Just in Case: Can Credit Insurance Cover you? [Business Credit]

What is peace of mind worth to a person?

People obtain life insurance policies to care for their loved oifcs in the event ot an untimely death. They obtain renters or homeowners insurance in case a lire or flood destroys their belongings. Those who drive pay for auto insurance (granted, this is a. legal mandate not a choice). The point is that purchasing insurance is a frequent occurrence, if not a natural inclination.

It is far less automatic to use credit insurance in trade credit. Whether because of objections to cost, the highly-detailed nature of policies or concerns about provider-imposed loopholes, there are plenty in credit who shy away from it. This may be changing due to factors such as the insolvency spike that came with the economic downturn and the increasing awareness that selling into unfamiliar territories, especially emerging economies, has become a necessity.

"Credit insurance is all about facilitating trade," said United Kingdom-based Fabrice Morel, deputy secretary general with Berne Union, a trade association for the credit and investment insurance industry comprised of both private insurers and publicly-backed export associations. "This is certainly a positive thing. We believe trade creates wealth."

While virtually no tool in credit management is perfect for everyone, FCIB Director of Business Development and Membership Ron Shepherd believes credit insurance can be a powerful defense against catastrophic events, especially involving critical debtors. He pointed to the example of a small or midsized business watching its largest customer head toward insolvency. "Mergers and acquisitions in many industries have resulted in larger concentrations of A/R portfolio exposure to key debtors," said Shepherd, who has 15 years' prior experience in insuring export and domestic receivables while a vice president with Euler Hermes. "If your largest customer is unable to pay you, what happens to your business? Can you absorb that loss or accept payment over a period of months or years? If the answer is 'no,' maybe it is more of a need and less of a want."

Still, there are those who have used credit insurance and found the experience disappointing, or even "useless."

Covering More Ground

The global economic downturn of recent years brought with it many lessons. One of these was that selling in familiar and comfortable markets may no longer be a diverse enough formula for success. Companies already engaged in selling to businesses based in emerging economies like the BRICs (Brazil, Russia, India and China) generally performed better than companies that stuck with traditional partners when the economies of the United States and, later, the European Union tanked.

Statistics released this summer by Berne Union, whose members are estimated to be involved in as much as 10% of all world export activity, illustrated a significant increase in new business for the insurance industry. Between 2008 and 2012, new short-term export credit insurance (the more traditional form), increased by $241 billion to a total of $1.538 trillion. Medium- and long-term export credit insurance (typically capital projects) increased by $27 billion to $180 billion in the same period, with much more expected out of developing nations in the coming years. Whether in developed or emerging economies, credit insurance proved reliable as an industry, such as during the early points of the crisis in Russia and Eastern Europe in 2008 and 2009. Nearly $5.5 billion in claims were paid out in 2009 alone, according to Berne Union data.

"The crisis showed it is a stable industry," said Morel at FCIB's Annual International Credit and Risk Management Summit in May where he served as a moderator. "No credit insurer collapsed. No one went bankrupt."

This is notable because of what Shepherd characterized as an opportunity to expand sales on open terms. Shepherd said one of the most overlooked aspects of credit insurance is the ability to provide a platform for safe sales expansion without additional risk. Take, for example, a situation where a company is not insuring their A/R portfolio. If a customer asks a company to increase their credit limit, and the request is denied, even for valid reasons, they may go to a competitor. With credit insurance, even if the carrier only approves the original credit limit amount, the company has a better opportunity to retain the customer, increase sales to them and, thus, the net profit on the account. All can be achieved without incurring significant additional risk, for the cost of a policy.

Also, shying away from credit insurance can stymie international sales in other ways. For example, letters of credit (LCs) are still widely used for cross-border sales. Still, despite the widespread use of LCs outside the U.S., requiring one can become a disadvantage if a competitor doesn't have the same requirement. The buyer's overseas bank will typically reduce the amount of funds accessible to the buyer by the amount of the seller-required LC. In essence, "you're squeezing them" from a working capital standpoint, said Shepherd. Joseph McNamara, CCE, CICP, who recently became vice president of credit and political risk at Equinox Global after a decade in credit at Samsung, agreed. He said such a situation plays into the "order prevention" credit department model that should be avoided.

Companies are often more worried about receivables when dealing internationally, and perhaps rightfully so when they're not experienced doing business in certain areas. McNamara said it is important to realize problems can quickly rear themselves in the form of political risk. Your debtor could be in fine cash standing and willing to pay, but there could be problems with the government and banking system that make getting money out of the country difficult. Such was the situation in Venezuela when the Chávez government started nationalizing many industries and created roadblocks to deals with U.S. businesses. Placing countries like Argentina and Brazil on the list where this could happen wouldn't be out of the question, said McNamara. The same could be true in parts of the Middle East at present. In short, just because a creditor is comfortable with a buyer, their ability to pay and positive historic behavior doesn't mean other factors can't cause havoc.

Though talk of credit insurance largely involves international use, Shepherd said perceptions that credit insurance isn't applicable, if not important, domestically are false. The use within the U.S. proved especially crucial when bankruptcy filings surged to historic levels late last decade. In fact, Shepherd and Berne Union statistics both noted that interest in credit insurance use in the U.S. by domestic businesses has been steadily rising for 10-15 years.

Whether foreign or domestic, another factor for at least considering credit insurance is the changing nature of the credit industry. With a "do more with less" culture and a shifting away from some traditional business models, insurance is being considered with increasing frequency. McNamara strongly believes an increase in companies at least investigating their insurance option is a trend that won't sunset anytime soon.

