Insurers are bracing for a wave of First Brands claims

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Insurers are bracing for a wave of potential claims related to the First Brands Group bankruptcy, as one of Wall Street’s biggest disasters in years ripples through the financial system.

Allianz, Coface and AIG are among the groups that have written policies that protect business partners or investors from losses through their trade credit businesses, according to people familiar with the matter, leaving them exposed to the auto parts maker’s supply chain.

Senior executives at some large credit insurers told the Financial Times they had canceled coverage linked to First Brands before its $12 billion bankruptcy.

A trade credit fund manager said his insurer began reducing its coverage about a year before First Brands collapsed, after discovering payment problems building up at one of the group’s subsidiaries.

“Insurance companies always know first,” the fund manager said.

Allianz, Covis and AIG declined to comment.

Securing invoices that support global trade has become one of the most profitable areas of the insurance market. While suppliers who sell raw materials or tools to large companies have long used insurance to protect them from the risk of not getting paid, credit insurance has evolved into a hedge for financial institutions that lend on invoices.

First Brands relied heavily on invoice financing, selling customer invoices for cash and using outside investors to finance its debt to its suppliers.

Some of First Brands’ largest off-balance sheet invoice financing providers have made heavy use of the product, including Point Bonita Capital, a fund managed by US bank Jefferies that disclosed a $715 million exposure linked to the Ohio-based group.

Point Bonita previously told investors that as of June, 20 percent of its $3 billion total portfolio of bill- and inventory-related debt was “hedged” through credit insurance and similar products.

Evolution Credit Partners, another major creditor to First Brands, has also benefited from credit insurance, according to people familiar with the group’s practices. In 2021, it appointed Kirsten Brown, a veteran of insurance company Coface, as managing director of the company.

Some insurers told the Financial Times they had no “material” exposure to First Brands’ off-balance sheet financing arrangements.

However, claims can escalate into messy legal disputes that take years to resolve. Japan’s Tokio Marine and Australia’s IAG have spent nearly five years fighting a potential multibillion-dollar payout on insurance linked to Greensill Capital, the supply chain finance specialist whose implosion in 2021 sparked a financial scandal.

In the case of First Brands, the Financial Times reported on Thursday that the US Department of Justice had opened an investigation into the company’s collapse. However, the investigation is at an early stage and does not necessarily indicate that any wrongdoing has occurred.

Whether the First Brands debacle turns into another Greensill moment for the insurance industry may depend on the steps insurers take to mitigate their exposure before the $12 billion bankruptcy, as well as their willingness to engage in heated legal disputes over the exact wording of their policies.

Policy wording varies and in some cases there is a high bar to avoid payments. When it comes to fraud — and First Brands was not accused of fraud — many policies can only be voided if the insurance company can prove that the policyholder was aware of the fraudulent acts and did not disclose or falsely file them.

One insurance market professional involved in several of the disputes said some policies would still pay out if a rogue employee made a mistake, citing individual executives who must have made misrepresentations so the policy would not pay out.

The source added that insurance companies paid out large sums following the collapse of the fraudulent dairy group Parmalat in 2003, because they were unable to prove that the banks had any knowledge of the fraud.

However, in recent years payouts have been much lower than other types of insurance. Earnings reports show that trade credit insurers, such as Coface and Atradius, paid about 40 cents for every dollar of premiums collected — less than half the typical 90-cent expense in other business lines such as property and casualty.

Boss Smith, a portfolio manager at BroadRiver Asset Management, said he has been using credit insurance for about a decade and has yet to claim it. He said the First Brands case provided an “important case study” for the insurance product.

“Given the high-profile nature of this bankruptcy, if credit insurance claims are paid without incident, the market will likely gain significant confidence in the product,” Smith said. “If not, many of us will be faced with a troubling data point.”