Insurance of International Trade Risks

Course Structure

Recommended bibliography
In Russian
Страхование. Учебник. Под ред. Федоровой Т. М.: Экономистъ, 2008
Селиверстов М.Н. Страхования экспертиза грузов. М.: Анкил, 2007
Чунтомова Ю.А. Транспортное страхование. М.: ТрансЛит, 2008
Шинкаренко И.Э. Страхование ответственности : справочник. - 2-е изд., испр. и доп. - М.: Анкил, 2006. - 416 с.
Гурков И.М. Страхование грузов, ответственности перевозчиков и экспедитора Вып.4.,, М.: Выбор, 2005
Экспорт товара: купля-продажа, перевозка, страхование, банковские сделки, Кокин А.С.,Левиков Г.А, Издательство Спарк, 2005
In English
Managing Risk in International Business. Ephraim Clark, Bernard Marois. Thomson Business Press, 1996
The Handbook of International Trade and Finance: The Complete Guide to Risk Management, International Payments and Currency Management, Bonds and Guarantees, Credit Insurance and Trade Finance, Anders Grath. Kogan Page. 2008

Web resources
Российский портал страховой индустрии http://www.allinsurance.ru
Сайт Всероссийского союза страховщиков http://www.ins-union.ru
Сайт, посвященный особенностям морской перевозки. Содержит интересные тематические справочники http://www.transrussia.net
Информационная платформа для всех участников транспортного рынка. Статьи по проблемам страхования. http:/www.seanews.ru
Портал, посвященный перевозкам грузов, в т.ч. международных, различными видами транспорта www.mezhtransavto.ru
Freight Transport Association http://www.fta.co.uk/
Insurance information institute http://www.iii.com
Swiss Re Portal www.swissre.com
Lloyds of London http://www.lloyds.com/
International Underwriting Association of London http://www.iua.co.uk/

1. Risk management in the international foreign trade operations

Risks in International Trade

Risk Management Tools
Loss Control
Loss Financing
Internal Risk Reduction
Loss reduction activities
Loss prevention activities
Retention and self –insurance (reserves)
Insurance
Hedging
Other contractual risk transfers
Diversification
Investments in the information
Loss Transfer
Loss Avoidance

Most popular risk management instruments
A documentary letter of credit
offers the best protection for overseas commercial transactions
The correct derivatives guarantee
cover against the exchange rate exposure

How a documentary letter of credit works?
A documentary letter of credit is opened by the purchaser's local bank (the credit-opening bank).
Via the credit-transmitting bank, the documentary letter of credit reaches the vendor. It checks whether the terms of the documentary letter of credit match the terms of your commercial contract. Only if the vendor is convinced can he send the goods to the purchaser.
The necessary documents (invoice, transport document, insurance documents) are handed over by the vendor to the credit-transmitting bank. After checking these documents, the credit-transmitting bank pays the sum that the purchaser owes to the vendor directly.
The credit-transmitting bank sends the documents to the credit-opening bank that, after checking the documents in turn, pays the amount due to the credit-transmitting bank.
Via the credit-opening bank, the documents finally reach the purchaser, who can use these documents to collect the shipped goods.
Finally, the buyer pays the amount owed to the local bank.

1. After a contract is concluded between buyer and seller, buyer's bank supplies a letter of credit to seller
LC

2. Seller consigns the goods to a carrier in exchange for a bill of lading
Goods
Bill of lading (BL)

Seller put bill of lading for payment from buyer's bank. Buyer's bank exchanges bill of lading for payment from the buyer.
BL
BL
Payment
BL
Payment

Buyer provides bill of lading to carrier and takes delivery of goods
Goods
BL

Exchange rate exposure
You make forward purchases of foreign currencies and wish to protect yourself against unfavourable trends in the foreign currencies that you have to buy.
You make forward sales of foreign currencies and wish to protect yourself against unfavourable trends in the foreign currencies that you have to sell.

