Transcript Euler Hermes Powerpoint Template 2010

Managing Trade Risk and
Business Credit Insurance
Seminar Date
Course Objectives
Understand accounts receivable risk and how
companies manage their trade credit
 Learn how business credit insurance can support your
clients’ financial objectives
Examine the resources and channels to purchase both
domestic and multi-market credit insurance
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Lesson 1: Understanding Management of Credit Risk
(Accounts Receivable)
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Account Receivables Risk
Which of your clients’ assets are protected by an
insurance program?
Where does the A/R fall on most companies’
balance sheet?
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Typically represents from 40% to 70% of a company’s
assets
Most vulnerable to unexpected losses
Likely to be affected by business cycles
Provides cash flow for the business
Only under-leveraged asset with financial lender
Few companies can effectively compete without
extending credit to their buyers
What amount of loss would seriously impact your
client’s annual profit? How many accounts
have credit extended over that amount?
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Risk Management - Business Failures
Bankruptcies are inevitable
Failures come from increasingly
unpredictable sources
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Management Deficiencies
Complex Financial Restructuring
Regulatory Changes
Legal Maneuvering (Chapter 11)
Product Liability
Political Upheaval
Global Economic Changes
Large Bankruptcies can cause a
bankruptcy domino effect with suppliers
- Set off chain reaction that trickles down
- Demands resources to monitor and
manage beyond primary debtor
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Consequences of Bad Debt Losses
A healthy credit management program customarily budgets for a
certain level of expected uncollectible debt write-offs in the financial
management of a business. However, even if an unprotected
company is able to withstand an unplanned catastrophic loss or
multiple losses to its financials, there are other consequences on
earnings and future growth.
 If a company’s revolving credit line is secured by its accounts receivable, a
write-off of part of those receivables immediately impacts cash flow. The
same level of funds is no longer available for the company to run it’s dayto-day operations.
 The company may become less comfortable with extending future credit
without highly secured forms of repayment, impacting the company’s
ability to successfully compete and acquire new customers.
 Future growth may suffer if the company lacks the necessary cash to
invest in product development, distribution, technology and other areas.
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How Companies Manage Credit Risk
At its most basic level, managing trade credit involves making
decisions on whether or not to extend credit, setting terms of a credit
arrangement and collecting on receivables.
Most businesses use a variety of tools to determine credit-worthy
customers and to minimize bad debt losses:
 Third Party Information – such as merchantile reports (e.g. Dun & Bradstreet)
 People Resources – such as credit managers, risk analysts, etc.
 Financial vehicles – such as factors and collection agencies
 Risk Mitigation Mechanisms – such as letters of credit, liens and credit
insurance
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What is Business Credit Insurance?
 Catastrophic Loss Prevention and Cash Flow Protection
• Prevent disruptive losses to one of company’s largest, unprotected assets
• Safeguard revenue stream from bad debt loss due to unforeseen non-payment, slow
payment or insolvencies due to commercial and/or political risks; assuring continuity of
business operations.
• Reduce the risk of key account concentration levels
• Improve timely collection of receivables, lowers DSO and strengthens cash flow
• Cap exposure to bad debt loss and smoothes financial results over the business cycle
– unlike an allowance for doubtful accounts - accomplishes this with tax deductible
premium.
 Financing – Strengthen Lender Relationship
• Improve borrowing power and increase available capital by converting receivables into
a performing asset.
• Eliminate lender’s concern over account concentration
• Enable eligibility of foreign receivables
• Reduce need for personal security requirements
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What is Business Credit Insurance?
 Sales Expansion
• Increase incremental growth opportunities with existing customers by safely extending
more credit
• Mitigate the risk of expanding sales into more volatile or new markets, both
domestically and abroad.
• Enhance customer relationships – safe profitable cooperation between sales and credit
functions.
• Increase ability to offer more competitive terms attract export customer base.
o No need for letters of credit and collateral requirements on foreign shipments.
o Open terms permit buyers to reserve their own working capital line for other uses.
