather large debtors or general economic indices.

Pricingwise the instruments will follow general financial pricing dogmas like Black/Scholes

and display a substantial volatility.

From a credit insurance point of view the assessment is not clear cut as these instruments can

be viewed both

as alternatives to credit insurance currently offered by banks

as an alternative means to reinsure

large individual exposures of indexed/rated debtors

frequency exposures represented by general economic indicators (e.g. proportion

of insolvent companies) - political/country risks

by tapping into a huge financial market.

Thus, these instruments have a seller and buyer perspective for the credit insurance industry.

FILE 2007013


CREDIT OPTIONS

Contracts by which one party commits itself to a second party to pay a pre-defined amount

for deterioration of the credit rating (including default) within a predefined period of time.

As credit insurance, the ‘guarantor’ receives a premium for this risk bearing.

Unlike credit insurance:

• single risks are insured

• not only default triggers a “compensation”

• the “insured” need not prove a loss

FILE 2007013


DEBT SWOPS

Contracts by which two parties, both holding a portfolio of credit risks (exposed assets)

• exchange part of their portfolio, or

• compensate each other for the credit deterioration of their respective portfolios

This financial instrument requires at least two parties, holding a portfolio of credit risks

(exposed assets). There is supposed to be a mutual interest to exchange (part of these

portfolios or to compensate each other for the deterioration of the respective portfolios.

The parties involved could be credit insurers or banks/financial institutions which may realize

the debt swop for single transactions or for (part of) their portfolio.

There is no legal framework for debt swops, except for the recourse facilities on debtors.

The underlying transaction can be the delivery of goods as well as any financial balance

resulting from other transactions or relations between creditor and debtor.

Players and customers may be banks or financial institutions seeing a benefit in the

development of the value of debts.

Credit insurers could be interested either way:

by selling a number of risks and stop being exposed to them more or less

comparable to reinsurance or

by buying risks for a price and return a higher return later on.

As far as buying debts is concerned, debt swops are not core business for credit insurers,

while selling debts could be an alternative for reinsurance (facultative, quota share, mutual),

where buying debts could be considered as an alternative for own retention.

Pricing may be considered as speculative especially when no experience or index is available.

The quality of debts, the spread of risks, the maturity, the attached securities and the

underlying transactions will help to determine the price of debt swops as well as their impact

as an alternative for credit insurance.

Where debt swops can be considered as “second hand risks” (the buyer of the debts was not

involved in the underwriting or risk selection at the commencement of the risk) the market

may be limited. Cherry picking and debt swops may not get along very well together, when

portfolios are for sale.

However, some banks have shown an attractive track record in debt swops as far as debts

owed by countries are concerned.