Participants of the financial markets and their interests

Participants of the financial markets and their interests
Commodity Markets
Commodities price growth
Commodities price decline
Commodities price decline
Commodities price growth
Commodities buyers
Commodities sellers
Investors
Credit Markets
Rates growth
Borrowers
Rates decline
Lenders

Currency appreciations and depreciations
Previous Exchange Rate (X): Currency A/ Currency B
Current Exchange Rate (Y): Currency A/ Currency B
If X > Y ( X – Y > 0), Currency A has appreciated and Currency B has depreciated, relative to one another
If X < Y ( X – Y < 0), Currency A has depreciated and Currency B has appreciated , relative to one another

Foreign currency exchange
rate risks
Translation risks
Arising from the ownership of operating companies outside the home country. The greater the proportion of asset, liability and equity classes denominated in a foreign currency, the greater the translation risk.
Transaction risks (contractual risks)
Arising from the time delay between entering into a contract and settling it. The greater the time differential between the entrance and settlement of the contract, the greater the transaction risk, because there is more time for the two exchange rates to fluctuate
Non contractual risks
Arise because exchange rate fluctuations can affect the competitive position of the firm

Minimizing contractual risks
Example: UK based company buys property in USA for $ 440 mln. Payment delayed for 2 month.
Method 1. Borrow GBP, convert proceeds to USD and invest dollars until needed

Minimizing contractual risks
Method 2. Buy dollars forward
Cost of hedging = Forward rate – Expected spot rate

Currency forward contracts and rates
$0,0655

Forward premium
Fair Forward Exchange Rate
= Spot rate * (1+ R for) / (1+R home)
where,
R for – risk free rate abroad
R home – domestic risk free rate
Suppose, current spot on SFr is $0,5800 / SFr (or SFr 1,7241 /$)
1 year risk free rate for borrowing in SFr = 5%, in USD = 6%.
One year forward rate = 1,7241 * 1,05/1,06 = SFr 1,7078 /$
Price of Forward Exchange Contract (in %)
= (Forward price – Spot price) / Spot price

Hedging with currency forward contracts
UK company expects to receive SFr 10 mln in 90 days
Spot ex.rate currently = £0.6050/ SFr (SFr 1.6529/ £)
Three month forward rate for SFr = £0.6051/ SFr (SFr 1.6526/ £)
1) If spot declines to £0.5800/ SFr what will be effect of hedging?
2) What are costs of hedging for UK company?

SWAPS & Interest rate risks
SWAPS – arrangement by two counterparties to exchange one stream of cash flows for another.
Company issues floating rate bonds (payments = LIBOR * notional principal $100 mln)
LIBOR -? If LIBOR 8,5% company has losses (-500 000)
Company has an agreement with dealer to pay LIBOR * 8% if rates less than 8%. Dealer pays LIBOR * 8% if rates higher than 8%.
Interest rate swap can transform floating rate bonds into synthetic fixed rate bonds

Fixed for floating swaps
Notional principal = $ 10 mln
Semi annual net CF for fixed rate payer, $
Semi annual net CF for floating payer, $
6 month LIBOR
0
$ 25 000
- $ 50 000
$ 42 500
- $ 32 500
8,5%
8%
7%
6 month LIBOR
7%
8%
8,5%

Example of currency swap
US based company A is going to invest in Germany in EURO
Germany based company B is going to invest in USA in USD
US based company A issues bonds in USA and collects $ 7 mln. to finance deal in Germany
German based company B issues bonds in Germany and collects € 10 mln. to finance deal in the USA
Fixed exchange rate
In swap = $ 0,7/€
At the end of 6 months US Comp pays: $ 7 mln. * 0,08 2 = $ 280 000 * 1,7 = 400 000 EUR
8% rate, 10 years
8% rate, 10 years
At the end of 6 months German Comp pays: € 10 mln. * 0,08 2 = € 400 000 * 0,7 = 280 000 EUR

Risk Hedging, Risk Management and Value

2. International cargo and marine insurance

Plan of the lecture
Structure of insurance programs
Forms of insurance agreements
International Cargo Clauses
Carrier’s liability insurance
Specific of handling claims

Insurance programs for foreign trade organizations
INSURABLE RISKS
Hull
Cargo
Carrier’s Liability
Damage, total
destruction
or loss of the
carrying conveyance
Damage, total
destruction
or loss of the cargo
Liability to the
third parties for
the financial losses

Who are interested in transportation of cargo insurance?
Importers, buying on FOB & CPT conditions
Exporters, selling on CIF/CIP conditions
International traders (buying in one country and selling to another country)
Goods producers, purchasing raw materials and selling finished goods
Distributors
Transportation and Stock Companies, who has a contract liability to buy insurance for clients’ cargo

