Attention given to trade credit insurance in Australia is normally quite low, but the financial crisis had put a spotlight on the subject. So what is credit insurance and how can it help your business? Unless you’re an exporter lucky enough to work on prepayment terms, you’d be familiar with the competitive advantage associated with offering generous credit terms to your international buyers. However, the worldwide economic downturn has changed the financial environment: customers are delaying payments and businesses are closing-so how can you ensure you are paid? "Credit insurance is what I would refer to as life insurance for companies," says Christian Vollbehr, general manager of insurance company Coface Australia. "It protects one of the key assets of the balance sheet, which is trade receivables." Trade credit insurance, also known as debtor insurance, indemnifies businesses against non-payment incidents and debtor insolvency. In the case of a non-payment incident, the insurer will typically pay the insured business the money owed-up to the amount covered by their specific policy-and then take measures to recover the money from the debtor. If the debtor is insolvent, the insurer will compensate the insured business and then become your buyer’s creditor. To take out a policy, you first need to conduct a risk assessment of your customers, usually undertaken in conjunction with the insurer. At this point, the insurer will be after key information to determine the financial health of your debtors and their exposure to risk factors. "If we're looking at an exporter, we'd have to get a spread of the countries that are involved," says Vollbehr. "We'd also need to get a list of the key debtors whether domestic or export. We make an upfront assessment on what kind of coverage we can provide on those specific debtors, under a named buyer policy." The more details you and your buyers can supply, the more comprehensive the assessment and more likely you are to receive coverage. Vollbehr says many debtors are uncomfortable with the level of scrutiny a risk assessment invites, but if you explain that a credit insurance policy allows you to give them more competitive credit terms, most of them are happy to open their books. Depending on your industry, your customers and the countries where they are located, your insurer will then calculate your premium. Vollbehr says to expect that amount to be between 0.15-0.4 percent of the insured amount, although this may increase due to higher risks in the current volatility of the world economy. "Unfortunately, non-payment incidents have doubled and the loss ratio between premiums received and claims paid has doubled. There are some sectors where there's a lack of capacity and capacity comes at a premium, so rates are going up because of the level of risk," he reports. Some industries are more exposed than others and may not find the coverage they require, he warns. Among these high risk sectors are building and construction, the printing industry and retail, particularly the jewellery business.
Small businesses need insurance
Regardless of industry, Vollbehr does see significant uptake of policies by smaller businesses, which he says reflects their awareness of their vulnerability. "SMEs need it the most because they can't take a large hit. If a company does $5 million in turnover and a key debtor that owes them $1 million goes out of business, and they don't have credit insurance, it probably means the company will follow them swiftly," he explains. "Credit insurance prevents the domino effect. The fact that some companies have credit insurance has a cushioning effect, they can weather the storm and do business as normal." For now, most commercial insurers only offer cover for up to 12 months due to global volatility. Vollbehr says this is the case with Coface Australia. "We'll take out a 12 month policy. There used to be multi-year policies but in the current environment it's hard to find multi-year commitments from anyone, so we do 12 months and then we'll make an assessment again," he notes. For medium and long-term credit insurance, exporters will need to turn to the government’s Export Finance and Insurance Corporation (EFIC). Several years ago, EFIC sold its interest in short-term credit insurance following a review showing that private companies had begun to provide businesses with access to sufficient short-term facilities. As part of its mandate, however, it is obliged to provide facilities in the market gap, which is currently for medium to long-term coverage "in markets and sectors where there is limited or no commercial market support," says Angus Armour, EFIC managing director. "The global market is constantly changing in response to events and evolving economic conditions. EFIC continuously adapts its products to meet the changing needs of exporters and their overseas buyers."
Cash flow insurance
Credit insurance can be used in conjunction with cash flow facilities such as invoice discounting or factoring, which are usually provided by financial institutions. While having credit insurance doesn’t reduce your payment cycle the same way as these debtor finance products, it can provide extra security to complement a cash flow facility. "The banks typically say ‘we'll lend you the money, but on the due date we'll debit your account. If the debtor hasn't paid, we will still debit you’. A company can tell the bank they have the policy in place so in the case of a non-payment, the bank can take claim of the payment instead. "The bank might then say ‘we can lend a bit more than [the standard] 80 cents in the dollar’ or at the time of the non-payment, ‘we will not debit your account because we know your insurer will make the indemnification’," explains Vollbehr. "You turn a recourse facility into a non-recourse facility backed by an insurance policy." To get the most from a credit insurance policy, Vollbehr says the insurer needs to work with your finance department, and the policy needs to complement any existing credit terms you have in place with your debtors, including proper notification of overdue accounts, before you can make a claim. "A policy should wrap around an existing policy that the company should have in place," he advises. "This product needs to be understood by companies capable of managing a credit insurance policy. It's a product that's used as an assistance to the credit department."
Where to buy
Credit insurers in Australia
- Atradius: www.atradius.com.au
- Coface Australia: www.coface.com.au
- EFIC: www.efic.gov.au
- Euler Hermes: www.oceania.eulerhermes.com
- National Credit Insurance (Brokers): www.nci.com.au
- OAMPS: www.oamps.com.au
- QBE: www.qbe.com.au
Do you need credit insurance?
If you answer ‘no’ to any or all of these questions, you should consider credit insurance.
- Do you have the capacity to assess your customers’ exposure to risk?
- Can you offer competitive credit terms and have confidence you will be paid?
- Are you confident that your largest debtors are capable of paying you on time?
- Do you have adequate contingencies to deal with late payments or non-payments?
- Are you confident that your key clients are not at risk of insolvency?
- Does your business have the capacity to manage debtors and collect debts as required?
- Can your business absorb all the risks to which it is exposed and still be profitable?