As economic conditions improve, trade credit insurance is giving companies confidence when doing business with new customers or entering new markets. But it’s also easy for companies to forget to insure the accounts receivable asset on their balance sheet.
Chris Doubé, CEO of Australia and New Zealand for credit insurance firm Euler Hermes, says typically between 30 per cent and 40 per cent of a business’s asset base is tied up in accounts receivable. But often this risk is not managed.
“A lot of businesses manage much smaller risks within the balance sheet, such as theft or fire but they don’t manage the biggest asset within the balance sheet. But a bad debt can ruin a business, particularly for small- and medium-sized firms,” says Doubé.
“We've paid claims that have meant the business has been able to keep the doors open. That shows why credit insurance is so important,” he adds.
John Sutherland, QBE’s general manager, credit and surety, agrees credit insurance is important for a number of reasons. Appropriate catastrophe cover is one.
“Catastrophe cover is important where one of the client’s largest debtors becomes insolvent while owing hundreds of thousands of dollars,” says Sutherland.
“Credit insurance is also important when turnover grows. It means businesses can increase credit limits for existing customers and attract new ones. It gives policyholders information to make a more informed decision on a buyer’s payment patterns,” he adds.
Additionally, he says financiers may feel more comfortable lending money to a business with trade credit protection.
Mark Hoppe, managing director of trade credit specialists Atradius, says credit insurance allows a business to sell with confidence. “It allows the company to grow, enter new markets or start exporting. Many of our clients have never made a claim against their policy, they use the insurance as comfort to explore new markets.”
Whole of turnover or portfolio cover is the most common type of trade credit insurance cover.
“The policy can cover your entire debtor book above the policy deductible. It may cover domestic transactions, export debtors and political risk. Selective risk policies may cover a handful of large debtors or even a single account,” Sutherland explains.
Kirk Cheesman, managing director of insurance brokerage Trade Credit Solutions, adds there are also ways to share risk. “This can be through the level of excess, qualifying losses or even a large first loss level prior to claiming on a policy.”
There are also options for multi-country, regional and global policies. “We can write policies for clients with operations in Australia, Asia, Europe or across the globe,” says Graham Crozier, chief executive of credit insurance specialists Coface.
Another approach is for a business to insure their top 10 or 20 clients. “Or they could insure all accounts over $100,000. Or the business might insure a single, large debtor with which a company has just started trading,” Doubé says.
The right cover depends on the client’s business. “Some clients have a large and varied debtor book which should all be insured. Others may have a couple of export clients they consider higher risk they may wish to insure. Generally, the more they insure, the better the pricing,” says Hoppe.
The right cover can also depend on whether the business has taken out credit insurance in the past. If it already has a credit policy in place it will probably have a better idea about the type of policy required compared to a business that has never taken out this type of cover before.
Says Doubé: “We look at the worst-case scenario for the business, and explore what would happen if one of the its top ten clients failed. It's about understanding the level of risk share the client can handle.”
Features and benefits
Trade credit insurance has changed considerably in recent years as the market has responded to client needs.
“We now have a collection offering,” says Doubé. “We can also engage early with the debtor to manage the receivable, which is particularly attractive for companies that can’t manage this internally.”
He says this has become particularly popular for exporters entering a market in which they don't know local debt collection practices and customs. “We have a global network where we either collect the debt ourselves or have partners who do it for us.”
Selecting the right policy
Cheesman says with so many variables, using a specialist credit insurance broker to assess risk will help a business make the right policy choice.
“A broker will take into account factors such as your spread of customer risk, size of credit risks, the terms of trade you offer customers, past loss history and industry trade requirements,” he says.
To determine the right cover it’s important for the business to talk through the company’s exposure, payment terms the business offers and how much risk the firm is prepared to take.
“The higher the excess, the lower the price. So, it's about understanding what the client can afford to lose versus the premium they want to pay,” says Hoppe.
Crozier explains every policy is bespoke. “We look at the client, their industry, their size, their credit risks, their credit management quality and loss history and tailor a solution.
“The client is the starting point. We look at the motivations for buying the policy, what they want to achieve with the policy, the budget and the risks and the concerns the client wants to address.”
Premiums are based on the business’ recent bad debt history, industry sector claims volumes and economic conditions. “We have seen an increase in recent years however, but competition is increasing with new providers joining the market,” says Sutherland.
“Premiums have been rising for two years, due to high levels of corporate insolvencies and claims activities. But we're expecting a flattening of premiums as insolvencies reduce,” says Stephen Allan, manager credit risks, GSA Insurance Brokers.
“There's increased competition in the market, with one new insurer, which has added fresh capacity,” he adds.
Credit insurance premiums are often linked to the economy. “Premiums rose during and after the financial crisis when there was a 200 per cent increase in credit insurance claims. Premiums had fallen by 2011 and since then, rates have tended to rise and fall by around five per cent year-on-year, depending on the policyholder,” says Cheesman.
Doubé says pricing is competitive for low- to medium-risk industries. “High risk sectors are generating more losses, for instance construction-related industries and premiums are higher for these industries.”
Sutherland stresses trade credit policies don’t replace the credit management process.
“We believe trade credit policies improve the credit management process and ensure credit managers are better informed when considering credit, which should lead to loss minimisation and preservation of the business’s lifeblood.”
As Cheesman notes credit insurance has moved with the times. “It’s more flexible, credit limit decisions are faster, technology offers ledger washing and matching and policies come with overdue collection support, including the cost of collections.”
He says credit managers looking for a total credit solution should consider trade credit insurance as a safety net for when a bad debt actually occurs. “Integrating electronic credit applications, company information reports, PPSR registrations and overdue collection actions into the policy gives credit managers a robust support service.”
Ultimately, businesses will achieve the best results with credit insurance if they commit to being transparent with the insurer and their broker.
Says Crozier: “It’s not the type of insurance you buy today and renew in 12 months. There's activity required throughout the year, and the best way to make sure the insurance still applies to your business is to engage constantly throughout the year. That’s the best way to protect the business when it really matters.”