 Improve Financial Monitoring and Operational Efficiency
• Strengthen structure and discipline for credit decision making
• Improve credit risk intelligence using unparalleled third party evaluations of
prospective customers, industries and countries.
• Install on-going and consistent key account analysis, supply chain monitoring and
back-up support for their credit management program
• Increase leverage over troubled accounts by utilizing insurer’s expertise and global
resources
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What Business Credit Insurance “Isn’t”
Financial Guarantee
A Substitute for Prudent Credit Management Practices
Routine Bad-Debt Protection.
Fraud or Trade Dispute Insurance
Accounts Receivable Factoring
Valuable Papers or Accounts Receivable Records Property
Insurance
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Key Indicators of Exposure
Vulnerability Factors – Greater Need for Risk Mitigation Vehicles
Sales Concentration – vulnerable to devastating losses when a single
industry sector or few customers represent more than 25% of total sales
Rapid Sales Growth or New Customer Risk – increased need to
safeguard bottom-line results from sales expansion, which is frequently
accompanied by write-offs of new customer receivables
Export Sales – relying upon LOC’s or other trade mechanisms can inhibit
ability to attract customers and achieve sales growth. There may also be a
untapped opportunity to leverage foreign receivables with lender.
Recent Bad Debt History - reserves for write-offs in excess of 1% of
sales may indicate company that has experienced impact of unusual
receivable write-offs on their past earnings and cash-flow.
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Key Indicators of Exposure
Vulnerability Factors – Need for Credit Risk Mitigation Vehicles
Special Order Goods – If custom-made orders are greater than 30% of
company’s total sales, the business is at greater financial risk because
inventory can not easily be sold to second party without loss or heavy
discounts.
Longer Terms of Sale – open credit terms of more than 60 days increase
amount and duration of credit risk (uncertainty of getting paid)
Financing Receivables
Limited Financial Capacity – thin profit margins/highly leveraged
companies
Low Risk Tolerance – senior financial executives, especially with public
companies, actively seek to avoid earnings volatility
Overburdened Credit Management Capability – prefers to supplement
credit decision making with external resources.
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Options to Manage Short-Term Credit Risk
Self-insurance – establishing bad debt reserves or captive program to
offset deficit should customers be unable to pay
 Offers flexibility to respond to issues – with nominal coverage exclusions
 May create liquidity problems, especially for unforeseen losses.
 Impacts capital allocation of balance sheet and may reveal operating weaknesses
 Requires investment in credit management systems, information acquisition, analysis and
monitoring, and finally audit controls
 No alternative “bad cop” to soften conflict resolution with clients who are slow to pay.
Collateral – transfer credit risk from balance sheet by using pre-payment,
cash on delivery, letters of credit or other assets (i.e. liens)
 Mechanism for quick recovery, depending on liquidity of the collateral
 LC’s are obligations and require performance of specific conditions
 Can make a business very unattractive to potential customers in competitive marketplace.
 May damage relationship with a client if the company has to move against the asset
 Requires administration to maintain security position (for example, filing UCC statements,
monitoring escrow accounts, and/or execution of LC documents)
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Options to Manage Short-Term Credit Risk
Credit Insurance – commercial insurance product that indemnifies a
company against non-disputed losses from non-payment or slow payment of
commercial trade debt
 Program flexibility – designed for an entire A/R portfolio or segment of customers
 Accommodates both sizeable and smaller exposures; rated and unrated companies;
delivered products and trading operations.
 Recovery triggered by defined events
 As credit quality deteriorates, cover may be restricted or cancelled (depending on insurer)
 Business maintains control of customer relationships; bearing cost of protection so
customer(s) may be unaware that coverage has been purchased.
Put Option – the right to sell a named trade receivable at a set price within
a defined period of time if an insolvency or other specified event occurs.
 Loss occurring with limited trigger for recovery, i.e. insolvency (shipment and loss event must
occur within “put period”.
 Typically available for public high-risk buyers (or buyers with public debt) that traditional
credit insurance market will not cover
 Backer is an investor – untested market in terms of claims settlement in event of catastrophic
occurrence
 Extremely expensive compared to other forms of credit protection.
