KANSAS CITY, MO — Receivables are often one of a company’s top three assets. Although insurance focuses primarily on people (workers compensation), property (real and intellectual) and third-party liability (general liability, auto liability, excess liability, executive liability, etc.), customer receivables can run 5% to 10% of sales. But there is a way to hedge this loss: trade credit insurance or, simply put, credit insurance. It’s an option that can help companies mitigate catastrophic losses, but in its entirety, it can also offer additional benefits.
Credit insurance includes credit monitoring for an insured portfolio. The largest and most critical clients are key for the growth of any company. They represent ongoing success, growth and cash flow to operate a business effectively.
It’s helpful to know how a key client’s financial health is faring. When buying a credit insurance policy, this information is included within the program. Buyers will know in real time how financially stable clients are, allowing the company to proactively manage terms vs. reactively manage a possible receivable crisis.
This ultimately makes commercial lenders happy. Banks want to know who their clients are doing business with. They are curious about who their client’s largest customers are and what terms exist for them. It is a proven benefit that lenders feel more comfortable if debt is secured. It can increase the available lending line, which will in effect help companies with capital needs achieve their goals.
Additionally, commercial lenders typically require that foreign receivables be insured to qualify them for borrowing base calculations concerning a company’s asset-based line of credit. Many credit insurance companies understand most foreign governments and can validate debtors in those countries.
As important as client receivables can be, knowing the health of a vendor’s balance sheet is equally
important. If a vendor became insolvent and was not able to deliver raw materials or component parts, it could be crippling.
An ancillary component of a credit insurance program is the ability to periodically check on the financial health of vendors or key stakeholders. This option can be negotiated into the final policy cost.
Under the terms of a credit insurance policy lives another primary benefit: protracted default situations or settlements to be handled by the credit insurance company. It can negotiate settlements and payments on the client’s behalf, which, at times, can alleviate the burden on internal accounting departments. Within the details of each policy are terms that promise payment from insured debts, normally within 60 to 90 days.
In cases of bankruptcies or credit defaults of insured obligors, having trade credit in place can be invaluable. It can insulate the insurance buyer from having to navigate the complexities of any bankruptcy filing of these debtors.
When an event like this occurs, it can often take months or years to properly secure renumeration. With trade credit insurance, the provider’s objective is to move the claim or debt to the “front of the line,” as opposed to a company without a trade credit contract in place.
With supply chain issues and uncertain economic headwinds, trade credit can be a valuable risk management tool. As the global economy enters more difficult times — which include inflation, financial market stability and geo-political challenges — trade credit insurance is a worthy consideration, especially prior to an economic downturn. Working with an independent insurance broker to offer various options through multiple carriers is a viable course of action.
There are two distinct types of credit insurance: cancelable and non-cancelable, with the most common being the former. The three primary carriers that brokers work with are Coface North America, Allianz Trade (formerly Euler Hermes) and Atradius. Each of these carriers has strengths and weaknesses; due to this, it’s up to the insurance broker to wade through options and craft
a program that’s the best fit.
It’s also important to realize that credit insurance would not normally cover a “chronically bad” client in terms of payment. This client is already extended beyond what is considered normal terms. These will be “carved out” during the underwriting process. On the flip side, very good paying clients will be included within the covered portfolio; the steady payers will be needed to offset the borderline risks and even out the risk for the underwriting companies.
Like other insurance policies, the final premium is subject to many underwriting considerations. Examples of these could include creditworthiness of clients and general risk grading scores, among other factors. One other cost factor, as previously stated, is determining which clients will be included in the insured portfolio. This can be negotiable. If a buyer’s key client is borderline, additional information such as trends, new contracts and potential infusions of cash can be presented. With all this in mind, a very general estimate would be one-fifth of 1% of sales insured or 25-50 basis points.
In the current climate, trade credit companies are seeing an understandable influx of claims. Existing terms are being tested, often exceeding acceptable receivable conditions. Commercial bakers or related companies need reliable clients, and these are obviously still the goal. If the economy continues to struggle, mitigating credit losses will become more critical. Now is the time to consider a program that includes trade credit insurance to soften the goal of an economy under stress.
Those in a commercial baking operation who are responsible for insurance purchasing need to bring this topic up with their brokers. With the era of uncertainty still upon us, it’s an option that’s worth a look.
This story has been adapted from the October | Q4 2022 issue of Commercial Baking. Read the full story in the digital edition here.
