TRADE CREDIT INSURANCE

4 Reasons Why Companies Use Trade Credit Insurance

David Gustin

- February 3, 2016 4:54 AM |

Categories: Credit Risk Management | Tags: credit management, Letter of credit, overseas receivables, Trade Credit Insurance

In my last Order to Cash post, I talked about setting buyer limits.  Instituting a credit management discipline in the order to cash space would not be complete without considering trade credit insurance.
There are four primary reasons insurance can be purchased

1. provide incremental sales,
2. provide default risk protection if buyers do not pay
3. act as a financing tool to increase the percentage of receivables eligible
4. act as a cost reduction tool to reduce bad debt reserves.

The reasons for purchasing trade credit insurance are not always so black-and-white. Many companies use the coverage for more than one reason: receivables financing; risk mitigation; penetrating new markets; expanding sales; using longer credit terms to convince distributors to stock more inventory in-country, thereby transferring inventory carrying costs from the exporter to the buyer; etc. Risk mitigation tends to be the primary reason and cost reduction (through lowering bad debt reserve) is the secondary reason from  conversations I have had with companies.
The interest in insurance as a way to reduce bad debt reserves makes sense.  The benefits accrue both on the balance sheet as well as on the income statement given the insurance premium is an expense.  Companies have told me they have been able to lower bad debt reserves.
Insurance cover to facilitate financing and lending on foreign receivables lending appears to be an area of opportunity. What we have seen with companies that have gone this route is a substantial increase in their eligible assets for the lending pool. For example, if a bank client is borrowing at 6% over Libor, and has 70% of his receivables eligible, through insurance, they are able to get 85% of the pool at the same or better rate.
Some things to think about when assessing the “risk” of your buyer portfolio:

• Leverage insurance to support overseas receivables. Insurance cover to facilitate financing and lending on foreign receivables appears to be an area of great opportunity, especially for the mid-market
• Assess your sales account concentration and country exposure risks and how it impacts your financials.
• Find partners that can help bring together the right tools for risk participation and technology, including asset based Lenders, insurers, software companies, etc. Technology enables tracking of compliance against policy conditions.  This enhancement broadens financing options for a company’s use of trade receivables financing.
• Evaluate the tradeoffs of moving even more trade off Letter of credit. Understand the risks involved by moving to open account and learn various techniques that can help with risk mitigation – ie, use of Standbys so your dealers can maintain OA payment terms, use of private insurance, or perhaps even the use of letter of credit confirmations.