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Options to Manage Short-Term Credit Risk
Factoring – Unless it is a non-recourse agreement, factoring is usually a
financing tool rather than a risk transfer mechanism. This option is typically
used by companies with temporary cash-flow problems or unusual cash
demands that do not have access to traditional financing sources. A factor
usually purchases a company’s accounts receivable at a reduced amount of
the face of the invoice.
 Immediate access to cash in exchange for a % of the receivables value plus a fee
 Many factors offer invoicing, collections and other bookkeeping services for companies
looking to outsource their entire accounts receivable function.
 Not all factors assume the risk of non-payment for invoice they purchase
 Considerable margin erosion
 Loss of control over customer relationships
 Asset is removed from balance sheet restricting line availability
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Lesson 2: Overview of a Business Credit Insurance
Policy
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How Does A Policy Work?
Unlike other types of business insurance, once a company
purchases credit insurance, the policy does not get filed away until
next year’s renewal, but rather relationship becomes dynamic.
Policy can change often over the course of the policy period and the
company’s credit manager plays an active role.
Requests for additional coverage on a specific buyer
Request for coverage on a new buyer
Many established credit insurers are “limits underwriters”, meaning the
company’s more significant buyers are analyzed individually and assigned
a credit limit for coverage.
A company’s less significant buyers may be insured under a blanket type
of cover, known as a “discretionary credit limit” or DCL.
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How Does A Policy Work?
The ultimate goal of credit insurance program is not to simply pay
legitimate claims as they arise, but rather to help a business to
avoid forseeable bad debt loss altogether.
It is credit insurer’s responsibility to proactively monitor the company’s
buyers throughout the policy period to ensure their continued creditworthiness
Gather financial information about private and public companies from variety of sources,
including visits to the buyer, financial statements, data supplied by other policyholders that
sell to the same buyer, public records, bank references etc.
When data signals that a company’s financial position is deteriorating, the
insurer notifies its policyholders that sell to that buyer of the increased risk,
and establishes an action plan to mitigate and avoid loss.
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How Does A Policy Work?
The ultimate goal of credit insurance program is not to simply pay
legitimate claims as they arise, but rather to help a business to
avoid forseeable bad debt loss altogether.
It is credit insurer’s responsibility to proactively monitor the company’s
buyers throughout the policy period to ensure their continued creditworthiness
Gather financial information about private and public companies from variety of sources,
including visits to the buyer, financial statements, data supplied by other policyholders that
sell to the same buyer, public records, bank references etc.
When data signals that a company’s financial position is deteriorating, the
insurer notifies its policyholders that sell to that buyer of the increased risk,
and establishes an action plan to mitigate and avoid loss.
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Policy – Purchasing a Policy
Submit a completed and signed application
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Business Description
Terms of Sale
Sales History and Bad Debt Experience
Sales Volume
Current Past Dues
Names and Addresses of Key Buyers
Export – Breakdown of Sales Distribution by Country with Terms of Sale
Brief Summary of Company’s Credit Procedures
Provide a copy of the company’s current Accounts Receivable Aging
Report.
Once policy is active, ongoing administration may include reporting to the
insurer past due exposures/invoices for buyers at the end of each calendar
month in order to keep coverage active.
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Lesson 3: Methods and Channels to Acquire Credit
Insurance
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Types of Insurance Providers
Private Insurers
 Privately owned, but may also act on government’s behalf for foreign
receivables
 Provides pure cover, insurance to business or a lending institution
•Public Export Credit Agencies (ECA’s)
 Country created, state owned export credit agency acting on behalf of
governments in the countries where they are located.
 In some countries, export credit agencies also provide financing support
 Cost is frequently more expensive than private insurers. Often avenue used
to obtain coverage for high-risk buyers that is not available in private market.
 Examples: EX-IM Bank or Export-Import Bank of the U.S., JEXIM or the
Export-Import Bank of Japan, and EDC (Canada).
