Unintended Consequences of Supplier Credit Insurance

Reported News:

The stationery chain Paperchase has come under mounting pressure after one of its main credit insurers reduced cover after a slump in profits.

Euler Hermes has refused to cover new contracts with Paperchase’s suppliers, although the retailer’s existing agreements with suppliers are unaffected.

The move follows a similar row over insurance cover at the struggling department store chain Debenhams, which has fought off claims that it is about to go bust after it was refused cover for new contracts. A withdrawal or reduction in cover can mean that suppliers demand payment upfront, putting a strain on cash reserves.

In September 2018, one of Paperchase's credit insurers reduced supplier insurance cover after a slump in Paperchase's profits.

The purpose of supplier insurance cover is to help Paperchase (or any other company) to get goods on credit rather than paying cash up front.

The insurance reassures suppliers that if Paperchase doesn't pay, then the insurer with its deep pockets will pick up the tab.

When insurance cover is reduced or withdrawn, suppliers are likely insist on payment up front or to reduce what they will supply on credit.

That puts more strain on Paperchase's cash, which doesn't help if it has already had a slump in profits.

It's a perfect storm, a vicious circle, but the fact that the situation exists at all is because of a problem built in to supplier insurance cover.

The inclination for Paperchase to take risks and for suppliers to take risks must be encouraged by the knowledge that someone else will pick up the tab if all else fails.

That masks bad management, maybe for months or a year, until the collapse comes.

So, how does an insurer decide whether and how much to insure a company's credit default risk.

It should do it the same way that a bank decides (RBS excepted) whether to lend to a company or extend its overdraft.

If the bank does its job properly then it spends time scrutinising the company, getting to know it, its customers, its workforce, its plant and machinery, and its management.

I wonder whether insurance companies do that? In this fast-moving world, I cannot imagine they do.

And if they don't, then companies like Paperchase can trade for months, maybe a year, on bad management and sliding profits.

Meanwhile, suppliers keeping on supplying them, cushioned from reality by the thought of Paperchase's supplier insurance cover.

It's a recipe for turning a problem into a bigger problem.