Forms of insurance agreements

Single insurance policy / Разовый полис страхования
Valid for one shipping
Valid for a period from 30 to 60 days from the date of insurance premium payment
Fact of shipment must be documentary confirmed by the insured
In case of delay in delivery, insurance premium has to be retuned by the insurer to the client (minus insurance loading)
Features:

Open cover /
Генеральный полис (договор) страхования
Applicable when:
Is issued once by the insurer under contract to cover all shipments (of cargo with similar characteristics) made by the exporter over a period of time (one year usually)
Open policy conditions:
Cargo characteristics;
Shipments periods and transportation routes;
Client’s loss statistics;
Type of vehicle;
Limits of sum insured by one vehicle;
Forecasted trade turnover of a company during the year ;
Insurance conditions & rates

Open cover
Client
Insurer
1. Specification of main conditions of insurance agreement
2. Signing the open cover agreement (policy) , with the rules (conditions) of policy attached
Client
Cargo shippment
Insurer
Do the cargo
characteristics correspond to the
open cover conditions?
да
Bill + insurance certificate
1.
2.
3.
Insurance premium payment
I Stage
II Stage.
Information about delivery
4.
3. Premium payment:
Advanced,
In the end of the agreed period,
Before each delivery

Sum insured (cargo)
Max sum insured by open policy on annual basis Max limit by each single delivery
Additional conditions can be specified, for example:
«Партии грузов стоимостью свыше _____USD заявляются Страхователем не позднее, чем за 2 дня до начала предполагаемой отправки»
« If cost of consignment exceed _____ USD it must be declared by the Insured not later than 2 days prior to the beginning of expected dispatch »

Open cover (frequent deliveries)
Client
Insurer
During the month:
Cargo shipments
Акцепт (Страховой сертификат) / Issue of insurance certificate for each accepted shipment
В конце месяца страхования (обычно - не позднее пятого рабочего дня месяца, следующего за отчетным)/ in the end of month
- Deposit withdrawal
Бордеро – подробные сведения об отдельных отправках*/ List of shipments’ details
- Bill (страховая сумма по всем перевезенным грузам * тариф)
* - По требованию страховщика - копии документов (инвойсов, коносаментов и т.п.), подтверждающих стоимость каждой единицы товара и их количество по каждой отправке

Open cover
Advantages:
- decreasing the administrative costs
all the shipments automatically insured for 1 year
- 20 – 30% chipper than the single policy
Disadvantages:
- cooperation only with one insurer during the whole year
Sum insured:
Forecasted invoice cost of cargo + All the transportation expenses*
* - Expenses on the freight, customs clearance fee, expenses on the armed support etc.

What factors influence on the amount of the insurance rate and cost of insurance?
Insurance Conditions (А, В, С - ICC)
Type of the cargo and the probability of its damage
Packing quality and its meet to the character of cargo
Character of Transportation
Type of the Vehicle
Seasonal Factors
Distance, expeditors accompaniment
The number of re-loadings in transit
Length of the period of insurance
Size of deductible

International Cargo Clauses (ICC)

A, B, C Clauses of ICC - Institute Cargo Clauses (Institute of London Undewriters)
С = 0,2 – 0,4%
В = 0,4 – 0,6%
А = 0,6 – 0,8%
Insurance premium
(in % of the Sum insured)
C
B
А
Risks and
Insurance coverage
All risks
exclusions
exclusions

Cargo insurance conditions
Clauses cover all risks of loss of or damage (All risks)
Clauses cover the risks of loss of or damage except (list1)
(With particular average)
Clauses cover the risks of loss of or damage except (list 2)
(Free from particular average)
Risks of storage

Cargo insurance conditions
All risks (A)
Damage, total destruction or
loss of the whole cargo
or any part thereof (1)
Expenses and contributions
allowed by general average (2)
All necessary and properly
incurred expenses for
salvage of the cargo (3)
With particular average (B)
Damage, total destruction or loss of the whole cargo or any part thereof
as a result of the listed risks + (2) + (3)
Free from particular average (C)
Total destruction or loss of the whole cargo, or any part thereofas a result
of the listed risks + (2) + (3)