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Examples of Private Global Insurers
Euler Hermes
Chartis/AIG
Foreign Credit Insurance Agency
(FCIA)
Atradius
Compagnie Francaise d’Assurance
pour le Commerce Exterieur (COFACE)
QBE Specialty Insurance
ACE
HCC Insurance Holdings Inc.
Zurich
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Public Export Credit Agency: EX-IM Bank
Established in 1934, EX-IM Bank is an independent government agency of the
United Sates headquartered in Washington D.C. with sales offices in NYC,
Miami, Chicago, Houston, Los Angeles and D.C.
Mission – support U.S. exports in order to create and sustain U.S. jobs with
reasonable assurance of repayment.
 Non-competition with private sector
 Products must have at least 51% U.S. content, including labor but excluding mark-up
Mandated Initiative
 Small business (85% of transactions)
 Africa
 Environment
 Minority Business
Available Products
 Working Capital Guarantee
 Short and Medium Term Insurance (Single buyer and multi-buyer policies available)
 Medium and Long-term Loans
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Benefit Summary – Credit Management Solutions
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Who Can Benefit from Credit Insurance?
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Any company that sells to other businesses on short-term open credit
terms of 180 days or less.
 Concentration of trade receivables
 Thin profit margins
 Growing sales due to market expansion and/or merger/acquisition
 Export sales
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Manufacturers, wholesalers, distributors, and service providers with
annual domestic or export sales of $3 million or more.
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Broad range of target industries including but not limited to:
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Machinery and Equipment
Metals
Pharmaceuticals
Life Sciences
Food Products
Electronics/Technology/Computers
Chemicals
Energy/Oil & Gas
Transportation/Global Logistics Firms
Telecommunications
Paper & Packaging
Consumer Goods
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Benefit Summary – Credit Management Solutions
Reduce Credit Risk and Improve Financial Planning
1.
Strengthen the balance sheet and safeguard sales and gross
margin. “The lower the gross margin percentage , the more
sales and production required to replace a bad debt.”
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ASK – What amount of loss would seriously hurt your company’s
financial stability or yearly profit? How many accounts are over this
amount?
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ASK – What percentage of total or current assets does your
customer’s accounts receivable represent?
2.
Secure the company cash flow and avoid the domino effect – a
large portion of business failures are directly attributed to
uncollectible accounts
3.
Reduce bad debt reserves and free up working capital to be
invested more productively
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Benefit Summary – Credit Management Solutions
Enhance Financing
1.
2.
Improve accounts receivable margining.
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ASK – Does your company rely on financing, collateralized by your
receivables, to fund working capital needs?
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ASK – Do you export products? Would you be interested in a way
to include foreign receivables in your lending base?
Reduce cost of borrowing
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ASK – Are you happy with the rate you pay with your current
lender? Is your operating line substantially used at this time?
Reduce bank security requirements
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ASK – Do you provide a personal guarantee to your bank? Do you
feel significantly over-secured at your bank?
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Benefit Summary – Credit Management Solutions
Expand Sales
1.
Expand sales to new, unknown or higher-risk customers and
new markets to which sales are currently restricted. Credit
insurance is a tool to increase incremental sales. The higher the
gross margin percentage, the greater the contribution from
incremental sales
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2.
ASK – Are there any new or higher-risk customers to which you
are restricting sales?
Improve export sales by selling on less restricted payment terms
(no need to require Letters of Credit)
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ASK – Do you have export sales? If so, which countries and under
what payment terms?
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ASK – Could selling on open account terms make you more
attractive to your potential client base and improve your
competitive position?
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Benefit Summary – Credit Management Solutions
Complement Credit Management Function
1.
Partnership with Credit Management
2.
Access to Risk Management System, Analysts and Evaluation
Intelligence
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ASK – Does your company currently utilize external resources in
your credit process? Which sources?
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ASK – How well do you know your customer’s customers? Do you
evaluate potential exposure to failures in the supply chain that may
adversely impact your customer’s ability to pay (domino effect)?
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Thank you
for your attention.
www.eulerhermes.com