The economic crisis, coupled with a greater emphasis on exporting, has rekindled interest in an underutilized insurance product:
Credit, or often times referred to as Receivables Insurance.
Although most companies' largest assets are their accounts receivables, few bother to protect themselves against the risk of customer default or insolvency. Yet for many companies, if just one major customer was to default or go bankrupt, it could spell their own doom. Indeed, the risk of a serious or even ruinous default by a customer is more likely than theft, fire or flood. Despite this very real peril, only about 1 in 10 American companies buys credit insurance, compared with more than 50 percent of European companies. Since the beginning of the economic crisis, interest in credit insurance has reached an all-time high. For American Businesses, the benefits of credit insurance are impressive: protection against non-payment, better financing terms, the ability to bargain aggressively.
According to the American Bankruptcy Institute, business bankruptcy filings reached well over 60,000 in 2009 alone. That's a 64 percent increase over the same period in 2008. 2010 is stacking up similarly. In fact, a recent survey of chief executives found that payment default--not the cost of capital or poor sales--represents the greatest risk to their balance sheets. Commercial credit insurance is a way for companies to protect themselves. It can be purchased to cover a single transaction, transactions with certain customers, certain industries, or all of a company's transactions with all of its customers. At its most basic, credit insurance provides two kinds of protection:
- It can cover counter-party insolvency. (If a customer goes bankrupt, your outstanding accounts receivable will be paid.)
- Or, it can cover bad debts. (If a customer defaults on a payment, the outstanding accounts receivable will be paid.)
The global market for credit insurance is $6.7 billion. Of that, about $4 billion is written in Europe. U.S. premium written is only about $800 million. However, that is changing.
Though credit insurance was invented in the United States back in the 1890's, less than 10 percent of American companies use it today. The reasons are the converse of the European experience. Most U.S. companies sell to domestic customers and terms in the United States tend to be shorter.
As the U.S. economy drags itself out of the recession, however, American companies need to protect their assets more than ever. As a result, all of the major credit insurers report that inquiries are significantly up. More and more American companies are finding credit insurance to be an effective risk management and operational tool. In addition to protecting against third party risk, credit insurance provides powerful advantages beyond the core benefit of protecting against bankruptcy or payment default.
Perhaps the most important benefit is the fact that credit insurance improves a company's financial profile. Lenders are more likely to extend credit to companies whose accounts receivables are insured. When credit is extended, interest rates tend to be lower. Credit insurance also gives companies a competitive advantage, enabling them to offer potential new customers extended or more open terms, while sharing that risk with a third party. It can also help businesses find the right customers and/or markets. This coverage can lower the cost of collections. In fact, many European companies use credit insurance as a way to outsource their credit departments.
Premiums are based on the number and creditworthiness of the company's customers. Customers with a checkered credit history are riskier and cost more. Certain industry segments may also constitute more risk and are priced accordingly.
Even businesses with a good distribution of customers with strong credit histories still buy credit insurance. Mitigating the risk of a bad debt is just one of the benefits; there are many more.
Many companies also use credit insurance as a financial tool to improve their own credit profile. With their accounts receivables insured, banks are willing to offer them much better terms for financing. In fact, some banks even require companies to obtain credit insurance as a condition of lending. Indeed, bankers frequently refer customers to knowledgeable insurance agents so they can buy credit insurance.
Many companies are now finding that credit insurance serves yet another important function. With domestic markets saturated, American companies are increasing exports. Foreign sales by small and medium-sized companies are up 20 percent this year alone. Many of them are finding that credit insurance is a must. First, it protects the exporter from non-payment or customer insolvency. It also is much faster and easier to use than old-fashioned credit risk mitigation tools like letters of credit, which can tie up customers' bank accounts. The unexpected dividend is the ability to compete head-to-head with foreign competitors. Even when they offer a superior product at a lower cost, many American companies are losing out to foreign competitors because the competition is offering customers better credit terms. In today's global economy, it's a buyer's market, and for foreign buyers, credit terms are a very important part of the sales process, much more so that in the U.S. Those competitors can offer better terms because they have credit insurance. With their accounts receivables insured, they can negotiate much more aggressively knowing those insured accounts will get paid one way or the other. Most of the larger credit insurance companies maintain credit histories on literally millions of companies. They can help you decide to whom you should and should not extend credit. Some can even assume responsibility for collections.
It is the economic recovery itself that poses an imminent risk. Savvy businesses know that the recovery period after a recession is the most dangerous. Many customers who have survived until now risk protracted default as they use scarce capital to rehire workers, buy materials and supplies.
Good times or bad, commercial trade credit insurance will be there to protect balance sheets and smooth volatility. Like it or not, the economy has changed for good. Market conditions are much more volatile. Credit will remain tight for the foreseeable future.
Despite the benefits and increased interest in credit insurance, many insurance agents are reluctant to sell what they consider a non-traditional product. If you consider credit insurance a sophisticated financial product, you're right. The Gaudreau Group has the solutions and the team of veteran professionals at our disposal who can assist you in finding the best solutions to protect your businesses.
WE WORK FOR YOU - REPRESENTING SEVERAL OF THE WORLDS LARGEST CREDIT INSURERS.
Our professionals can help you to look at your business - the customer base, credit practices, risk appetites, etc., and analyze how best a credit insurance policy can go to work for you and where it can bring value. With this accomplished, you'll be better prepared to have a productive dialog on whether it is an effective risk management tool and how best to secure the ideal program.