Comparative analysis of ICC coverages

Carrier’s liability insurance

Insurance of liability for international transportation organizations
Responsibility to cargo damage (including insurance within the limits of convention КДПГ 1956). Risks: destruction, loss of cargo in case of road accident, a fire, overturning of a vehicle, theft
Responsibility for the financial losses connected with consequences of omissions of transport company’s employees. Risks: delay in delivery, wrong send of cargo, failure to carry out of instructions of the sender, wrong official registration of papers etc.
Responsibility to the third parties. Risks: a damage caused by cargo to property, life and/or health of individuals or business, surrounding environment
Warranty insurance TIR (a financial guarantee for customs in auto transportations). Risks: Responsibility for payment of customs fees to premises of the goods under a customs regime (the Insurance sum amounted USD 50 000 under one TIR carnet).
Responsibility to customs in the international transportation of cargoes with application of TIR carnets or other customs’ papers.

Claim cover limitations (cargo damage)
* - The SDR is an international reserve asset, created by the IMF in 1969

Special Drawing Rights (SDR) Valuation
It is calculated as the sum of specific amounts of the four currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.

Specific of handling claims

Handling of claims
What are the steps if the losses took place ?

The process of handling the claims
Damage
Insured
info
Written Notice of Loss
Carrier
Survey/ inspection
Results of Survey
Within 3 days period
Any independent surveyor who approved by Lloyd’s of London
Surveyor
Insurance company
1
2
3
Notifying Letter
First Tree Steps:

Who else involved in claim producing process?
Surveyor
Adjuster
Defines:
Fact of damage
Amount of loss
Fact of insured event
Adjusters and examiners:
- Investigate insurance claims
- Negotiate settlements
- Authorize payments
Consultancy
Preparing necessary documentation
Work with insurer

What documents are included in the claim to insurance company?
Proof of ownership of cargo
Survey report (with color photos)
Cargo invoice (showing value of cargo)
Statement of claim (claimed amount and cause of damage)
Disposal/ destruction certificate or proof of salvage value

Survey report is one of the most important documents for insurer
A survey should contain the following information:
Date/place of survey
Date of delivery of cargo into the custody of the consignee (you)
Vessel’s name and voyage number
Bill of Lading (or Invoice) number
Container number(s)
Cargo description
Background for survey held
Accurate description of the survey process (cargo condition, container(s), etc.)
Extent of damage
Probable cause of damage
Colour photos
Conclusion

Generally the following documents will be required to settle a claim
1. Proof of Insurance: Declaration Form or Original Certificate
2. Commercial Invoices
3. Non-negotiable copy of bill of lading or air waybill (front and back)
4. Claim Statement (an itemization of loss/damage claimed).
5. Copy of letter(s) to carrier(s) giving notice of claim.
6. Carrier's reply(s) if any.
7. Delivery receipts with exceptions noted.
8. Photographs
9. Survey report
10. Packing List.
11. Repair estimates (when applicable)
Additional documents may be requested at a later date !

Cases when insurers don’t respond to the clients
When claims have to be sent to the sellers or carriers directly:
Cargo have been lost or damaged because of the delay in delivery
If there is no damage to the packages or seals on the containers are not broken
Lost or damage of cargo resulted from the improper packaging
Re-grading of goods

3. Insurance
of international credits and investments

Country risks classification
Political risks are related either to the country of a foreign buyer or borrower, or to a third country which can cause the exporter, investor or financier to incur a credit loss.
Political risks include:
restrictions on transfer of the credit currency,
rescheduling of debts,
expropriation, and war or insurrection.
Commercial risks Commercial risks arise from foreign banks, companies or project companies.
Typical commercial risks include
the buyer's, borrower's or guarantor's insolvency
unwillingness to pay its debt.

