The Geneva Papers on Risk and Insurance, 10 (No 35, April 1985), 100-111
Private Initiative and Public Intervention
on the Market for Export Credit Insurance
by Henri Louberge* and Pierre Maurer**
1. Introduction
The present article is based on a report (Louberge and Maurer [1985]) prepared by the
authors on behalf of the Geneva Association. The objective of this report was to analyze the
present situation and the likely developments of the market for export credit insurance in
seven representative industrial countries: The Federal Republic of Germany, Austria, France,
the Netherlands, the United Kingdom, the United States of America, and Switzerland. The
emphasis was put on the role that private credit insurers play in this market and on the perspectives for an enlargement of this role, given the recent appearance of new entrants in this
market (see Berry [1984] and Tyler [1984]).
A posteriori, this research may be interpreted as a case-study in the economics of markets
with imperfect information, because the recent developments in the market for credit insurance closely parallel the sequence of adjustments to unstable equilibria in a market with
adverse selection (see Rothschild and Stiglitz [1976]).
The paper is organized as follows. Section 2 introduces the reader to the problem of
export risk and to the present structure of the export credit insurance market. The main findings of the study regarding the present, and likely future involvement of the private insurance sector in the export credit risk area, are presented in section 3. Desirable improvements
and reforms for better cooperation between private insurers, the State and commercial banks
are proposed in Section 4.
The conclusion summarizes the parallel between the recent history of export credit insurance and the results from the economic analysis of markets with imperfect information.
*
Professor of Political Economy, University of Geneva.
** Former Director and Member of the Board, "The Federal" Credit Insurance Company Ltd.
Zurich.
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2. Export credit insurance
2.]. Export risks
When the manager ofa firm decides to export all or part of its output, his decision is motivated by the advantages of export sales compared with domestic sales:
An exporting firm operates on a larger market; if the pattern of demand remains the same,
this means that the price elasticity of the product increases; the firm is thus able to expand
its output without having to incur strong effects on the price of the product.
The increased output may result in scale economies.
Sales at the international competitive price may be the source of extra profits if the firm ope-
rates more efficiently than its foreign competitors.
Last, but not least, public aid is available in all developed countries and in some developing
countries for domestic firms active, or desiring to become active, on export markets. Whatever the procedure used to grant this aid, it means that operating costs of the exporting firm
are lowered.
However, as usual in competitive economies, these prospects of increased profits have to
be weighted against additional risks of losses. These risks are listed inTable I and classified
according to two criteria: their origin and their nature.
Origin of export risks
Export risks may be accidental, i.e. due to the occurence ofa specific undesirable state of
nature, such as an earthquake, a fire, a theft, etc.
They may be "macroeconomic", i.e. due to administrative decisions and socioeconomic
or political events occuring in one of the countries concerned by the export transaction.
They may also be "microeconomic", i.e. due to the behavior and decisions of the foreign
buyer.
Nature of export risks
Here, a distinction can be made between economic risks, credit risks and damage risks.
Economic risks are defined as those which affect the profitability of the export transaction.
The most important are interruptions in trade relationships and the cancellations of contracts
occuring for various accidental, microeconomic or macroeconomic reasons such as natural
catastrophes, embargos, wars, revolutions, import quotas, buyer's insolvency, etc. But
changes in local regulation, monetary instability and foreign exchange controls are also
sources of potential economic losses.
Credit risks arise when the buyer is granted a delay of payment. In this case, there is a risk
that the exporter will not recover the full price of the transaction after it has been completed. If
the buyer defaults or delays his payment, the exporter incurs a loss, whatever the reason of
this default or delay (accidental, microeconomic or macroeconomic).
Damage risks are defined as those which threaten goods, materials and staff that the firm
implicated in the foreign stage of the export process. They arise mainly for accidental or
macroeconomic reasons during transport or on the site of operations.
