One of the key components of the recession has been the banking industry’s reluctance to extend credit to businesses across the country and around the world, putting a strain on many organizations.
Therefore, if businesses want to stay afloat in these tough economic times, they need to not only be able to collect the payments owed to them, they need to be able to collect them on time.
“More companies are turning to credit insurance to protect themselves during the economic downturn,” says Pat Cantwell, director for Aon Risk Services Central Inc. and a member of its Special Situations Group. “Credit insurance protects against the risk of nonpayment of trade debt, which are the amounts owed to you as a result of goods or services that you have supplied.”
While standard credit insurance covers insolvency and nonpayment for domestic and/or export trade, companies can also add protection for political, pre-credit and work-in-progress risks. Analysis in work-in-progress may also help prevent unexpected or negative outcomes in today’s volatile credit environment.
Smart Business spoke with Cantwell about credit insurance and how you can use it to help your business in any economy.
What are some of the key benefits of credit insurance?
Credit insurance protects your profit-and-loss (P&L) statements and balance sheets by transferring payment risk to your insurers. It facilitates access to financing and helps you obtain improved terms from the banking market. The banking market is changing daily, and terms that you may have secured in the past are subject to change overnight. Further, credit insurance provides access to complementary debtor evaluation tools and expertise that underpin the credit decision.
A good credit insurance policy will enhance your credit management and help you comply with corporate governance best practices. You’ll be able to increase sales through secure credit lines on your customer base and increase export revenue through competitive, but secure, credit terms.
Both small and medium-sized organizations benefit from the protection and the outsourced credit evaluation provided by credit insurance. There has also been significant growth in the purchase of credit insurance by multinational organizations. These companies are looking to protect against large credit exposures that seem to be appearing overnight, irrespective of their country of origin, while achieving a commonality of credit management across their national operations. That makes credit insurance very attractive to them.
How does credit insurance help the bottom line?
Credit insurance can be used to enhance your receivables portfolio, which, in turn, allows competitive financing, improved ‘cost of funds’ and the ability to negotiate advance rates. This can apply to the full spectrum of facilities, from invoice discounting to off-balance-sheet securitization.
In addition, credit insurers have developed sophisticated data analysis tools that can provide you with the latest intelligence on your company and on the economy. They can provide a credit evaluation service, which will help you decide on the best level of credit for each of your customers, or provide you the ability to set your own insured credit limits.
How does credit insurance work?
A typical policy covers a total debtor portfolio or a selection of key customers. To activate the coverage, you establish credit lines on your customers, either internally or via the credit insurer’s in-house resources. Premiums can be charged on the credit line, on outstanding receivables, or on turnover (sales). Claims are paid at 85 to 100 percent of the bad debt after an agreed-upon grace/waiting period (e.g. 30 days for insolvency).
Why do companies need credit insurance?
There are a number of scenarios in which companies buy credit insurance. Some buy it to reduce or transfer the risk of nonpayment from their balance sheets to an insurance company. Others buy it to increase their ability to borrow against receivables, or to be more competitive by offering longer terms of sale or increased credit lines to their buyers. Another group may buy it to allow the company to safely enter new markets and to be able to safely offer terms to new buyers.
Has the need for credit insurance increased as international business has increased?
Absolutely. Credit insurance is very common in Europe. Because of this, European companies are more willing to offer payment terms when they export. Companies in the United States have now found that they, too, have to offer similar terms to be competitive. Many companies have turned to credit insurance as a way of mitigating the risk of offering credit terms when they export.
Another benefit is that the leading credit insurers have extensive databases of financial information that their insureds can tap into to help them make more informed credit decisions in foreign markets.
Do all companies need credit insurance?
Any company can suddenly find itself having financial difficulties, and there aren’t very many buyers of unquestionable credit quality remaining. Unless a company derives all of its revenue from sales to the U.S. government, there is a reason to explore how credit insurance may enhance your receivables against a sudden financial meltdown.
Over the past couple of years, credit insurance has become a lot less expensive than it was in the past. Even though the market is beginning to change, rates are still relatively low, and quality coverage and capacity are available.