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| Offers risk reduction and professional partnership designed to insure accounts receivable, enhance financing, and expand sales. |
Do you require capital to expand your business but are constrained by your existing lending agreement, particularly over the advance rate available on your domestic receivables and exclusion of export accounts receivable from your borrowing base?
Do you worry about the financial strength of your key buyers and the implication their insolvency would have on your business?
Are you losing business to your competitors who are extending financing to their buyers? Do you want to aggressively expand your customer base while limiting corporate bad debts?
If you have asked yourself any of these questions, then you should consider credit insurance as a risk management tool.
Credit insurance provides payment protection for commercial trading terms of less than 360 days. Longer repayment is possible for capital goods (e.g. production equipment, trucks, drilling rigs etc.). Its chief purpose is to provide protection against financial losses resulting from insolvency-related events or buyer nonpayment.
Buyer nonpayment losses occur when a buyer either goes bankrupt or simply refuses to pay its valid debt oftentimes claiming that the seller did not honor contract terms, giving rise to a dispute. Disputes are not covered under a Trade Credit Policy but may be covered under a Specification Compliance Insurance Policy ("SCI") designed specifically to address the dispute exclusion in all credit insurance policies. For more details on this product, click here.
Exporters who purchase credit insurance can also obtain coverage for losses resulting from political risk events that include:
· Conversion or transfer of currency;
· War and related disturbances;
· Cancellation of import and/or export permits; and
· Imposition of debt moratorium; confiscation, expropriation and nationalization of assets by sovereign authorities |
| Benefits of the Product
There are five primary benefits of the Credit Insurance Policy:
1. Enhancement of financing
2. Cash flow relief
3. Sales expansion tool
4. Securitization tool
5. Access to credit expertise
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| 1. Enhancement of Financing |
| By purchasing a Policy, the company is able to improve its accounts receivable advance rates with its lender. Banks normally allow up to 90 % advance on both domestic and export receivables when the operating line is supported by a Credit Insurance Policy. The Policy allows the bank to provide the borrower with additional working capital. In addition, companies may successfully negotiate a lower borrowing rate by providing the lender additional security from the Credit Insurance Policy |
| Credit insurance provides cash flow relief when one of your active customers becomes insolvent or does not pay. The loss incurred is indemnified by the credit insurer thereby maintaining your cash flow. |
| Credit insurance is a popular tool for companies with aggressive sales expansion programs. It provides Policyholders with a method to expand their sales base by identifying and targeting credit-worthy customers while limiting payment risk. The example provided later in this article demonstrates how a marginal sales increase will allow the insurance to pay for itself. |
| For companies wishing to securitize their accounts receivable, credit insurance offers the ability to enhance the underlying value of the receivables, hence providing a better rate of return for this corporate financing tool. |
| 5. Access to Credit Expertise |
| Credit insurance also provides companies access to professional credit analysts who provide a sounding board and a second opinion for the company's credit department This exchange of information is frequently useful in identifying high risk buyers. This independent analysis of information from a variety of sources complements your credit department. |
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Credit Insurance Misconceptions
While credit insurance has many features and advantages, there are also some misconceptions associated with the product.
Some prospective clients believe credit insurance should act as a replacement for their existing credit department. Nothing could be further from the truth!
The Underwriters rely heavily on the expertise of a company's credit management and the premium rate is normally a function of the company's credit granting capabilities. Credit insurance should not be used to replace your existing credit department; it should be regarded as an enhancement to the credit department.
Secondly, one should not expect that credit insurance would cover normal annual bad debts. If your company consistently incurs losses of $20,000 per year, then you should expect a deductible equal to that amount.
Credit insurance policies are designed to cover unforeseen losses triggered by events that put the company's most vulnerable asset, accounts receivable, at risk. These events may be catastrophic.
Finally, credit insurance is not a collection service or a factoring product. It is a risk management tool that operates much differently from a collector or factor.
Tangible Benefits Derived From a Credit Insurance Policy
The following are specific examples of the tangible benefits a company may derive from the use of credit insurance.
1. Enhanced Bank Financing
Most major financial institutions now recognize the financial strengths and benefits of the product and provide enhanced accounts receivable financing to their customers when the customer purchases a Credit Insurance Policy. This is particularly evident for exporters, as banks have traditionally been unwilling to include export receivables in the customer's borrowing base. As a result, the customer whose export sales are substantial is unable to take advantage of a significant amount of financing.
