16 Jan Carillion Contagion
There has understandably been a great deal of press around Carillion and the loss of jobs. In this blog post, I want to explore a little about how that comes about via a chain of events and also how it could be mitigated. The knock-on effect could be disastrous. Let’s take an example. If a company has £800k outstanding with Carillion (let’s assume zero recovery) that creditor might have a further £500k+ outstanding with sub-contractors related to that one contract with Carillion. It takes a fairly robust company to withstand that kind of stress. If they default many of those sub-contractors will also have no option but to default on their own commitments.
There has been a lot of noise about trade credit insurers pulling cover on certain names prior to this default in construction but also retail (New Look and Maplins for example). The reason for this is that the concentration of risk for the insurers has become too great. The exposures we are talking about are from large corporates with millions outstanding and, let’s be clear, they are covered for the majority of their exposure. The smaller contractors do not have such protection either directly or indirectly. This means that contagion from Carillion could be catastrophic. In some respects it is more important that the smaller companies have cover in place as they are less able to withstand those sorts of losses. What we have is a potential systemic risk.
Contractors should take out insurance against their employer becoming insolvent. In reality, very few do, largely because it is not readily available. Working as a contractor through a limited company has many benefits but you do not get the same rights as employees in an insolvency. Employee salaries are paid before unsecured creditors and shareholders so you are further back in the queue. Those lending to those contractors certainly should insist on insurance. While difficult to enforce the sub-contractors themselves should insist their employer takes out cover or perhaps discount their services as a result of such securities. The reality is that very few consider these risks as being relevant to them.
Why do small businesses not have this protection? Firstly they cannot afford the premiums demanded for whole turnover. Secondly it is not even offered for small turnovers. For most they don’t need whole turnover cover or at least they can’t afford it. Sometimes they have a high concentration to a single debtor but only for a fraction of the year or as a one-off. The existing products simply do not fit. This is where Nimbla comes in.