Our new Markets & Risks section kicks off with an in-depth look at small businesses


Britain’s small and medium-sized enterprises (SMEs) know they’re in bad shape. But nobody can be sure how much worse things will get – or what the survival rate will be.

Brokers and insurers who rely on the SME market insist everything will be OK. Those contacted by Insurance Times admit they are seeing some negative effects on SME markets but insist that, so far, the impact has been minimal.

The real worry is about what lies ahead. According to the Federation of Small Businesses (FSB), 40 businesses are closing every day because of the credit crunch. The pace of closures is on the increase and the problem is confounded by a decline in start-ups.

SMEs have been suffering from hikes in interest rates for loans and overdrafts, as well as poor treatment from banks despite good credit histories. It’s also harder to make loan repayments because of non-payment from their own customers.

The FSB says almost half of its 215,000 members have found it harder to get finance in the past year. And more than half of its members say it’s taking longer to receive full payments from invoicing. SMEs are owed £18.6bn in outstanding payments and the average sum owed is £30,000. Ten per cent of all business failures are due to non-payment and, according to a survey conducted by Bacs in January, a third of companies say they could go bust if hit with overdue invoices of just £20,000.

The consensus is that construction companies and related businesses have been the worst hit so far when it comes to insurance demand. New building work is down, so there has been a decline in all areas of construction cover.

Fleet insurers are also starting to feel the pinch, while directors’ and officers’ (D&O) insurers are expected to take a hit from increased claims.

Insurers themselves are limiting their exposure to some business areas, such as professional indemnity insurance for solicitors, due to rising claims sparked by the economic downturn. Trade credit insurers have also become more selective.

Third-quarter trade credit figures, released last month by the ABI, showed the number of claims had soared to 6,805, up 34% from 5,084 in the same period of 2007 (see charts, overleaf).

But there’s no guarantee about which businesses will get cover. Last month, a spokesman for Atradius confirmed that the company had pulled cover from 12,000 businesses – about 7% of its book – within just two weeks.

Then there’s the issue of banks not passing on interest rate cuts and refusing new lending.

All in all, the climate is the worst for SMEs in recent memory. Last week’s pre-Budget report delivered a lifeline to SMEs, but will it be enough of a remedy?

The worst affected sectors

The construction industry, which made 31,000 workers redundant in the third quarter of this year (see table), has become the sorest spot for the insurance industry. Housing construction has been worst hit, but commercial construction has also performed badly.

According to the UK Statistics Authority, construction began on about 22,200 homes in the three months from July to September.

This seasonally adjusted figure is 33% down on the previous quarter and 48% lower than the same period last year.

“On our tradesman business we’ve seen quite a big downturn in premium, which we put down substantially to the fact that there’s a lot less building work going on than there has been in recent years,” says Malcolm Smith, commercial insurances manager at Groupama. The insurer’s tradesman business, which has gross written premium (GWP) of £20m, has dropped off by about a third in the past four months.

Smith says the company’s other two main areas, commercial combined and residential let, have been better sheltered.

“Residential let, or buy-to-let, still actually seems to be quite buoyant for insurers,” he says. “There’s more and more people going to be renting houses now, rather than buying.

I think there are some owners of buy-to-let houses who may have over-extended themselves but, in the main, the feedback we’ve had is the market is still relatively strong.”

Recession-linked arson is another area of concern for insurers (see Claims, page 34). The number of claims on Groupama’s shopkeepers account has risen; its biggest SME arson claim so far this year was about £350,000. This is relatively small, as is the case for most SME claims because the buildings are small. But these claims add up.

Angel Underwriting, meanwhile, is concerned that D&O claims will also rise significantly.

Mark Shreeve, its chief executive, says recent high-profile casualties including Lehman Brothers, Freddie Mac and Fannie Mae – not to mention, the woes of AIG and the impending recession – will have a big impact on the D&O market on both sides of the Atlantic.

“Insurers that provided cover for the directors and officers of failed companies are now bracing themselves for what could prove to be an avalanche of claims from disgruntled shareholders, creditors and government agencies now investigating the events of the past months,” says Shreeve.

Another worry is that SMEs desperate to save money will cut back on their insurance cover – which could leave them dangerously exposed.

Biba wrote to business minister Baroness Vadera in October to draw attention to the issue and was still waiting for a response when Insurance Times went to press.

Graeme Trudgill, Biba’s technical and corporate affairs executive, says: “The message we’re sending is there’s a fear that SMEs will try to cut back on insurance. They need to be very careful because you might cut back on something that’s vital.”

By law, all businesses are required to insure against certain kinds of risk, such as employers’ liability.

But SMEs could decide to scrap other covers such as business interruption, consequential loss or personal accident, and then get stung by big claims. Biba has already noticed some SMEs scaling back on fleet insurance, with some downgrading from comprehensive cover to third-party liability.