Normally, the bank will ask to be named as the beneficiary under the Policy and, as a result, claim payments are made directly to the bank. Banks view this benefit as additional security under their lending agreement. This is crucial as it allows the Policyholder to renegotiate their existing security arrangement, potentially reducing, or eliminating personal guarantees.
The Policyholder may also be able to reduce their borrowing rate, given the additional security provided by the Policy. The following is an example demonstrating the additional liquidity provided to a company by purchasing credit insurance:
Example: U.S. Exporter
Financing available prior to purchasing a Credit Insurance Policy:
| Sales | $ 20,000,000 | | Domestic A/R | $1,750,000 | | Export A/R | $750,000 | | Domestic A/R Advance Rate | 75% | | Export A/R Advance Rate | 0% | | Maximum Borrowing | $ 1,312,500 |
Assume company buys a Credit Insurance Policy with a cost of $100,000:
Bank Increases Domestic Receivable Advance Rate from 75% to 90% and Export Receivable Advance Rate from 0 to 90%
| New Maximum Borrowings: | $2,250,000 |
| % increase in borrowing: | 71 % | | Dollar increase: | $937,500 |
2. Improved Corporate Profitability and Enhanced Shareholder Value
Credit insurance also provides a company with the ability to mitigate the impact a bad debt has on corporate profitability and shareholder equity. In order for a company to recover from a significant bad debt, the company must increase their sales by the amount of the loss divided by their gross margin. This is required in order to recover the lost gross profit.
Intuitively, the lower the company's gross margin, the larger the additional sales volume required to recover the lost gross profit. As a result the lower the profit margin, the less room for poor credit decisions and the greater the need for credit insurance.
The following example shows the additional sales volume required to recover from a bad debt of $ 50,000 assuming a 10% gross margin.
| Sales | $10,000,000 | | Gross Margin | 10% | | Bad Debt Loss | $50,000 |
| Incremental Sales to recover | | Lost gross profit | $500,000 |
| Sales Increase Required to | | Recover Loss | 5% |
An aggressive sales expansion program would be required to recover from this bad debt during the fiscal period. Clearly, a Credit Insurance Policy plays an important role in protecting corporate profitability.
3. Sales Expansion Tool
Policyholders normally derive additional benefit from their ability to use credit insurance as a sales expansion tool. The Policyholder is able to obtain an opinion on the credit-worthiness of customers they would like to develop to enhance their sales base. This allows the Policyholder to channel their marketing efforts towards credit-worthy customers, thus expanding their sales base and improving their corporate profitability.
Credit Insurance enables a business to extend larger credit lines with minimal risk therefore enhancing sales growth. Credit insurance also provides companies access to professional credit analysts who provide a sounding board and a second opinion for the company's credit department. This exchange of information is useful in identifying high-risk buyers.
| Internal Credit Limit: | $750,000 | | Approved Credit Insurance Limit | $ 1,000,000 | | Account Turns Per Year | 10 | | Increased Revenue: | $2,500,000 | | (= Increased credit limit x turns per year) | | Gross Profit (GP) Margin: | 10% | | Impact of increased sales on GP: | $ 250,000 |
Conclusion
Credit insurance is a product that has and will continue to gain more prominence in the years to come as U.S. companies continue to compete and grow in the international arena. Those companies that wish to finance their expansion through the use of credit insurance or wish to use credit insurance, as a means of identifying a financially sound customer base will benefit most as the credit insurance market continues to evolve
The principal attribute of export credit insurance is the protection it gives a company for what is typically the riskiest part of its business: foreign receivables. The claim proceeds of export credit insurance can be assigned to a lender as security. The insured's financing advantages may also extend to its foreign buyers through the insured's Policy. Local credit facilities may be difficult to secure and can be prohibitively expensive for an insured's buyers. Export credit Insurance thus provides the insured with a marketing tool, because it can reduce overall costs to foreign buyers and enables the exporter to provide more attractive credit terms to foreign buyers, which they, in turn, can extend to their own customers. Export credit insurance also enables the exporter to add or expand new and existing markets in unstable areas that had previously been considered too risky. |
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