Competition, the ECAs and the private market
Most ECAs in the developed world do not compete with the private sector for ‘marketable’ risks; but when it comes to ‘non marketable’ risks, life is a lot more complicated.
A degree of competition between ECAs and the specialist credit and political risk insurance (CPRI) market has become inevitable and appropriate because, of necessity, both now often cover the same type of risk. We welcome this choice for clients (whether exporters or financiers) but issues remain:
- First, many in our industry continue to deny the existence of this competition. This denial threatens the proper development of our market.
- Second, for the competition between ECAs and the CPRI market to be fair, ECAs need to comply with the OECD Arrangement with its minimum premium rates, and there needs to be a level playing field on premium taxes.
- Third, some ECAs have begun to compete with their clients. When an ECA approaches the CPRI market for facultative reinsurance, simultaneously as its client approaches the same insurers for cover on the same transaction, ECA and client find themselves in competition for the same private market capacity. We need safeguards to ensure that when pursuing reinsurance, ECAs do not restrict client choice.
Capacity constrained marketable risks
Our views challenge the traditional narrative, enshrined by the European Commission, that private insurers and ECAs operate in different risk categories, with private insurers covering ‘marketable’ risks and ECAs covering ‘nonmarketable’ risks.
The EU’s definition of ‘marketable’ risk, though narrow, is reasonable: short term business in the EU and a handful of developed countries is indeed the only area of the business “where there is sufficient private capacity to cover all economically justifiable risks”. Therefore the EU ECAs do not normally cover ‘marketable’ risks so defined.
The problem is that everything else is considered ‘non-marketable’, a view that is confounded by the activities of the CPRI market. BPL Global’s portfolio of close to $40 billion of live policies represents about 15% of the CPRI market and is typical of the market as a whole. Less than 5% of our portfolio is ‘marketable’ under the EU classification, and this shows that there is a market for most so-called ‘non-marketable’ risks. Traditional thinking is further confounded by our portfolio being predominantly medium and long term (MLT) risk, and by it revealing that CPRI market insurers have proportionally more exposure in high risk emerging markets than the ECAs do.
Of course some risks remain truly nonmarketable, either because of size or tenor, particularly for private sector obligors. However, the clear majority of risks deemed ‘non-marketable’ are individually within the risk appetite of the CPRI market. But collectively they are not fully ‘marketable’ in the EU sense, because there is not sufficient private capacity to cover all such risks. There is therefore a third category of risk, “capacity constrained marketable risk”, where the CPRI market is very active, but ECA participation is still essential.
The CPRI market’s capacity constraints arise from the concentrations by obligor and by country that inevitably arise in export credit insurance, particularly in emerging markets. CPRI market capacity is a scarce resource, and its providers underwrite selectively because they need balanced risk portfolios. So a risk may be overpriced or even unacceptable this week, simply because the market wrote a large identical risk last week. Country aggregate is a particular concern. From Berne Union figures we estimate that total global demand for MLT cover in high exposure countries like Brazil, China, Russia and Turkey may approach $50 billion. The CPRI market can meet at best perhaps 25% of that total demand. These very real capacity constraints are not going to change soon.
The need for government support to address aggregate exposure and risk concentrations is well known in other classes of insurance, such as terrorism and flood risk. The export credit insurance market is unusual because, for historical and structural reasons, government support comes as direct insurance, rather than as reinsurance sitting behind the private sector. It is this necessary presence of ECAs in the direct market which makes our class of insurance complicated. Given the rise of the CPRI market, we need to face up to the inevitable competition that has arisen.
Competition is now inevitable
Competition is indeed inevitable for capacity constrained marketable risks. Consider 50 clients who each require MLT policies on the same obligor in a medium to high risk country, whose risk is well within the appetite of the CPRI market, but where the market has enough aggregate capacity to write only 10 to 15 of these policies. How should these essentially identical risks be allocated between the ECAs and the private insurers?
If ECAs were serious about not competing with the private market, they would have to withdraw their support until the private market capacity was exhausted, holding back even when the price of the private insurance rose well above the OECD minimum premium rates as it became more scarce. This would be a disaster for clients. If ECAs only offered cover on an obligor when the CPRI market had run out of capacity, they would simply exacerbate the imbalance between demand and private market supply, with the obvious consequences.
So while some ECAs maintain that they do not compete with the private insurers, in practice they issue cover where private market cover would be available, albeit on less favourable terms. The ECAs cannot fulfil their role without competing with the private market. If a European exporter with a CPRI market quote at 125% of the OECD minimum price, finds itself in competition with an Asian exporter with ECA support at the minimum price, the European ECA has little alternative but to put its client first, and undercut the private insurance market.
Competition is appropriate
However, the policy of not competing with the private market is not only impractical, it is misguided. Consider the effect of the policy on the clients’ behaviour. The clients naturally prefer the established ECAs, to the less well established private insurers. So the ECA policy of not competing with the private market becomes in effect a threat to withdraw ECA support if the client obtains terms from the CPRI market. We cannot think of a better way of discouraging clients from approaching the CPRI market, or of perpetuating the ECAs’ de facto monopoly. In any other context, the ECAs would be accused of anti-competitive behaviour and abuse of their dominant market position. The CPRI market accepts that it is the new entrant and has to prove its worth. But ECAs should encourage clients to explore the private market, not position the private market as a threat to the still necessary ECA supply. Is it surprising that many clients treat the CPRI market as a market of last resort, only to be approached when ECA cover is not available?
