EXPORT CREDIT INSURANCE CHAPTER 1 INTRDUCTION TO INSURANCE 1.1 MEANING OF INSURANCE The business of insurance is related to the protection of the economic values of the assets. Every asset has a value. The asset would have been created through the efforts of the owner. The asset is valuable to the owner, because he expects to get some benefits from it. The benefit may be an income or some thing else. It is a benefit because it meets some of his needs. In the case of a factory or a cow, the product generated by is sold and income generated. In the case of a motor car, it provides comfort and convenience in transportation. There is no direct income. Every asset is expected to last for a certain period of time during which it will perform. After that, the benefit may not be available. There is a life-time for a machine in a factory or a cow or a motor car. None of 1
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EXPORT CREDIT INSURANCE
CHAPTER 1
INTRDUCTION TO INSURANCE
1.1 MEANING OF INSURANCE
The business of insurance is related to the protection of the
economic values of the assets. Every asset has a value. The asset would
have been created through the efforts of the owner. The asset is valuable
to the owner, because he expects to get some benefits from it. The benefit
may be an income or some thing else. It is a benefit because it meets
some of his needs. In the case of a factory or a cow, the product generated
by is sold and income generated. In the case of a motor car, it provides
comfort and convenience in transportation. There is no direct income.
Every asset is expected to last for a certain period of time during
which it will perform. After that, the benefit may not be available. There
is a life-time for a machine in a factory or a cow or a motor car. None of
they will last forever. The owner is aware of this and he can so
manage his affairs that by the end of that period or life-time, a substitute
is made available. Thus, he makes sure that the value or income is not
lost. However, the asset may get lost earlier. An accident or some other
unfortunate event may destroy it or make it non-functional. In that case,
the owner and those deriving benefits there from, would not have been
ready. There is an adverse or pleasant situation. Insurance is a mechanism
that helps to reduce the effect of such adverse situations.
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1.2 HISTORY OF THE INSURANCE SECTOR
The business of life insurance in India in its existing form started in
India in the year 1818 with the establishment of the Oriental Life
Insurance Company in Calcutta. Some of the important milestones in the
life insurance business in India are:
1912: The Indian Life Assurance Companies Act enacted as the first
statute to regulate the life insurance business.
1928: The Indian Insurance Companies Act enacted to enable the
government to collect statistical information about both life and non-life
insurance businesses.
1938: Earlier legislation consolidated and amended to by the Insurance
Act with the objective of protecting the interests of the insuring public.
1956: 245 Indian and foreign insurers and provident societies taken over
by the central government and nationalized. LIC formed by an Act of
Parliament, viz. LIC Act, 1956, with a capital contribution of Rs. 5 crore
from the Government of India. The General insurance business in India,
on the other hand, can trace its roots to the Triton Insurance Company
Ltd., the first general insurance company established in the year 1850 in
Calcutta by the British.
Some of the important milestones in the general insurance business in
India are:
1907: The Indian Mercantile Insurance Ltd. set up, the first company to
transact
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All classes of general insurance business.
1957: General Insurance Council, a wing of the Insurance Association of
India, frames a code of conduct for ensuring fair conduct and sound
business practices.
1968: The Insurance Act amended to regulate investments and set
minimum solvency margins and the Tariff Advisory Committee set up.
1972: The General Insurance Business (Nationalization) Act, 1972
nationalized the general insurance business in India with effect from 1st
January 1973. 107 insurers amalgamated and grouped into four
companies’ viz. the National Insurance Company Ltd., the New India
Assurance Company Ltd., the Oriental Insurance Company Ltd. and the
United India Insurance Company Ltd. GIC incorporated as a company.
2000: with effect from Dec'2000, these subsidiaries have been de-linked
from the parent company and made as independent insurance companies).
All the above four subsidiaries of GIC operate all over the country
competing with one another and underwriting various classes of general
insurance business except for aviation insurance of national airlines and
crop insurance which is handled by the GIC.
Besides the domestic market, the industry is presently operating in
17 countries directly through branches or agencies and in 14 countries
through subsidiary and associate companies.