Political risks
Political risk may materialise as the consequence of a long course of events, or may result from internal or external economic and political shocks.
Political risks are assessed according to the following criteria:
Economic growth potential
Economic policy
Vulnerability
size of the economy
dependence on exports/imports
dependence on foreign aid
Indebtedness and finance
balance of payments
foreign debt
access to finance
Foreign and domestic policy
political structure and continuity
efficiency of administration
international relations

Political risks classification

Risk management for political risks
Internal techniques:
Decreasing overall risk exposure (choice of country or trade portfolio structure)
Increasing of operational earnings (contract price regulation)
External techniques :
-Letter of Credit (Revocable and Irrevocable)
Factoring
Insurance

Commercial risks
Financial risk assumed by a seller when extending credit without any collateral or recourse.
The risk that a debtor will be unable to pay its debts because of some business events

Guarantees offered to exporter in the export/import operations
Credit Risk Guarantee provides the exporter with cover against credit losses in export trade.
Buyer Credit Guarantee provides lenders with security against credit risks caused by a foreign buyer, buyer's bank or buyer's country. An LCF Guarantee is based on terms and conditions of the Buyer Credit Guarantee supplemented with additional terms.
Letter of Credit Guarantee is an insurance for domestic or foreign confirming bank.
Bank Risk Guarantee - For securing conter-guarantees associated with export trade.
Investment Guarantee can be used by domestic investors to cover foreign investments against political risks.
Bond Guarantee is an insurance for the exporter and/or counter-security for the bond issuer.
Finance Guarantee provides a lender with security for credits received by exporters to finance exports.

Biggest credit insurers/guarantee providers in Europe

Coface

Euler Hermes Group

Guarantee Services
Guarantees are issued for clients in respect of their contractual or statutory obligations to their principals at home and abroad, comparable to bank guarantees.
Insurer guarantees a payment of principal and interest in connection with debt instrument issued by purchaser.

Guarantee Premiums
Short-term (repayment period less than 2 years) Buyer Credit and Credit Risk Guarantees usually cover corporate risk;
in consequence, the total premium charged includes both the political base rate and a commercial surcharge.
The short-term corporate risk is divided into 4 "premium categories".
For country categories 0 and 1 premium category I,
for country categories 2 and 3 premium category II,
for country categories 4 and 5 premium category III
and for country categories 6 and 7 premium category IV.

Example of Guarantee Premiums Table

Country Ratings
Rating classification for credit guarantees’ rates:
0 : Advanced economy - no minimum premium rate
1 : Very low risks
2 : Low risks
3 : Relatively low risks
4 : Intermediate risks
5 : Relatively high risks
6 : High risks
7 : Very high risks
Country classification is determined by:
an assessment of the country's ability to meet its external liabilities
expectations of the country's economic development
political stability
the legislative environment
Country classification
influences on:
the level of the guarantee premium
the security requirements

Credit rating agencies
Business Environmental Risk Intelligence (BERI)
Frost and Sullivan (Index WPRF – World Political Risk Forecasts)
Standard & Poor’s Rating Group
Moody’s Investor Services
Political Risk Services: International Country Risk Guide
Coface

Credit Insurance

Structure of credit insurance market
Private insurers
State
Insurance of commercial credits inside the countries
Insurance of short-term export credits (up to 2 years)
short-term political risks
Moderate-terms export credits (2-5 years)
Long-term export credits (more than 5 years)
Reinsurance of large risks
Credit insurance helps company to manage the credit it extends to its customers and protects the against the risks of a customer default.
It allows to improve trade receivables management and support revenue growth

Capital concentration in the European credit insurance market

Commercial insurance companies, operating on the export credit insurance market
Lloyds of London (Robert and Hiscox syndicate) - UK
American international group (AIG) - USA
Unistrat Assurances – France
Gerling Kreditversicherungs AG – Germany
Ingosstrakh - Russia

Export credit scheme
Risks considered by insurer:
Unpaid maturities notified by one or more insureds
Bankruptcy, receivership, liquidation or other winding up of a debtor

Types of credit insurance policies
1. Extraordinary coverage (specific coverage)
Is used when the outstanding balances of a single customer or a few customers represent a serious exposure to a firm
Generally purchased by companies who deal with limited number of customers
2. General coverage policy
Includes protection on all policyholder’s customers with a credit rating as specified in a policy
Each account insured must have a capital and credit rating, which express the net worth of the company and its credit standing
The coverage on each account is determined by a table of ratings, selected by the insured and included in contract
Sales to customers outside of these classifications is at the insured’s own risk.