In accepting the existence of competition our industry should take comfort that competition between an ECA and the CPRI market is very different to the head-to-head, destructive competition that occurred amongst ECAs before the OECD Arrangement. If an ECA loses out to the CPRI market, its client has not lost to a foreign competitor but simply found a better insurance alternative. Furthermore, when the CPRI market loses a transaction to an ECA, its scarce capacity remains available for what may well be a better opportunity down the road. Like many participants in complex industrial markets, the private insurers will play to their competitive advantages of flexibility, speed of response and freedom from the constraints of eligibility criteria and the OECD Arrangement. This is why clients see the ECAs and the CPRI market as complementary. But this coexistence is the result of competitive strategy, and the two remain competitors whenever clients can choose between them for all or part of a risk.
Competition needs to be fair
The real question facing our industry is not whether competition between the ECAs and the CPRI market does or should exist, but whether it is fair. Here the OECD Arrangement takes on a new importance. As well as its original purpose of limiting government subsidy for export credits, so preventing the market distortions that subsidy can create, the arrangement, with its minimum premium rates, now serves a second purpose of ensuring that the ECAs compete fairly with private insurers. Private insurers have an interest in ECAs abiding by the arrangement and in the Arrangement’s minimum premium rates fully reflecting both risk and the cost of capital.
The CPRI market also needs a level playing field on premium tax. We are not aware of any EU ECA that is subject to premium tax. It follows that no private insurer operating at the same level of the market as these ECAs, should be subject to premium tax when covering ‘non-marketable’ risks. The Berne Union should take up the cause.
‘Horizontal’ risk sharing
With both ECAs and the CPRI market competing for capacity constrained marketable risks, new opportunities have emerged for risk sharing between the two. This risk sharing is ‘horizontal’ when it takes place across the market, between insurers operating at the same level of the market who can quote against each other for all or part of a risk. With our base in the London subscription market, we of course welcome such risk sharing when it serves the client’s best interest.
In particular we agree that clients can benefit on certain transactions by the CPRI market reinsuring an ECA. However, where this risk sharing remains ‘horizontal’, an ECA pursuing such reinsurance may find itself competing with its client for the CPRI market’s capacity.
Therefore, where the client might itself be in negotiation with the CPRI market, the ECA should first obtain the client’s permission before approaching private insurers for reinsurance. If an ECA fails to do this, its intervention in the market may limit the client’s choice and thereby affect the price the client can obtain. Simple examples illustrate the point:
- Even when a client knows that Insurer A, B and C would all be acceptable to an ECA needing reinsurance on a transaction, the client should be able to restrict the ECA to approaching only Insurer C, where, for example, it needs Insurer A’s capacity to support a financed down payment, and Insurer B’s capacity to cover an onshore portion of the project.
- In a situation where Insurer A has offered terms that undercut the ECA’s price, but where the client needs Insurer B’s support to complete the private market placement, the client should be able to prevent its ECA approaching Insurer B with an offer of reinsurance at the higher ECA price. By unilaterally entering the market and securing Insurer B’s capacity for itself, the ECA, maybe unwittingly, would scupper the CPRI market better offer.
The above rule – that an ECA needs its client’s permission – will provide the client with the oversight and control it needs to ensure that risk sharing, whether by coinsurance or reinsurance, between public and private insurers operating at the same level of the market, leads to the best result for the client.
If ECAs do not immediately see the need for this rule, it indicates that there is an opportunity for the Berne Union to perform a valuable service for its ECA members by reminding them that they are undertakings subject to competition law; by helping them to identify when they are operating at the same level of the market as the CPRI market insurers, and when therefore risk sharing would be horizontal (as not all reinsurance of ECAs by private insurers is horizontal); by reminding them why competition authorities remain deeply suspicious of all risk sharing and ‘co-operation’ between insurers operating at the same level of the market, particularly when they involve insurers with a dominant market share; by understanding how following the best principles of the subscription market can keep the competition authorities happy; and by understanding why the process of horizontal risk sharing should be controlled by the client, not by the insurers or any one of them.
ECAs have entered unfamiliar territory. Used to the OECD Arrangement and its laudable aim of limiting state subsidy, ECAs now find themselves in an environment where a similar arrangement or understanding between an ECA and a private insurer would breach competition law. No private insurer is bound or could be bound by the Arrangement. Indeed, freedom from the OECD Arrangement’s constraints is a souce of competitive advantage to the CPRI market.
Competition between ECAs and the CPRI market is inevitable and appropriate given the fact that most risks once deemed ‘nonmarketable’, are today in this new category of ‘capacity constrained marketable’ risks. In conclusion, though, there are some real benefits that flow to ECAs from recognising this new category of risk.
For despite the fact that the ECAs collectively remain a vital part of the world’s commercial infrastructure, supporting trade and development globally, many individually still struggle to make their case to their government owners. The reason is that the narrative of ECAs only covering ‘nonmarketable’ risk must be inherently unattractive: it inevitably paints a picture of the ECAs as a dumping ground for substandard risks rejected by commercial insurers. This conjures up images of tax payer subsidy and corporate welfare, images that persist, despite the Berne Union ECAs’ very healthy financial performance over the last 20 or so years.
The narrative around capacity constrained marketable risks presents a more complex, but more accurate and pleasing picture of the ECAs’ role. The market gap is different but clear: not a lack of risk appetite at the transaction level, but a problem of capacity aggregation at the portfolio level. This narrative still sees the ECAs fulfilling a vital role: this they can do on commercial terms, without providing a subsidy, and earning a return for their government backers. Abiding by the OECD Arrangement and following sensible policies, the ECAs can provide a haven of consistency, stability and capacity around which the CPRI market can ebb and flow, guided by a normal market process of client choice.
Chairman - BPL Global