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CHAPTER 2
INSURANCE SECTOR REFORMS
The Malhotra Committee Report
In 1993, Malhotra Committee, headed by former Finance Secretary
and RBI Governor R. N. Malhotra, was formed to evaluate the Indian
insurance industry and recommend its future direction. In 1994, the
committee submitted the report and gave the following recommendations:
2.1 Structure
Government stake in the insurance Companies to be brought down to
50%.
Government should take over the holdings of GIC and its
subsidiaries so that these subsidiaries can act as independent
corporations.
All the insurance companies should be given greater freedom to
operate.
2.2 Competition
Private Companies with a minimum paid up capital of Rs.1bn should
be allowed to enter the industry.
No Company should deal in both Life and General Insurance
through a single entity.
Foreign companies may be allowed to enter the industry in
collaboration with the domestic companies.
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Postal Life Insurance should be allowed to operate in the rural
market. Only one State Level Life Insurance Company should be
allowed to operate in each state.
Regulatory Body.
The Insurance Act should be changed.
An Insurance Regulatory body should be set up.
Controller of Insurance (Currently a part from the Finance Ministry)
should be made independent.
2.3 Investments
Mandatory Investments of LIC Life Fund in government securities
to be reduced from 75% to 50%
GIC and its subsidiaries are not to hold more than 5% in any
company (There current holdings to be brought down to this level
over a period of time)
2.4 Customer Service
LIC should pay interest on delays in payments beyond 30 days
Insurance companies must be encouraged to set up unit linked
pension plans. Computerization of operations and updating of
technology to be carried out in the insurance industry
Overall, the committee strongly felt that in order to improve the
customer services and increase the coverage of the insurance
industry should be opened up to competition.
But at the same time, the committee felt the need to exercise caution
as any failure on the part of new players could ruin the public
confidence in the industry.
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Hence, it was decided to allow competition in a limited way by
stipulating the minimum capital requirement of Rs.1 billion. This
amount is not very high for foreign firms, as it translates to only about
US$25 million. Further, to date it is unclear whether equity should be
payable in one go or should be brought in as installments. Also, the
foreign equity participation was to be restricted to only 40%.
The committee felt the need to provide greater autonomy to
insurance companies in order to improve their performance and enable
them to act as independent companies with economic motives. For this
purpose, it had proposed setting up an independent regulatory body.
2.5 Scenario after Malhotra Committee Report
The Government of India liberalized the insurance sector in March
2000 with the passage of the Insurance Regulatory and Development
Authority (IRDA) Bill, lifting all entry restrictions for private players and
allowing foreign players to enter the market with some limits on direct
foreign ownership. Under the current guidelines, there is a 26 percent
equity cap for foreign partners in an insurance company. There is a
proposal to increase this limit to 49 percent.
The opening up of the sector is likely to lead to greater spread and
deepening of insurance in India and this may also include restructuring
and revitalizing of the public sector companies. In the private sector 15
life insurance companies have been registered. A host of private
Insurance companies operating in life segments have started selling their
insurance policies since 2001.
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CHAPTER 3
FUNCTIONS OF INSURANCE
3.1 Primary Functions
1. Provide protection: - Insurance cannot check the happening of the
risk, but can provide for the losses of risk.
2. Collective bearing of risk: - Insurance is a device to share the
financial losses of few among many others.
3. Assessment of risk: - Insurance determine the probable volume of
risk by evaluating various factors that give rise to risk
4. Provide certainty: - Insurance is a device, which helps to change
from uncertainty to certainty.
3.2 Secondary Functions
1. Prevention of losses: - Insurance cautions businessman and
individuals to adopt suitable device to prevent unfortunate
consequences of risk by observing safety instructions.
2. Small capital to cover large risks: - Insurance relives the
businessman from security investment, by paying small amount of
insurance against larger risks and uncertainty.
3. Contributes towards development of larger industries.
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Chapter4
CREDIT RISK
4.1 MEANING OF CREDIT RISK?
Credit risk is the risk of loss due to a debtor's non-payment of a loan or
other line of credit (either the principal or interest (coupon) or both)
4.2 Faced by lenders to consumers
Most lenders employ their own models (credit scorecards) to rank
potential and existing customers according to risk, and then apply
appropriate strategies. With products such as unsecured personal loans or
mortgages, lenders charge a higher price for higher risk customers and
vice versa. With revolving products such as credit cards and overdrafts,
risk is controlled through the setting of credit limits. Some products also
require security, most commonly in the form of property.