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Macroeconomic
Microeconomic
Accidental
the risks
Nature of
the risks
Foreign exchange risk
Transfer risk
Damage to employees
S Damage to vehicles
and machines
Non payment
Cancellation of contract
Change in regulation
S Damage to goods
Delay payment
S Non payment
S Delay in payment
Damage to third parties
Business interruption
Cancellation of contract
Business interruption
Damage to vehicles
and machines
Non payment
Cancellation of contract
Damage to employees
Damage to goods
Delay in payment
risks
risks
risks
Business interruption
Damage
Credit
Economic
Table 1: Export risks
It can be noted that most of these "export risks" are not specifically export risks in the
sense that they also exist in domestic trade. The foreign exchange risk and the transfer risk are
the only risks specific to export. All the other risks (contract cancellation, changes in regulation, buyer's insolvency, etc.) are known in domestic operations, but they become more serious as soon as different jurisdictions are involved and when long distances, as well as ignor-
ance of foreign customs and business practice make the outcome of the transaction more
uncertain.
Not all the risks listed in Table I are considered as export credit risks. The latter term is
reserved for the risks classified as "economic risks" or "credit risks". These are risks concerning export credit insurance institutions. Damage risks traditionally concern multi-lines property-liability insurance companies.
It may also be noted that this classification, although comprehensive, does not reflect the
main distinction used in export credit insurance parlance. Here,commercial risk is opposed to
political risks. Commercial risk is defined as the risk of a private buyer's insolvency. All other
export credit risks are labelled "political risks".
2.2. The export credit insurance market
A priori, in a market economy, one would expect private insurance institutions to be the
major suppliers of guarantees against export credit risks. But reality presents a completely different picture. Credit insurers who extended their activity for own account to export credit
risks adopted several principles which greatly restricted their insurance supply. The following
principles emerged out of the bitter experiences of pioneers in this insurance branch:
Private export credit insurance covers exclusively the commercial risk, as defined above.
Only commercial credits are concerned: financial credits as granted by banks and other
financial houses are excluded from the policies.
Credit insurance policies are mainly whole turnover policies covering short-term business
(credits of less than 2 years). Individual policies, insuring one single contract, exist in
medium-term business (credits between 2 and 5 years), but private credit insurers are more
and more reluctant to cover medium term export transactions.
The insured party remains liable for a substantial part of the risk: 20 to 30% of the amounts
involved.
As a rule, the insurer examines the solvency of the buyer before insuring the risk.
Most insurers take care themselves of the collection of debts which were not paid at due
date.
These principles restrict severely the supply of export credit insurance by professional
credit insurers. Given the growth in international trade, the lengthening of credit terms, and
the increasing relative importance of political risks, this led the banks and the States to enter
the market and to become the major suppliers of services to exporters.
A. Public intervention
State intervention in the market for export credit insurance is not recent. It began as early
as 1919 in the United Kingdom with the creation of a sub-department of the Department of
Overseas Trade. But the major developments have taken place since the Second World War,
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as the policy-makers became better aware of the direct beneficial effects of exports on employ-
ment and the balance of trade. All industrial countries set up their own export insurance
schemes, in order to compensate for the lack of private insurance supply, specially in the field
of political risks, and to promote the development of a strong domestic export industry.
In most countries, the State chose to cooperate with existing credit insurance firms. This
is the case in West Germany, where the Federal State mandated a private company (Hermes)
to administer the public export insurance scheme. This is also the case in the Netherlands,
where a private company (N.C.M.) provides insurance against a wide range of export credit
risks, with the support of the State which accepts to provide l00% reinsurance on risks which
are not insurable on the private market. Another type of cooperation was imagined in France
where the private sector received a financial interest in the operations of a national company
(COFACE) issuing guarantees against political and "extraordinary" commercial risks and
insuring the "ordinary" commercial risks for its own account. A similar arrangement existed
until 1983 in the United States, where ajoint subsidiary of some 50 private insurers (FCIA)
participated to the operations of the public export agency (Eximbank)and covered the commercial risk for its own account. In October 1983, the FCIA decided to abandon the business
on own account, due to heavy financial losses. Since that date, it operates only as an agent of
Eximbank.