“We’ve not seen brokerages at this point coming under real pressure or threat. The number of business closures is actually quite low. I don’t think we’ve seen how bad it could get.

Mike Crane, ABC

Policyholders could also unwittingly fail to meet policy conditions such as security, by stopping payment on burglar alarm bills. Or, they could decide to cut back on their sums insured to the point where they would only get a proportional payout.

Mike Crane, head of broker underwriting for ABC Insurance, the broker distribution arm for LV=, warns: “If your margins are getting tighter, now’s the time you’ve got to make sure you have the right cover and not cut back on it."

He adds that policyholders are more likely to shop around for better deals. So brokers will have to work extra hard for renewals.

Crane says ABC’s broker business remains healthy. “We’ve not seen brokerages at this point coming under real pressure or threat. The number of business closures is actually quite low. I don’t think we’ve seen how bad it could get.

“My concern is despite all the nice words about banks improving lending and reducing interest rates, it’s not feeding through in terms of increasing business confidence.”

Unfortunately, it’s not only SME clients that brokers need to worry about. Many brokers are small businesses themselves.

Groupama’s Smith says: “The tradesman business is suffering so brokers who specialise in that area – and there are quite a few – are struggling to grow their business.”

But Smith says he hasn’t seen any brokers go into the red yet. Rather, these brokers are experiencing slower growth and are trying to improve their position before they fall behind. Many of the 900 brokers on Groupama’s agency base – including 160 that are mainly provincial and independent brokers with SME clients – are using Groupama’s marketing training in order to generate more business.

The pre-budget report

SMEs were thrown a major lifeline in last week’s pre-Budget report, in the form of the £1bn Small Business Finance Scheme to be launched early next year.

The scheme is a temporary measure that will make up to £1bn of government funds available through the UK’s nine regional development agencies (RDAs).

The FSB said the government should have been tougher on banks, but conceded that the £1bn scheme would allow SMEs to access £1,000 to £1m of financing without having to ask the banks.

“There will be some competition for the banks with the £1bn fund, which will be distributed through RDAs,” said an FSB spokesman. “If it’s successful, it could ensure the government allocates more money to the fund.

“The banks will hopefully get jealous because they don’t like it when people go elsewhere for money.

“If it works, we’ll look at lobbying the government to look at other avenues where money for small businesses could be made available, such as post offices and town halls.”

The spokesman added that banks could also face more pressure if the Financial Ombudsman Service gets more powers – something the FSB will continue to push for.

The pre-Budget report also included good news for SMEs on tax. The planned increase in corporation tax to 22% for small firms was postponed until after the 2009-10 tax year, Vat was cut from 17.5% to 15% from Monday and businesses have been granted a temporary extension from one to three years on up to £50,000 on “carry-backs”. This enables businesses to carry back a loss to set against profits of the previous year, resulting in a tax repayment. Struggling businesses will also be able to spread their tax payments throughout the year with a temporary new HM Revenue & Customs timetable.

The FSB was less pleased with the Vat reduction, saying it would be difficult and costly for some SMEs to implement so quickly. The ABI backed the Vat cut.

The headline rate of corporation tax still stands at 28%, however. In its Pre-Budget Report 2008: Making the Country Safe for Business, the Institute of Directors called for the headline rate to be reduced to 24%, which it said would also have a knock-on effect for small business.

“If in the next few years it was possible to make a further reduction to 22%, the small companies rate would disappear as a separate rate, removing all the complexities of identifying associated companies and of computing marginal relief. “Any further reductions below 22% would allow small companies to regain the benefit which they have lost through recent increase in the small companies rate,” the report said.

A question of confidence

ABC’s Mike Crane believes SMEs just need to get their confidence back.

“You’ve got the double whammy of banks being quite reluctant to lend to businesses, and businesses that are quite reluctant to take on new debt if they don’t have it at the moment.

“A friend of mine runs an engineering business. He doesn’t have a lot of debt in the business and says now is not a time he feels comfortable expanding.”

ABC does not have much exposure in tradesmen or construction – its speciality is general business such as manufacturers and retail. But Crane says he has seen SMEs across the board tighten their spending. He believes insurers can play a part in supporting SME growth through the credit crunch, while SMEs can ensure they have proper protection.

Some companies have been taking advantage of the climate to introduce new products. Aon Risk Services, for example, recently launched Aon Flex, which ensures a company is not left without cover if its existing insurer goes bust.

Meanwhile, Matthew Donaldson, group director of BGL Group – owner of price comparison site, Comparethemarket.com – believes aggregators stand to gain during the slump.

“Small to medium-sized enterprises will, like everyone else, be looking to reduce their costs, which is why we are offering price comparisons in other areas such as business insurance products.”

It remains to be seen how SME insurers and brokers will fare. The true effects of the recession will not be felt until well into 2009.