4.3 Faced by lenders to business
Lenders will trade off the cost/benefits of a loan according to its risks and
the interest charged. But interest rates are not the only method to
compensate for risk. Protective covenants are written into loan
agreements that allow the lender some controls. These covenants may:
Limit the borrower's ability to weaken their balance sheet
voluntarily e.g., by buying back shares, or paying dividends, or
borrowing further.
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Allow for monitoring the debt requiring audits, and monthly
reports
Allow the lender to decide when he can recall the loan based on
specific events or when financial ratios like debt/equity, or interest
coverage deteriorate.
A recent innovation to protect lenders and bond holders from the
danger of default are credit derivatives, most commonly in the form of a
credit default swap. These financial contracts allow companies to buy
protection against defaults from a third party, the protection seller. The
protection seller receives a periodic fee (the credit spread) as
compensation for the risk it takes, and in return it agrees to buy the debt
should a credit event ("default") occur.
Credit scoring models also form part of the framework for which a
banks or lending institutions grant credit to clients. For corporate and
commercial borrowers, these models generally have qualitative and
quantitative sections outlining various aspects of the risk including, but
not limited to, operating experience, management expertise, asset quality,
and leverage and liquidity ratios, respectively. Once this information has
been fully reviewed by credit officers and credit committees, the lender
provides the funds subject to the terms and conditions presented within
the contact (as outlined above).
4.4 Faced by business
Companies carry credit risk when, for example, they do not
demand up-front cash payment for products or services. By delivering the
product or service first and billing the customer later - if it's a business
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customer the terms may be quoted as net 30 - the company is carrying a
risk between the delivery and payment.
Significant resources and sophisticated programs are used to
analyze and manage risk. Some companies run a credit risk department
whose job is to assess the financial health of their customers, and extend
credit (or not) accordingly. They may use in house programs to advice on
avoiding, reducing and transferring risk. They also use third party
provided intelligence. Companies like Standard & Poor's, Moody's, Fitch
Ratings, and Dun and Bradstreet provide such information for a fee.
For example, a distributor selling its products to a troubled retailer
may attempt to lessen credit risk by tightening payment terms to "net 15",
or by actually selling fewer products on credit to the retailer, or even
cutting off credit entirely, and demanding payment in advance. Such
strategies impact sales volume but reduce exposure to credit risk and
subsequent payment defaults.
Credit risk is not really manageable for very small companies (i.e.,
those with only one or two customers). This makes these companies very
vulnerable to defaults, or even payment delays by their customers.
The use of a collection agency is not really a tool to manage credit
risk; rather, it is an extreme measure closer to a write down in that the
creditor expects a below-agreed return after the collection agency takes
its share (if it is able to get anything at all).
4.5 Faced by individuals
Consumers may face credit risk in a direct form as depositors at
banks or as investors/lenders. They may also face credit risk when
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entering into standard commercial transactions by providing a deposit to
their counterparty, e.g., for a large purchase or a real estate rental.
Employees of any firm also depend on the firm's ability to pay wages,
and are exposed to the credit risk of their employer. In some cases,
governments recognize that an individual's capacity to evaluate credit risk
may be limited, and the risk may reduce economic efficiency;
governments may enact various legal measures or mechanisms with the
intention of protecting consumers against some of these risks. Bank
deposits, notably, are insured in many countries (to some maximum
amount) for individuals, effectively limiting their credit risk to banks and
increasing their willingness to use the banking system.
4.6 Counterparty risk
Counterparty risk, otherwise known as default risk, is the risk that
an organization does not pay out on a credit derivative, credit default
swap, credit insurance contract, or other trade or transaction when it is
supposed to. Even organizations who think that they have hedged their
bets by buying credit insurance of some sort still face the risk that the
insurer will be unable to pay, either due to temporary liquidity issues or
longer term static issues.