In one country - Switzerland - State intervention resulted in a division of the market.
The State through a public Agency (ERG) guarantees the political risks, whereas two private
companies are in competition to provide export cover against the commercial risk. There is
no institutional cooperation between the State and the private insurers but a gentlemen's
agreement on who does what.
Finally, in the United Kingdom, a public agency (ECGD) covers both commercial and
political risks. Theoretically, this agency is in competition with several credit insurers who
cover commercial risk, and with some Lloyd's syndicates underwriting political risks. In
practice however, the ECGD has far more weight than its private competitors. A similar system existed in Austria until 1977, but it was changed in that year to introduce more cooperation between the public OeKB and the private OeKV, the former having delegated to the latter
the cover of commercial and political risks on credits up to 180 days, with respectively 75% and
100% counter-guarantee from the State.
B. The role of banks
Besides the cover of foreign exchange risk that they traditionally supply through the forward exchange market, the banks and their affiliated institutions have created several services
combining their usual financing activity and guarantees against export credit risks. Three
types of arrangements are particularly important in this respect:
Confirmed documentary letters of credit, whereby the confirming bank, located in the exporter's country, promises to pay the exporter, or to deliver a Banker's acceptance, upon reception of the export documents. If a credit is granted, the exporter can thus easily obtain the
proceeds of his sale. In addition, he is guaranteed against all risks of non-payment, nontransfer of funds, buyer's insolvency, etc.
Export factoring, whereby a financing institution, generally an affiliated to a bank, manages
the export bills, provides the exporter with liquidity (up to 95% of the outstanding
amounts), and issues a guarantee against the commercial risk of non-payment.
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Forfaiting, whereby a bank, or its affiliate, purchases the export claims at a discount price,
and agrees to cover all the risks attached to these claims: forfaiting is thus a financing arrangement which also insures the exporter against exchange risk, commercial risk, transfer
risk, and all other political risks arising after the transaction has taken place.
Although these services are not yet very widely demanded because they remain
expensive, they provide exporters with a useful complement to export credit insurance
schemes, and they have turned the banks into suppliers on the market for the coverage of
export credit risks.
C. Recent developments
Several important events have occured in recent years in the market for export credit
insurance.
Firstly, sluggish economic growth and the debt burden accumulated by many industrialising countries led to severe losses, not only in the political risks area (Iran, Poland, etc.), but
also in the commercial risk area. The professional credit insurers reacted by restricting further
their supply, but the public schemes, constrained by their commitment to the support of
domestic exporters, could not do so. As shown inTable 2, most of them were heavily in the red
for 1982, and all are in this case for 1983.
Table 2: Financial results of public export credit insurance schemes*
(1982 figures in millions Swiss francs)
FEDERAL REPUBLIC OF GERMANY (Hermes)
AUSTRIA (Oe.K.B.)
UNITED STATES (Eximbank)
(FCIA)
FRANCE (Coface)
ITALY (Sace)
JAPAN (E.I.D. - MITI)
+ 39.4
- 106.5
-
9.6
- 32.3
- 680.6
- 194.5
- 159.5
NETHERLAND (N.C.M.)
UNITED KINGDOM (E.C.G.D.)
- 56.2
SWITZERLAND (E.R.G.)
- 186.-
- 446.2
* Receipts include premium income and recoveries; expenses include claims paid and operating
expenses.
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Secondly, there is now a common agreement among the policy makers of the industrialised countries that public deficits are harmful for the economy and must be kept to a minimum. The financial losses of public export credit schemes have thus come under closer
scrutiny and it has been said on different occasions that these schemes should be self-supporting '. As a restriction of the services offered to exporters is excluded a priori, a solution has
been sought in premium increases. In Germany, for example, rates increased by 40% in Spring
1984. However, it is doubtful that these premium increases will produce their intended effect.
According to the economic theory of insurance markets, they will lead rather to new imbalances, because the low-risk insureds will either step out of the market or look for alternative
arrangements.
