ART adds weight to insurance guarantees

Since insurance guarantees are closely related to credit risk, it will come as no surprise that the current credit crunch has taken its toll on the availability of these facilities. And this at a time when, with construction for the 2010 World Cup in full swing, the local demand for guarantees of various kinds is at an all time high.

Thanks to the global economic climate, and the resulting decrease in the appetite for taking credit risk, the conventional route for providing these guarantees has become very difficult. As little as a year ago, guarantees were freely available but, in just 12 months, the ability of traditional providers (banks and conventional insurers) has shrunk significantly. And, not only has capacity decreased, costs have soared and corporates looking to use traditional providers’ guarantee facilities can, in many instances, expect to pay two to three times more.

The parties most affected by the situation are those seeking performance guarantees in the construction industry and customs and excise guarantees, and with 2010 deadlines looming, they don’t have time to shop around.

And it’s not only 2010 that is creating demand in the guarantee market: there is also ongoing demand for mining rehabilitation guarantees and utility guarantees. The latter is big business; with power becoming an increasingly scarce resource in South Africa, Eskom and local municipalities are demanding bigger guarantees to cover monthly usage and minimum demand contracts. 

Unfortunately, there is going to be no short-term resolution for the problem of little capacity and high prices for insurance guarantees. When reinsurance treaties are renewed in December 2009, further shrinkage of availability and even higher prices are expected.

The current economic downturn has even led some government entities to question the validity and financial security of guarantees issued by the private sector and the insurance industry is currently in discussion with National Treasury, the Financial Services Board and the Department of Minerals and Energy (with regard to mining rehabilitation guarantees), to reassure them that guarantees remain a valuable – and credible – tool, which the industry still has the capacity and appetite for.

It is expected that, in future, much of that capacity and appetite will reside in the alternative risk transfer (ART) market. Corporates that already own ART facilities have, in effect, ‘established their credentials’ proving that they are willing to risk their own money and able to manage their risks effectively. They can now use the capacity that has been built up in their ART facilities to issue guarantees and, as is always the case with ART, because there is a risk sharing element, these corporates will find it easier to attract reinsurers, who are increasingly looking to enter into shared risk agreements.

With more and more guarantee providers requiring some form of collateral from the insured, it is envisaged that, in future, more corporates will choose to house this collateral in ART facilities. All of this bodes well for the local ART market and could plant the seeds for corporates to house even more of their risks in ART facilities, as they experience the benefits of shared risk and reward.

For further information please contact:
Herman Schoeman, MD of Guardrisk
Telephone: 011 669-1001

Prepared  by:
Melanie Davis, PR@Work
Telephone: 011 615-3309 / 083 225 7450