There has been a surge in the number of trade credit insurance claims during the first quarter of this year 2018 as tough trading times continue to harm firms badly, according to Association of British Insurers (ABI) recent report.
The number of claims was estimated at 3,966 which was a 50% increase on the previous quarter, and has been attributed to the recent insolvency of construction giant Carillion. With an average of over 40 new claims on a daily basis, ABI puts these figures at an all-time high since Q3, 2009.
Mark Shepherd, Assistant Director, Head of Property, Commercial and Specialist Lines, ABI commented on the latest financial crisis: “The demise of Carillion is a powerful reminder of how trade credit insurance can be a lifeline for businesses in these uncertain trading times.”
Shepherd further added: “This is a tough time to be in business and it is not getting any easier. The collapse of Carillion was one of many high-profile major insolvencies, which dramatically highlighted how the ripple effect of a company failure can have a devastating impact throughout the supply chain.”
Construction giant Carillion finally buckled under a massive £1.5 billion debt in January 2018 following failure to secure a bailout from the government. Out of 43,000 Carillion employees, 20,000 of them are from the UK.
Insolvency service, PricewaterhouseCoopers (PwC) has addressed the employees on the Carillion website’s ‘Employees’ page, however, advising them to report to work as usual unless ‘instructed otherwise’ and they will be paid their salary as usual.
The Financial Times observed on the latest development with a comment that the Carillion’s liquidation would be felt outside Britain as well.
Carillion debts and mismanagement
Construction giant Carillion provides facilities management and ongoing maintenance. The company has worked on several private and public projects in the UK and is identified for provision of services to the public sector. Carillion is part of a consortium for construction of the HS2 high-speed railway line.
The company maintained 50,000 homes for military personnel, provided meal services for 218 schools, spent £400 million for revamping of the Battersea Power Station, maintained 50 prisons, provided 11,500 hospital beds under the NHS Scheme, and had sunk £1.4 billion in the HS2 joint venture.
Carillion’s half-yearly losses of £1.15 billion were added to an existing deficit of £900 million during December 2017.
The main reason for the company’s collapse is attributed to a series of cost overruns with three significant projects – Midland Metropolitan Hospital, Royal Liverpool Hospital and Aberdeen Bypass.
These projects and a set of others were found to be less profitable than previously estimated. The company then approached the government for a bailout of £20 million which the government refused, stating that it might be perceived that they were “bailing out yet another private firm.”
Cabinet Office Minister David Lidington stated that it could not be expected for taxpayers to bail out a private sector company, however, in contradiction of this statement, the National Audit Office noted that “the collapse of construction giant Carillion will cost UK taxpayers an estimated £148 million).”
The spillover effect of the Carillion collapse has hit other companies in varying degrees. Big names like Galliford Try, Balfour Beatty, and Morgan Sindall provided reassurance to their investors that all is still well with them. Others like Van Elle Holdings, Speedy Hire, and John Laing Infrastructure Fund have taken a beating, but they all claim that they are taking remedial measures.
Meanwhile, Carillion’s partner on the HS2 project, Kier, claims that they have a contingency plan and are working closely with clients to ensure business continuity.
Trade Credit Insurance
Trade credit insurance (TCI) is a provision where cover is provided to a business if customers do not pay or make delayed payments. This facility offers a buffer to a company for extending credit and making funding more accessible at all times, which results in the smoother functioning of the business.
It also helps a business to sell their products or services at more competitive rates. The outer time limit for providing trade credit insurance is usually set to 12 months. Cover can be obtained across different countries, and the insurers also assist with advice regarding credit risks, particularly concerning new markets. A company can apply for credit risk allocated to individual customers or all customers within its portfolio.
There are two categories of risk under trade credit insurance:
Commercial risk – Customers cannot pay their dues due to specific underlying financial problems like insolvency or default in payments due to involuntary or voluntary reasons.
Political risk – In the customer’s country, there may exist a prevailing political crisis like war, military coup, and natural disasters like floods or earthquakes. Alternatively, there may be some economic crisis like currency shortage or demonetization, which may prevent the customer from transferring the money to the company’s account.
Why TCI failed for Carillion
Although Carillion also had trade credit insurance, the warning signs were ignored and insufficient remedial action was taken to avert a financial crisis. The purpose of TCI is to assure a company that in the event of non-payment of dues from debtors, funds will still be available for the company to function smoothly.
However, in the case of Carillion, enough corrective measures weren’t taken despite the warning signs of an impending financial disaster. In July 2017 when CEO Richard Howson stepped down, Carillion chairman Philip Green said that the company would fall short of its targets for the reduction of debt in 2017.
Green stated: “…we have therefore concluded that we must take immediate action.” Although attempts were made to remedy the looming crisis, the company failed to come up with a practical action plan. The total debts incurred extended well beyond the limits of the trade credit insurance coverage, which led to Carillion going down under.
What remains to be seen now is how the spillover effect is going to impact the financial atmosphere of the region and the dynamics of the aftermath.