Thirdly, several U.S. property-liability insurers interpreted the difficulties faced by the
public schemes and State agencies as a sign that many exporters are dissatisfied with the
present service offered by the State. These insurers have recently entered the market. Most of
them merely seek to provide exporters with complements to already existing policies. But one
of them (A.I.G.) aims to attract the lowest risks with a complete policy covering commercial
and political risks, and linked to a financing arrangement.
To summarize, State intervention is predominant on the market for export credit insurance. Public schemes were designed to cover as many risks as possible, at a moderate price.
Banks also succeeded in developing useful services, but these services are expensive and
exporters use them only on a case by case basis. The market share of professional credit
insurers has remained modest and concentrated on one specific segment of the market: shortterm commercial risk on debtors from OECD countries. But recent changes in governments'
attitude regarding export subsidies 2 and the entry of property-liability insurers might be signs
that fundamental changes are presently in process. The problem is to assess the importance of
these developments: are they only transitory disturbances, or are we on the verge of a lasting
redistribution of roles in the market?
3. The role of private export credit insurance in the future: the opinion of professionals
A distinction must be made between two groups of private insurers active on the export
credit insurance market:
professional credit insurers, who restrict their activity to the insurance of the short-term
commercial risk;
a limited number of property-liability insurers, who are newcomers to the market and who
are mainly interested in political risks.
For this reason, this section will be divided into two paragraphs, the first dealing with
commercial risk, the second with political risks.
Several countries (especially the United Kingdom and France...) are considering a reform of their
schemes in order to reduce the level of public involvment.
I
2 State support to export credit insurance is only a subset of a wide package of subsidies. In countries experiencing high interest rates, such as France and Italy, subsidies to export financing schemes
represent the major burden for the State.
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3.1. Commercial risk
All private credit insurers and reinsurers that we met during our study strongly oppose
the idea of an extension of their activity, not only regarding political risks, but also regarding
the commercial risk beyond the OECD zone. Among the reasons given for this reluctance, the
following are the most typical:
In the non-OECD countries, it is often difficult to obtain from the court that a defaulting
debtor be declared insolvent. And although the protracted default clause has gained wide
acceptance in the market for export credit insurance, most private credit insurers still stick
to the insolvency rule, for fear of moral hazard.
In these countries, it is more and more difficult to separate commercial risk from political
risks. When a debtor defaults, it is often hard to decide whether his financial troubles are
due to his own behavior or to the general socioeconomic climate. Now, the private credit
insurers can only assess commercial risk; they have no expertise in the assessment of political risks.
Even in the OECD countries, it has become difficult to assess commercial risk because the
State often intervenes to prevent or to delay the failure or large firms.
Since the first oil shock, the number and the severity of export credit claims has increased
tremendously. Export credit insurers are consequently more cautious.
In addition, present economic and monetary difficulties have led to more volatility in the
financial results of industrial firms. Credit risk assessment has thus become more uncertain because a profitable firm can quickly run into trouble.
For all these reasons professional credit insurers feel insecure, and they prefer to restrict
their coverage to carefully selected risks, so long as the economic situation remains unstable.
3.2. Political risks
As stated above, guarantees against political risks have traditionally been provided by the
State or by private insurers operating on the State's account. Professional credit insurers
refrain from issuing such guarantees for the following reasons:
These risks are catastrophic; when losses arise, a whole country is concerned; and possibly,
several countries at the same time.
When public buyers default, there is no way for a private and foreign insurer to force them
into payment. A public institution or firm cannot be declared insolvent, and the private
insurer cannot use diplomatic arguments to recover the insured's claims.
The geographic spread of political risks is too narrow. Most risks are concentrated in a few
countries.
Nevertheless, some private insurers provide guarantees against political risks for their
own account. These insurers can be divided into three groups:
The first group is made up of two companies which cover exclusively risks on exports to
communist countries: "Garant" in Vienna, and the "Black Sea and Baltic" in London.
The second group is composed of Lloyd's of London and a few U.S. property-liability
insurers who have tentatively entered the political risks area in order to bridge some gaps in
the coverage provided by the public schemes.
