It has been around for quite some time in other asset classes but in recent times non-payment insurance applications are becoming ever so much more popular as a risk mitigation tool. The main reasons for this are to strengthen credit security and to diversify capital sources.
It is also known as trade credit or credit insurance and can be utilised when customers, borrowers or counterparties renege on their contractual debts, covering the possibility of non-payment because of insolvency or political events. This can prevent problems with cash flow, promote growth and reduce capital requirements since the default risk is transferred to an insurer.
Arrangements in the aviation sector have been used, in this way, for some considerable time, but now there are some insurance groups who are specifically geared up for the maritime sector and its capacity to protect maritime jobs.
So, in practice if a default occurs when a ship has been delivered, non-payment insurance will allow the financier to not lose his or her investment when the counterparty involved does not meet its financial obligations. In the maritime sector companies such as Marsh with its “MSF” or Marine Supported Finance are now putting in place specifically designed policies for protection in this area.
The person deemed responsible for payment of the non-payment premium would be the borrower or lessee. Sometimes payment may be financed through such things as a drawdown under the loan. Drawdown distinguishes how there can be a decline in an investment’s value from peak to trough, calculated as a percentage to show risk. This helps assess downside risk and volatility.
If an investment goes down from £100 to £80 (a trough) and then back to £90, the drawdown is calculated as a £20 loss from its £100 peak, expressed as a 20% drawdown. In the case of an MSF non-payment insurance policy, tailoring to the financing structure, which will cover loans (covering the borrower’s/ shipowner’s default) can be optimised. Another option is to finance lease structures which again cover the lessee’s / shipowner’s default. This documentation may be led by a primary shipping bank or by an insurer depending on the product. These will be the parties both in receipt of the premium and the ones taking the non-payment risk.
Some of the strategic benefits for the shipping industry and others include a new source of capital, in that insurers are strongly rated companies bringing with them additional balance sheet to the capital-intensive shipping industry.
The use of non-payment insurance-backed loans shows how a shipping company can utilise a diverse number of ways to carry out its day-to-day financing business, including using private insurers. By transferring the risk of a borrower’s default to a highly rated insurer, a bank can free up capital for other lending activities.
There will be shipping companies with a lower profile or those emerging businesses who can benefit from this type of cover, newly available. Insured loans can be more attractive in the secondary market, allowing syndication and risk distribution among those financial institutions wishing to be involved.
Under the EU Capital Requirements regulations, as applicable to European lenders, non-payment insurance can reduce the weighting of a transaction but always be aware that the terms of the policy should be scrutinised so that it adheres to those very regulations.
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