Transcript Document

Managing Trade Risk and
Business Credit
Insurance
1 Hour Continuing
Education – Oregon
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 2
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?






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?
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 3
Risk Management - Business Failures
Bankruptcies are inevitable
Failures come from increasingly
unpredictable sources
−
−
−
−
−
−
−
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
−
−
2013| © Copyright Euler Hermes
4
Set off chain reaction that trickles
down
Demands resources to monitor and
manage beyond primary debtor
Oregon CE – 1 hour 4
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 day-to-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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 5
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 creditworthy 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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 6
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 7
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.



No need for letters of credit and collateral requirements on foreign shipments.
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 8
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 9
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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 10
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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 11
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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 12
Options to Manage Short-Term Credit Risk
Credit Insurance – commercial insurance product that
indemnifies a company against non-disputed losses from nonpayment 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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 13
Options to Manage Short-Term Credit Risk
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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 14
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 15
Lesson 2: Overview of a Business Credit Insurance
Policy
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 16
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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 17
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 credit-worthiness

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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 18
Policy – Purchasing a Policy
Submit a completed and signed application








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.
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 19
Lesson 3: Methods and Channels to Acquire Credit
Insurance
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 20
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).
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 21
Examples of Private Global Insurers
Euler Hermes
Chartis/AIG
Foreign Credit Insurance
Agency (FCIA)
Atradius
2013| © Copyright Euler Hermes
Compagnie Francaise
d’Assurance pour le
Commerce Exterieur
(COFACE)
QBE Specialty Insurance
ACE
HCC Insurance Holdings Inc.
Zurich
Oregon CE – 1 hour 22
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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 23
Benefit Summary – Credit Management Solutions
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 24
Who Can Benefit from Credit Insurance?

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

Manufacturers, wholesalers, distributors, and service providers
with annual domestic or export sales of $3 million or more.

Broad range of target industries including but not limited to:












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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 25
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.”

ASK – What amount of loss would seriously hurt your
company’s financial stability or yearly profit? How many
accounts are over this amount?

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
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 26
Benefit Summary – Credit
Management Solutions
Enhance Financing
1.
2.
Improve accounts receivable margining.

ASK – Does your company rely on financing, collateralized
by your receivables, to fund working capital needs?

ASK – Do you export products? Would you be interested
in a way to include foreign receivables in your lending
base?
Reduce cost of borrowing

3.
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

2013| © Copyright Euler Hermes
ASK – Do you provide a personal guarantee to your bank?
Do you feel significantly over-secured at your bank?
Oregon CE – 1 hour 27
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

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)

ASK – Do you have export sales? If so, which countries
and under what payment terms?

ASK – Could selling on open account terms make you
more attractive to your potential client base and improve
your competitive position?
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 28
Benefit Summary – Credit
Management Solutions
Complement Credit Management Function
1.
2.
Partnership with Credit Management
Access to Risk Management System, Analysts and
Evaluation Intelligence

ASK – Does your company currently utilize external
resources in your credit process? Which sources?

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)?
2013| © Copyright Euler Hermes
Oregon CE – 1 hour 29
Thank you
for your attention.