Large insurers are counterparties to many transactions, and thus
this is the kind of risk that prompts financial regulators to act, e.g., the
bailout of insurer AIG. On the methodological side, counterparty risk can
be affected by wrong way risk, namely the risk that different risk factors
be correlated in the most harmful direction. Including correlation between
the portfolio risk factors and the counterparty default into the
methodology is not trivial; see for example Brigo and Pallavicini
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4.7 Sovereign risk
Sovereign risk is the risk of a government becoming unwilling or
unable to meet its loan obligations, or reneging on loans it guarantees.
The existence of sovereign risk means that creditors should take a two-
stage decision process when deciding to lend to a firm based in a foreign
country. Firstly one should consider the sovereign risk quality of the
country and then consider the firm's credit quality.
Five macroeconomic variables that affect the probability of sovereign
debt rescheduling are:
Debt service ratio
Import ratio
Investment ratio
Variance of export revenue
Domestic money supply growth
The probability of rescheduling is an increasing function of debt
service ratio, import ratio, variance of export revenue and domestic
money supply growth. Frenkel, Karmann and Scholtens also argue that
the likelihood of rescheduling is a decreasing function of investment ratio
due to future economic productivity gains. Saunders argues that
rescheduling can become more likely if the investment ratio rises as the
foreign country could become less dependent on its external creditors and
so be less concerned about receiving credit from these
countries/investors.
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Chapter 5
CREDIT MANAGEMENT TOOLS
5.1 MEANING
There is no clear definition of what credit management is. It is
usually regarded as assuring that buyers pay on time, credit costs are kept
low, and poor debts are managed in such a manner that payment is
received without damaging the relationship with that buyer. A credit
insurance company does all that. Either directly or in conjunction with a
company’s credit department. An approved credit management policy can
offer assurances to a financing bank, which may facilitate financing.
Suppliers that deliver goods and/or services on credit will have to
manage this credit risk to ensure that payment is received on time.
Several tools come to the aid of today's credit manager. These can be
used as additional security to existing credit management procedures. If
no procedures are in place, these tools can assist in setting these up.
5.2Buyer Information One of the most important credit management
tools is reliable up to date buyer information. A supplier only sees one
side of his buyer. Independent information is essential for efficient credit
management.
5.3 Country Reports A buyer may be sound, but the country he is in
may be experiencing severe problems. Country reports detect trends and
alert exporters before serious problems arise in a particular country.
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5.4 Credit Management Suppliers need to manage their outstanding
receivables. This can be done through complex financial solutions.
Alternatively companies can insure against bad debts, obtain detailed
market intelligence, implement ledger management, factor, or seek
professional help in recovering debts.
5.5 Debt Collection Pro-active debt collection procedure has a high
success rate. A buyer may be in difficulty, but the supplier can still
control payments, provided professional debt collection procedures are in
place.
5.6 Factoring
By transferring receivables, this financial technique makes it possible for
companies to fund all or some of their invoices and thus cover their
operating capital requirements; obtain cover against their customers'
insolvency; obtain payment of receivables with shorter payment terms;
obtain information on their customers' financial soundness; outsource or
vary their administrative expenses; and optimize current assets and
liabilities.
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Chapter 6
EXPORT CREDIT INSURANCE
6.1 MEANING OF EXPORT CREDIT INSURANCE
Export credit is providing pre-shipment and post-shipment credit
either in Indian rupees or in foreign currency to an exporter. The credit is
given for short term i.e. up to 6 months, medium/ long term which
extends more than 6 months according to the eligibility of the products
and projects. Usually medium/ long term export credit is given after
inspecting the supplier's credits.
Export credit insurance protects the exporter from the consequences of
the payment risks due to the far-reaching political and economic changes.
Outbreak of war or civil war might block or delay the payment for goods
already exported. Coup or an insurrection in the importing country may
also bring the same result. In India export credit insurance in provided by
the Export Credit Guarantee Corporation (ECGC).
6.2 EXPORT CREDIT INSURANCE Functions
Formulate underwriting policy
Evaluate export projects
Assess credit risks
Structure securities to mitigate risks
Manage insurance portfolio
Endeavour to diversify portfolio
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6.3 EXPORT CREDIT INSURANCE : Strategic Goals
1) Focusing on Customers
Provide high quality service to allclients including