The tumultuous first quarter of 2020 has closed, leaving businesses struggling to account for current and future losses and wondering what the remainder of 2020 will bring. As increasing numbers of borrowers struggle with cash flow issues and face defaulting on loan facilities in this early stage of the COVID-19 crisis, we set out some guidance to financial institutions and other lenders on their structured credit risk policies. We also highlight points for businesses to consider when reviewing what cover may be available under their trade credit risk policies for non-payment by their suppliers. Finally, in this article, we take a look at political risk and violence policies and the extent to which these might provide additional cover to insureds in certain circumstances.
You can view our previous articles on business interruption and event cancellation insurance on reedsmith.com.
In this third of our series of alerts, we focus on two broad areas of insurance: (1) credit risk (both structured and trade), and (2) political risk and violence. Read our previous articles on business interruption and event cancellation insurance on reedsmith.com.
Throughout the first quarter of 2020, we have witnessed COVID-19 spreading across the world at a dramatic speed. Its impact across all industries and businesses cannot be underestimated and, for many, the recovery will be slow. In a number of cases, there has been an effective shutdown of entire industries (including the aviation industry and the hospitality and tourism sector); others have suffered extensive supply chain issues and a wider stalling of production and service lines.
Some key questions that we explore in the first section of this article are:
For lenders and financial institutions: does any insurance you have in place provide an indemnity when your borrower defaults?
For businesses: does your trade credit risk policy cover missed payments by customers?
Structured credit risk (or non-payment) insurance
How structured credit risk works and what it covers
Structured credit risk insurance protects a financial institution (or lender) from defaults or other instances of non-performance on the part of their borrowers. This form of insurance is also commonly taken out by exporters, importers and manufacturers as it offers a means of mitigating cross-border payment risks. It is frequently used to support business growth in new geographic territories or in new lines of business in respect of which the risks of default may be greater.
By way of example, such a policy will indemnify an insured when a borrower fails to make a scheduled payment under a loan facility. Typically, the indemnity will be in respect of the principal sum only, and will not cover any interest or costs.
Generally, the loss (i.e. the unpaid principal sum) does not need to be caused by a specified insured event. This is of clear benefit to an insured as there is no need to demonstrate that the default was the consequence of a specific event, for example, a government order relating to COVID-19.
Unless, therefore, an express exclusion (or other policy terms restricting the cover) is triggered, we would expect a credit risk insurance policy to respond when borrowers default, regardless of whether such default was as a result of closures or other disruption caused by COVID-19.