Credit risk reforms expected to disrupt UK insurance line

Credit risk insurance policies are likely to become more expensive and less readily available if regulatory changes proposed by the UK’s Prudential Regulation Authority (PRA) are pursued, according to the International Underwriting Association (IUA).

The PRA has published the consultation paper “Credit risk mitigation: eligibility of guarantees as unfunded credit protection,” aiming to clarify expectations regarding the eligibility of guarantees as unfunded credit protection. The PRA’s consultation is looking at some of the key credit risk mitigation (CRM) eligibility criteria of unfunded bank guarantees, including non-payment insurance, in terms of timeliness of payment, enforceability, clarity and incontrovertibility.

Planned reforms could cause some London Market insurers to conclude that credit risk insurance policies are no longer viable, which may have a subsequent impact on bank lending, the IUA has warned.

The IUA stated that the proposed changes failed to recognise the importance, flexibility and effectiveness of credit risk insurance provided to banks and other financial institutions. The association called on the regulator to reconsider its proposals and review their potential impact on the London insurance market, the UK economy and wider global trade flows.

“The credit insurance product has historically worked well, continues to do so and is valued by clients,” commented Chris Jones, IUA director of legal and market services. “Our research on this issue has revealed widespread concern that the regulatory proposals will make the market less attractive and that alternative forms of security are in some circumstances problematic and limited”.

The PRA’s consultation paper interprets the obligation for insurers to pay out in a timely manner as settling claims within days of a credit default occurring, the IUA said, noting that it is not uncommon for many weeks to pass before a bank even informs its insurer of a potential claim. This delay may be for quite valid operational reasons as, for example, a bank evaluates the extent of a borrower’s financial difficulties before deciding whether an insurance claim is required.

Necessitating claims to be settled within days of a borrower failing to make a payment would not allow time for usual investigation and claims assessment processes to be followed, according to the IUA.

“The proposed changes would result in insurers becoming de facto liquidity providers,” Jones said. “In order to process claims quickly insurers would be quite reliant on receiving information from the lender in good time – a process over which they have limited control.

“Our feedback suggests that banks do not rely on credit insurance as a primary source of repayment in the immediate term. There seems little value in turning an insurance claim based on indemnity principles into a stop-gap payment.”

“If the market for credit risk insurance is disrupted there is a danger that banks will transfer their lending to other jurisdictions which would be hugely detrimental to London banking, insurance and the UK financial services sector generally,” Jones added.

Meanwhile the Lloyd’s Market Association (LMA) warned of a $150 billion exposure gap in credit risk cover in its response to the consultation.

James Bamford, chairman of the LMA Political Risk, Credit and Financial Contingencies Panel said: “Disruption to this market could create a series of negative effects for banks, such as damaging financial stability, reducing resilience to volatility, increasing costs, reducing lending capacity and ultimately reducing global trade flows.”

Non-payment insurance products paid over $2.6 billion in claims to regulated financial entities between 2007-2017, with no claims made going unpaid except those where operational failure on the part of the insured made the claim invalid. These products support a wide range of lending, with global exposures insured on a transactional basis currently estimated at $100 billion to $150 billion, according to the LMA.

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