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c) A single US company (A.I.G.) forms the third group. It provides insurance against commercial and political risks.
A.I.G.'s experiment is the most interesting, because this company is the only one trying
to offer a substitute to the public insurance schemes. Moreover, it may be considered as the
first attempt to apply the theory of discriminating contracts to export credit insurance. As a
matter of fact, this company's declared strategy is to design a policy only considered attractive
by the large multinational companies. Since these companies remain financially strongly interested in the outcome of export transactions, and as they often have their own departments of
political risk assessement, they can be considered as better than average risks. Thus A.I.G.
claims that it can do better than other public or private insurers.
This experiment will however probably fail on two counts. Firstly, it is considered untimely by professional credit insurers and reinsurers. They predict that it will end up with catastrophic losses, with undesirable effects on the whole credit insurance market. For this reason,
they are not prepared to support it with reinsurance treaties. Secondly, the world financial
situation is still too unstable to allow ambitious but isolated experiments to succeed.
4. Towards better cooperation between private credit insurers, public agencies and banking
institutions
The experience from our study, the opinions expressed by the private and public insurers
we met, and some recent reform projects in the United Kingdom, Switzerland and France,
lead us to present several suggestions for a better organization of the market. As usual, these
suggestions are classified by making a distinction between commercial and political risks.
4.1. Commercial risk
In this area, five changes could bring a better contribution of the private insurance sector
to the coverage of export risks.
a) The subsidiarity principle, according to which the State intervenes only in areas where
private initiative is failing, should be applied more extensively. In the countries that we
visited, it is strictly applied in the Netherlands, and to a lesser extent in the Federal
Republic of Germany and in Austria.
The strict application of this principle would allow the private credit insurers to diversify
their risks and to spread their rating system. For exporters, this would mean less administration and more commercial flexibility.
State intervention should be reserved for problems of national importance, leaving to the
private sector the mass of small credits requiring an information system that professional
credit insurers have long established through a network of international data exchange.
This principle could be extended in either of two ways:
either the State would abandon the underwriting of short term commercial risks on the
OECD countries (Austrian system);
- or it would still cover all risks, but would allow the exporter to exclude the OECD countries
from its whole turnover policy (German system).
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However, the main obstacle to an extension of the subsidiarity principle is the State's fear that
still heavier losses would result from the transfer of short-term commercial risk to the private
sector. But it remains to be seen whether the saving in administrative costs would not, to a
large extent, balance the worsening in quality of the portfolio of risks.
The extraordinary commercial risk, that the private sector is not prepared to insure, should
be 100% reinsured by the State. Thus, exporters would be able to insure all their commercial risk with one single company.
Similarly, the State should provide 100% reinsurance on political risks in the OECD zone.
This would allow the private sector to supply the exporters with a full package of commer-
cial and political risk insurance in this zone.
The efforts to bring about a harmonization of export credit insurance policies should be
intensified. One of the results from our report is that there still exists a very large disparity
of export credit insurance practices in the industrial countries. More homogeneous practices, under the auspices of the I.C.I.A. would have the following advantages:
- A uniform I.C.I.A.-approved policy would receive more credit from banks;
- it would be welcomed by multinational companies;
- it would suppress market distorsions between exporters from different countries.
Cooperation between banks and private credit insurers should improve. Banks complain
that insurance policies are too complicated, that they entail too many clauses which reduce
their reliability. Public insurers met the bank's wishes, mainly in the buyer credits arrangements, by increasing the percentage of cover, reducing the delays of protracted default and
introducing unconditional guarantees to the banks. Private credit insurers are unable to go
so far, but they should try to make some steps in this direction.
4.2. Political risks
As professional credit insurers and reinsurers strongly oppose an extension of their activity to the political risks area, a larger role for the private sector could not be obtained without
major reforms in the present organization of the market.