Neil Ross, trade credit insurance profit centre manager EMEA for AIG Europe Limited, hit on that topic at the FCIB conference as well. Ross said he believes banks have insufficient resources to perform the kind of analysis needed with the growth of international trade, and there is a widespread desire therein to actually decrease headcounts. This will continue to shift the onus from banks onto private companies. "There is no shortage of banks wanting to finance the top companies," Ross said. "But doing analysis on thousands of buyers is frankly not where the banks want to be right now." Shepherd added that while bank leverage since 2008 has come down, the increased bank capital required by Basel III will force banks to again reassess their portfolios and strategies.

The Foul and the Fair

Like anything, not all experiences with credit insurance have gone smoothly. "My experience proved to be useless," said Jeff Perlstein, a regional credit manager with Berlin Packaging, based in the Chicago area. Among his complaints, he believed that the maximum credit limits one particular insurance provider would cover actually hindered the ability to sell or be flexible with customers. He also believed the highly-specific rules of the policy were far from advantageous to the credit grantor. "Of course the policy was written to protect the insurance company," Perlstein recalled. "When there was a claim, they scrutinized every part of it looking for a way not to pay it out."

Susan Muñoz, CBA, credit manager at Creative Teaching Press in California, also had a less-than-positive experience. Her company insured international sales for about a decade. In that time, three claims were filed, and all of them were denied. She recalled that certain practices considered trade credit standards simply aren't the same within the insurance industry. Eventually, the company stopped believing there was enough benefit to justify the cost of international credit insurance and didn't renew policies.

Cost was also the reason cited by others in recent NACM interviews and social media exchanges-simply too high to offset the risk. A common factor cited was the requirement by the provider to insure a sizable portion of the portfolio even though a company may have only been concerned with a couple of customers.

Sebastian Srulevich, international credit manager at WMS Gaming in Spain, said the cost of insurance can vary greatly, depending on the where's and when's involved with a policy. Srulevich recalled the good timing of the credit department with Whirlpool Iberia when he worked there in late 2007, when signs of an economic crisis became apparent. Having, and more importantly, understanding the specifics of a strong credit insurance policy saved the company huge amounts of money while others suffered historic losses. "One of Whirlpool's major customers in Spain went bankrupt, and several small ones followed not long after," said Srulevich. "Whirlpool collected from the insurance 40 times more than what the insurance cost was on the receivables that became uncollectable "

McNamara recalled that his credit department filed three claims during his time with Samsung. Its insurers paid out all of them. Granted, there can be discrepancies between the amount of receivables your credit department and the debtor has listed. Even if a lower amount is taken in a dispute, it's definitely better than how an unsecured creditor makes out following a debtor's Chapter 11 bankruptcy filing. Perhaps the best example of domestic credit insurance working in a positive way was the epic collapse of big box electronics giant Circuit City. "We had credit insurance on that. We were paid out," said McNamara.

McNamara said that Samsung had another experience where the insurance provider fought to avoid paying a claim. In that case, the debtor wasn't insolvent. Its proprietors simply refused to pay the bills. The insurer did, however, help pay legal costs for Samsung to file a suit against the debtor and, eventually, settle the claim.

With Changes Ahead, the Decision is Yours Granted, it would be hard to argue against reassessing options and changes in credit insurance periodically, even if previously shunned. In the not-too-distant past, there was a perception that insurance providers were typically rigid on offerings and dictated to customers on issues like having whole turnover-type policies instead of more flexible, almost á la carte options. Angela Bradbury, MICM, ICCE, group credit manager at Innospec, Inc. in the United Kingdom, is among many who noted significant changes in the dynamic between policyholders and providers. "I think there is so much more interest in what the insurers have to offer because the insurers have changed their offerings. It's that simple," said Bradbury, who is also on FCIB's European Advisory Council. "They had to find a product that will sell. The power has shifted toward the client immeasurably in the last couple of years. They now have to compete, and that means offering something useful, and at a reasonable price."

Even so, Bradbury admitted her company has had some disagreements with a provider within this new landscape. Still, her company considers the cost of credit insurance justified in the right situation. Bradbury, as well as Srulevich, McNamara and others, stressed the often-echoed sentiment that insurance is another tool, not the only tool, for "just in case" situations. It is not a replacement for credit management fundamentals and due diligence.

"If companies do not have a professional credit department and do not follow its processes, two things will happen: overdue accounts will go up and claims with insurance will be rejected, as chances are the claims will not go through due to noncompliance with the insurance contract," Srulevich said. "Some people are under the wrong belief that insurance should be used to cover those customers you are unwilling to grant credit to. It is the opposite. You should never insure customers you are not comfortable giving credit to. The insurance company will only insure (at reasonable rates) if they are comfortable knowing you will look after the assets with the best of your knowledge, proven track record of success and diligence."

Credit insurance is like all other types of insurance. It is helpful to have, but you hope you don't have to use it. It is a tool for the right situation. Sometimes, on a small loss, it might just be better for the credit department to let it go if all other collections attempts have failed. After all, if a driver damages his or her car to varying degrees once per week and files a claim each time, the odds of finding car insurance at an inexpensive price, if at all, will only grow worse and worse, li

f your largest customer is unable to pay you, what happens to your business? Can you absorb that loss oraccept payment over a period oí months or years? It the answer is no, maybe it is more of a need and less ot a want."

Brian Shappell, CBA, (JCP

Brian Shappell, CBA, CICP, NACM staff writer, can be reached at [email protected].