Credit cover pull-out threatens businesses
By Kiran Stacey

Published: November 24 2008 02:00 | Last updated: November 24 2008 02:00

Total Security is not a big company. The security materials supplier does business in the hundreds of thousands of pounds rather than the millions. So when its partner, David Hermanns, won a contract to provide £100,000 of turnstiles to Leisure Connection, which operates 80 sports and leisure centres for local authorities, he was delighted.

Winning the contract marked the end of a long bidding process and, finally, Mr Hermanns' business would be able to employ the people it needed to get on with the job.

But there was a problem. Leisure Connection wanted to pay Mr Hermanns' company on credit. That in itself was normally not a problem. But when Total Security's credit insurer, Atradius, refused to provide cover in case Leisure Connection's debts were not repaid, Mr Hermanns decided he simply dare not take the risk and cancelled the contract.

Mr Hermanns was furious. He says Leisure Connection, which has recently refinanced, was a well-established business with significant market share and was paying some of its bills upfront, and yet Atradius refused to run the risk that it might go bust before the bill was paid.

Mr Hermanns' company is now struggling. Rather than taking on staff to fulfil contracts, Mr Hermanns is laying people off and cancelling those orders. He is in no doubt who is to blame. "We worked tooth and nail for this contract and, when Atradius pulled out, we had to cancel the contract. Our oxygen is being totally cut off."

Mr Hermanns' business is among those affected by sharp reductions on cover offered by each of the country's big three credit insurers, Atradius, Euler Hermes and Coface. Atradius alone withdrew cover on 12,000 buyers last week.

Woolworths' struggles have also become more intense since credit cover was withdrawn to its suppliers, while the failure of Fopp, the music chain that was rescued in an emergency sale, was hastened by lack of cover.

ScS Upholstery was bought for nothing after its suppliers lost their cover. "Credit insurance is important and was a major factor at the time of our failure," says David Knight, ScS's chief executive.

The three companies dominate a market that has long gone unnoticed but is now being thrust into the spotlight as they find themselves unable to provide what has been called "the lubricant vital for everyday trade". Even though only about 20 per cent of UK companies take out such credit insurance, the knock-on effects of that lubricant being removed are apparent for people such as Mr Hermanns.

It is not just the suppliers who are unhappy at the insurers' actions. Nick Hedley, chairman of the financial risk division at the broker Jardine Lloyd Thompson, says: "In the past five or six years, credit insurers have become inappropriate and undisciplined in the cover they offer."

Anthony Brown, managing director for the international region at asset-based lender First Capital, agrees, adding that credit insurers have undercut lending rates offered by banks. This has meant those banks have had no option but to lend against bills due to be paid, and then insure the risk of them not being paid with the credit insurers themselves.

If the credit insurer then pulls out of the market, banks find themselves with unsecured risk - the last thing they can afford in this climate. Unsurprisingly, small businesses then find their loans being called in.

But Stephen Haddrill, director-general of the Association of British Insurers, defends the insurers. "You can't complain about them being competitive. Why would they have ramped up prices when none of this could have been foreseen?"

The credit insurers are themselves victims of the general downturn in the economy. They do not want to provide cover against failing businesses going under. As Kelly Ostler-Coyle, spokesperson for the ABI, says: "It would be like trying to take out flood damage cover when your house has already been flooded." Atradius say it is "reacting prudently to our view of current economic conditions".

Insurers have seen their claim figures rise steeply as more companies have gone into liquidation and are now simply trying to cover their position. Figures released today by the ABI show that UK insurers faced £97m in claims over the third quarter, a 41 per cent jump from the last quarter.

But it is a vicious circle. When times are bad, insurers retreat to cut losses. That retreat further blocks credit lines and takes struggling companies closer to the wall.

It could get worse still. Not only should businesses watch out for how much cover the insurers provide, they should also keep an eye on those insurers' credit ratings. If banks offer a loan based on bills due to be paid that have then been insured, that loan is less secure if the insurer is not regarded as sufficiently creditworthy to honour its commitments.

So banks put a covenant on their loans relating to the credit rating of the insurer. If breached, companies can see interest on that loan escalating fast. This is why, when Standard & Poor's, the ratings agency, put a "negative outlook" on Atradius' "A" rating last week, it was yet another reason for small businesses to worry.

"It's going to affect a lot more retailers," warns Mr Knight at ScS. "And some will be really big names."