Stages of insurance

Factors, influencing on the decision about insurance

Credit limit 2
Credit limit 1
Credit limit 3
Credit limit 4
Buyer B
Buyer А
Buyer
C
Buyer D
Sum
insured
Insurance premium in % of turnover
Trade turnover
Setting up the sums insured

3. Financial results became worse
4. Serious declining of financial position
Buyer
Monitoring of contractors enables to make one of the following decisions:
2. Credit rating hasn’t changed
1. Improving of financial results
Corrections of the sums insured
Credit limits are left unchanged
Revision of insurance conditions
Revision of insurance conditions
Increasing the credit limits

Risk analysis of credit portfolio and conditions of insurance
Buyer
Risk class (solvency, financial stability, ratio analysis, market experience)
Insurance rate
Deductable (usually not less than 20%)
Trade turnover

Amount of debt
minus
Sum that was
partially paid
Revenue from
the sales of
returned goods
Debt of buyer
Deductable
Insurance coverage
=
=
Loss calculation scheme:
Insurance coverage calculation
minus

Example of coverage table
(credit limits)

Coinsurance and Loss

Условия:
Поставлен товар на сумму 100 000.00 руб.
Безусловная франшиза-20%
Сумма неоплаченного счета- 50 000.00 руб.
Сумма, полученная Страхователем при помощи Страховщика в течение Периода ожидания- 25 000.00 руб.
Пример расчета Страхового возмещения
Расчет:
Фактическая задолженность: 50000-25000=25000 руб.
Сумма страхового возмещения: 25000-20%=20000 руб.

Dynamics of payments’ delays index by branches of economics (Basis - 100)
(chemical industry)
(mechanical engineering )
(pharmaceutical )
(average on the world )
Source: Sector Analysis, Documentation by Dominique Fruchter - Paris: Coface University, 2007 - с 24

Dynamics of payments’ delays index by branches of economics (Basis - 100)
(average on the world )
(cellulose &paper industry)
(metallurgical)
(electronic equipment)
Source: Sector Analysis, Documentation by Dominique Fruchter - Paris: Coface University, 2007 - с 24

Branch risks by regions and the world countries (according to ratings of Coface)
Source: Sector Analysis, Documentation by Dominique Fruchter - Paris: Coface University, 2007 - с 34
C-
Min risk
Max risk

International investments’ insurance agencies
Multilateral Investments Guaranteeing Agency (MIGA) - a member of the World Bank Group
MIGA Member Countries (168):
Industrialized Countries (23) - Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, Norway, Portugal, Slovenia, Spain, Sweden, Switzerland, United Kingdom, United States
Developing Countries (145)
Source: http://www.miga.org

Functions of MIGA
Political risks insured:
Currency transfer restriction
Expropriation
War and civil disturbance
Breach of contract
MIGA is a multilateral risk mitigator, promoting foreign direct investment into developing countries by:
INSURING investors against political or noncommercial risks

Who eligible for MIGA’s Guarantee Coverage?
New cross-border investments originating in any MIGA member country, destined for any developing member country
New investment contributions associated with the expansion, modernization, or financial restructuring of existing projects
Investment projects must be financially and economically viable, environmentally sound, and consistent with the labor standards and other development objectives of the country hosting the investment

MIGA's Reinsurance Partners (1)

MIGA's Reinsurance Partners (2)

Currency transfer restriction
Coverage protects against:
losses arising from an investor's inability to convert local currency (capital, interest, principal, profits, royalties, or other monetary benefits) into foreign exchange for transfer outside the host country.
insures against excessive delays in acquiring foreign exchange caused by the host government's actions or failure to act. Currency devaluation is not covered.

Expropriation
Coverage offers protection against:
loss of the insured investment as a result of acts by the host government that may reduce or eliminate ownership of, control over, or rights to the insured investment.
also covers partial losses, as well as "creeping expropriation," a series of acts that over time have an expropriatory effect. Bona fide, non-discriminatory measures taken by the host government in the exercise of its legitimate regulatory authority are not considered expropriatory.

Breach of contract
Coverage protects against:
Losses arising from the host government's breach or repudiation of a contractual agreement with the investor.
In the event of such an alleged breach or repudiation, the investor must be able to invoke a dispute resolution mechanism (e.g., arbitration) set out in the underlying contract and obtain an award for damages.
The investor may file for a claim if, after a specified period of time, payment is not received.