Credit insurance: Why it matters
Hope for the best and prepare for the worst is the mindset many businesses operating in Asia have taken amid the recent slowdown in the region. With risks such as non-payment on the rise, treasurers and CFOs have started to take a prudent approach when dealing with current and potential new buyers.
While most insurance policies are signed and never seen until a claim or renewal, trade credit insurance is different as it requires the institutional policyholder to be constantly aware of the receivable risks facing the business. In general a trade credit insurer promises to pay a company’s receivables in an event that a customer/buyer is unable to fulfil its payment obligation. It essentially gives the supplier a safety net when transacting with their customers.
“The market has become increasingly competitive in Asia Pacific. More and more companies are starting to offer credit terms on open account in order to stay competitive,” explains Victoria Ma, executive vice president and chief risk underwriting officer at Coface. For Ma, the fact that most companies’ trade over an open account instead of letters of credit (LC) to be competitive means that there is a large part of a company’s receivables that is unprotected from non-payments.
Coface’s recent survey of its Asian customers in 2015 revealed that 84.6% of them trade on an open account structure. “Typically account receivables count a good portion of company’s assets around 40%. Their customer's default in payment could be detrimental to their business,” observes Ma.
The insurance product could be a game changer for SMEs that need to offer attractive payment terms to secure some business. For Wilkie Wong, group chief financial officer at textile manufacturing Esquel Group, the gradual industry shift from LC documentation to open account got him thinking about his potential risks. “After the global financial crisis a lot of our customers have been asking to lengthen their payment terms. When a customer asks you to do these things it’s difficult to say no,” says Wong. Credit insurance adds a layer of comfort when working with open account customers, he adds.
“If you are a middle-sized company or an SME, one of the biggest assets on the balance sheet is receivables,” says Gordon Cessford, regional commercial direct for Asia Pacific at Euler Hermes. “If you are an SME one loss can put you out of business. If you are a multinational it’s about corporate finance and risk management. It’s about being aware of the risks you have out there.”
Outside the benefit of protecting a company from counterparty risk, trade credit insurers claim that they also act as a third party that gives an unbiased view of a supplier’s customers. “We give them a third party opinion of the credit worthiness of their customers,” states Eric den Boogert, managing director Asia at Atradius. It’s a similar message voiced by Ma who believes that “even if some businesses have a dedicated credit team, having a third party's value-added advice will help the credit managers to better explain to their sales managers the level of risk and make sound sales decision.”
Gaining additional financing from banks via schemes such as supply chain finance can also be easier to obtain, most trade credit insurers say. “Banks are willing to finance people with a credit insurance policy,” adds den Boogert. “Banks have become stricter in lending especially to private sector companies.”
In terms of evaluating buyer coverage, most trade credit insurers look at several factors when underwriting. “Obviously fundamental will be the financial statements of a company. We also look at the payment experience, years of relationship with the supplier, business environment, sector and country risk, etc. “states Ma. Information is critical if you want to stay ahead of the game explains Cessford, “We spend a lot of money on information because that is what is driving the business,” he notes. “The person with the most information about the buyer is actually the supplier. Because they are seeing how much product they are taking and how much they are paying and when they pay. We tap into our clients to see how they are performing with their own clients.”
But is it the perfect solution to credit risk management? It can be argued that credit insurance has its limitations. For one, credit insurance for high-risk accounts may be tough to obtain. Moreover, there are deductibles and minimum loss thresholds that limits its usefulness.
In the region, premium cost is a major factor holding back many companies from obtaining insurance.
“Historically this is a low penetrated market (Asia-Pacific) generally speaking. It’s immature in many markets in Asia-Pacific and we have room to grow,” says Ma. “It’s really a matter of how we educate the market because many companies we talk to have never heard of trade credit insurance.”
In terms of expanding the market within Asia, credit insurers turn to external organizations for additional support. “Credit insurance normally starts with export credit insurance. You have the big government agencies like Sinosure and K-sure, which are very active in promoting this product for quite a long time,” notes den Boogert.
Moreover, Cessford believes it’s a matter of partnering with banks to offer this service to their clients. “There is an increasing awareness of credit insurance drive by the banks and by companies’ appreciation of the increased risk environment,” he observes. “Of clients that took credit insurance they were 25% less likely to fail themselves. Meaning that if you have robust procedures in place you don’t get surprised with the insolvency and non-payment.”
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18 Aug 2016