# Commission Decision of 23 November 2011 on State aid No C 28/10 implemented by Portugal for the short-term export credit insurance scheme (notified under document C(2011) 7756) (Only the Portuguese text is authentic) (Text with EEA relevance) (2014/532/EU), Annex: PRICING OF TOP-UP TRADE INSURANCE COVER

Extent: E+W+S+N.I.

Premiums for insurance cover are set in such a way as to cover at least the expected loss and the administrative costs. Therefore the minimum premium acceptable for a sound economic operator can be expressed as follows:
PR = Pr ob × ExpectedLoss + adm = Pr ob × ExposureAtDefault − Recov eryAmount + adm , where:
PR premium charged by the private insurers on the stand-alone basis;
Prob probability of the insured event;
Recovery Amount expected amount of recovery, based on historical market data;
adm administrative costs. For the sake of simplicity, in this analysis administrative costs are assumed to be equal to zero (). This assumption does not affect the outcome of the analysis because administrative costs are not a decisive component for setting the premium level. If reliable data on administrative costs are available, the variable can easily be included in the analysis.
(ExposureAtDefault — the maximum loss amount to which an institution would be exposed in case of the default of its counterpart.)
In the following, the subscript ‘0’ designates a variable in the absence of (or prior to) the State intervention, and the subscript ‘S’ designates a variable with the State intervention.
From the formula above, it can be seen that:
PR S PR 0 = Pr ob S Exposure S − Recov eryAmount S Pr ob 0 Exposure 0 − Recov eryAmount 0
By definition:
Recov eryRate = Recov eryAmount Exposure
or Recov eryRate × Exposure = Recove ryAmount
The expression is transformed as follows:
PR S PR 0 = Pr ob S × Exposure S 1 − Recov eryRate S Pr ob 0 × Exposure 0 1 − Recov eryRate 0
A feature of the measure under scrutiny is that the cover under the scheme is at most equal to or lower than the cover provided by the private (base) insurer in the absence of State aid (that is, that the State supported cover is at most equal to the cover provided by the private insurer). Assuming for the moment that the State supported cover is exactly equal to the cover provided by the private insurer, the following relation results: Exposição S = 2 × Exposição 0 .
In that case the expression is transformed as follows:
PR S 2 PR 0 . = Pr ob S 1 − Recov eryRate S Pr ob 0 1 − Recov eryRate 0
The consequences of what is known in the industry as ‘over-crediting’ on the correct pricing of a trade insurance cover are explained below. Over-crediting is observed both at the level of the probability of default and at the level of the recovery rate.
The probability of default increases with the trading activity of the buyer. Trade credit and bank loans are imperfect substitutes: in particular, both can be used to expand the activity of the buyer/borrower. Therefore, as in the case of bank loans, increased trade credit creates a risk of over-crediting, i.e. the buyer expands his activity beyond what is economically efficient. In the terms of the formulas presented, over-crediting can be expressed as:
ProbS Prob 0
That situation would in particular arise in cases where the exporter is the main supplier of the buyer. In that case the economic activity of the buyer increases proportionately to the trade transaction concluded with the insurer exporter and thereby increases proportionately to the amount of credit cover granted.
Owing to the increase in credit exposure, the amount to be recovered also increases. However, given that the recoverable amount depends on the hypothetical liquidation proceeds, this theoretical recoverable amount is capped by the amount of the assets that the buyer (or the liquidation administrator) can sell to cover the trade credit liability and, as the amount of assets is finite, the recovery rate would increase less than proportionately to the increase of credit cover.
Recov eryRate S = Recov eryRate 0 × α , where:
0,5 ≤ α ≤ 1 (α = 0,5, if the recovery amount does not increase at all where the exporter is granted the State's top-up for a transaction with a certain buyer; α = 1 in the theoretical case where the recovery amount increases at the same pace as the total credit limit received by the exporter for the transaction with a certain buyer.)
Given the above, it can be concluded that PRS 2PR 0
Therefore, the premium to be paid on the State cover is higher than the premium paid to the private insurer for the initial cover.
A premium of 110 % of the premium paid for the initial cover can be considered to factor in to an adequate extent the increase in the probability of default and the decrease in the recovery rate. Such level of premium would be consistent with the pricing in the market. Under approved export credit schemes, the increases in premia from one category of risk to another were in the range of 25-50 %.
If, ExposureS 2 × Exposure 0, PRS decreases proportionally (but is always higher than PR 0). In order to take that factor into account, recital 93 of the Decision envisages quantification of the amount to be recovered in each transaction as the amount charged by the State multiplied by 5/6, based on the following reasoning. In each transaction the State charges 60 % of the rate charged by the private insurer, whereas the market price would have been 110 % of the rate charged by the private insurer. Therefore, the market premium is calculated by dividing the premium effectively paid to the State by 60 % and multiplying it by 110 %. From that premium the amount already paid to the State should be subtracted in order to arrive at the amount to be recovered.
Pr emiumPaid × 110 % 60 % − Pr emiumPaid = Pr emiumPaid 110 % 60 % − 1 = Pr emiumPaid × 5 6

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Source: https://www.legislation.gov.uk/eudn/2014/532/annex (the official version)
Page: https://openlegislation.uk/eu-decision-2014-532/annex
Contains public sector information licensed under the Open Government Licence v3.0. Source: legislation.gov.uk, The National Archives.