To this end, we would recommend - like Bastin [1978] a variant to the system presently
in force in the Netherlands, where a private credit insurer the N.C.M., insures both commercial and political risks with the ability to obtain from the State as much reinsurance as
required. More specifically, we think that:
- in each country, the direct export credit insurance business should be left entirely to the
initiative of private companies operating in competition with each other;
- in each country, these companies should be able to rely on the support of a public reinsurance agency, providing excess-of-loss treaties, stop-loss treaties and even 100% reinsurance
for certain risk classes that the direct insurers would judge uninsurable. This system of
public reinsurance would not, of course, exclude the opportunity for the direct companies
[C.I.A.: International Credit Insurance Association.
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to deal with private reinsurers. The public reinsurance agency would adjust the terms of its
treaties according to Government policy, and it would be able to exchange parts of its portfolio with similar agencies in other countries (see Glibert [1983]).
Such a system would have several advantages. It would allow:
- to maintain State intervention, but with concomitant reduction in administrative structure
on which this intervention is based;
- the exporters to benefit from open competition between private credit insurers. This system would thus be closer to the working of a market economy than the present Dutch system where the NCM enjoys a de facto monopoly;
- private insurers to be protected from the catastrophic character of political risks;
- private insurers to be backed up with the diplomatic support of the State for recoveries on
claims of political origin;
- the reduction of moral hazard and adverse selection problems through the design of a welladapted rating structure;
- the introduction of more flexibility in the supply of export credit insurance.
The adoption of such a system would no doubt completely turn the practices to which the
parties involved have adapted over the years upside down, but it would provide a better framework for the adaptation of export credit insurance procedures to changing economic reality.
5. Conclusion
In fact, our study on export credit insurance can be considered as a case-study of
problems arising from moral hazard and adverse selection in insurance markets. Briefly, the
story of credit export insurance can be told thus:
Through experience, professional credit insurers have learnt that they must take care with
export credit risks. They cannot provide exporters with wide coverage because they lack
information on the probabilities and amounts of claims, particularly when political risks are
involved. They cannot increase their premium too much to make up for this uncertainty,
because the best insureds would step out of the market, thus bringing the insurance portfolio into imbalance. Their reaction has therefore been to operate a careful selection of risks
and restrict their coverage as much as possible.
Faced with this restricted supply, exporters turned to the State to obtain complete insurance
coverage. The State, taking into account the positive side-effects of exports on employment
and the balance of payments, agreed to provide extensive guarantees on attractive term. But
the growth in international trade, the lengthening of export credit terms, economic recession and moral hazard led to the heavy losses that public export credit insurance schemes
are now experiencing.
In general, the State tries to make good these losses by increasing the premium rates. But
the main result of this reaction is that good risks abandon the public schemes, which
increases the probability of high losses.
no
Non professional credit insurers are thus attracted to the market, because they suppose that
discriminating contracts would allow them to attract only the good risks. Their success is
however subordinated to an improvement in the world economic and financial situation,
and to the availability of reinsurance. But the professional reinsurers are still very reluctant
to enter the political risks area.
A solution to this unstable situation lies in closer cooperation between private insurers and
the State. The latter, acting as reinsurer, would still be able to provide indirect support; but
retreating from the forefront it would be better able to control the amount of its involvement. The former, acting as direct insurers, would face the total market. They would be in a
better position than the State to select risks and to adopt an appropriate rating schedule.
National interests would still be preserved as the direct insurers would be able to reinsure
extraordinary and catastrophic risks with the State.
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Paris.
BERRY, C. [1984]: "Private insurers edge in", Trade Finance Report, January 1984, 18-20.
GLIBERT, F. [19831: "Reassurance et coassurance des risques politiques", Droit etPratique du Commerce
International, 9 (No 2/1983), 261-276.
LOUBERGE, H. and P. MAURER [1985]: Financement etAssurance des Credits ii l'Exportation - Aspects
Theoriques et Pratiques en Vigueur dons les Pays Européens, Editions Droz, Genève.
ROTHSCHILD, M., and J. STIGLITZ [1976]: "Equilibrium in competitive insurance markets: An essay
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