Relegating letters of credit to the dustbin: credit insurance and advanced financing are gaining wider favor in global trade, and sound risk management practices are finding favor with U.S. exporters. Banks and underwriters are cheering because the trend increases lending capacity and enhances an underused asset class

Risk & Insurance, Nov, 2004 by Gregory DL Morris

Overt lack of trust is no way to start any relationship, but that is exactly how international markets are coming to view traditional letters of credit (LC). Once the sine que non of international trade, the LC has largely been supplemented and even replaced in Europe by trade credit insurance. This practice is now gaining currency in the United States and elsewhere in the world.

Trade credit has been around for decades in the United States, but it was never a major business for underwriters because most small and midsize manufacturers did the bulk of their business domestically. There is a significant domestic market for receivables insurance and financing. Indeed, it represents the majority of business in this sector for some carriers. But it tends to be a stable, quiet business. Trade credit was always bigger in Europe because of the many small exporters in many small countries.

"But with a lot of change in the U.S. economy and greater emphasis paid to comprehensive risk management, trade credit insurance is making inroads in the United States," says Peter Aitken, vice president of trade credit insurance for Chubb. That carrier serves the middle market with a minimum premium of $25,000 to cover $10 million or more in receivables.

By another underwriter's estimate the total credit insurance market in the United States stands at about $400 million to $500 million in annual premiums, covering sales of roughly $400 billion. That range reflects a wide variation in premiums. In contrast, the European market stands at about 83 billion to $4 billion in annual premiums. Another underwriter cites industry surveys showing the business growing about 10 percent a year. That may be a strong growth rate, but it is out of a small base. And even with U.S. exports flat, they represent a $700 billion market that is nowhere near fully served.

The effects of growing trade credit insurance are large, and in a rare case of true synergy, favorable to almost all parties. Sellers/exporters who technically buy the coverage report no trouble in passing along the cost to the buyer/importers--sometimes as a specific line item in the bill, but more often as part of the overall cost. Buyers, or importers, are generally content to pay the premiums because it usually nets out to substantially less cost in time and money than the traditional letter of credit.

Insurers, of course, are only too happy to write more new business; and in some cases the coverage leads to what amounts to a consulting relationship with the client. Even banks, which obviously stand to lose a traditional revenue stream from LCs, are broadly favorable. The biggest commercial institutions have been doing business on open accounts for years with multibillion-dollar trading partners.

REGIONAL BANKS GAIN THE MOST

Small to midsize exporters and regional banks have gained the most. Sellers of modest size are in a better position than ever to venture deep into international markets. And the regional banks that often serve their local industries and entrepreneurs no longer have to wave from the quayside when their clients do business overseas. With insured or financed receivables, they can now take a larger role in their clients' business.

One such bank is M&T, based in Buffalo. "Open accounts facilitate trade," says Charlie Murphy, vice president of international banking. "But people have to think more. It increases options, but it also increases responsibilities. The use of insurance also puts banks into a new role. Instead of just coming to us with or for LCs, clients are asking us to help them do something with their assets. The banks that appreciate the use of insurance are really in a position to help their clients."

Another option, especially for small businesses seeking export markets in developing countries, is the U.S. Export-Import Bank. John McAdams, senior vice president, says ExIm's working capital program has been particularly successful in supporting open account financing. Average transaction size is $1 million to $2 million, but there are no minimums or maximums. "We are not in competition with other lenders or insurers," says McAdams, stressing that is not the ease with analogous agencies in other countries. "We are instead the lender or insurer of last resort."

TWO MODELS THAT MATTER

There are basically two models for underwriters in trade credit, says Aitkin at Chubb: The American model is a straight transaction where the exporter buys coverage as necessary. Under the European model, the underwriter becomes an extension of the exporter's credit office--or in some eases for small manufacturers, the entire credit office. "We prefer not to interfere with our insureds," says Aitkin. "Our customers know their customers. But carriers on both sides of the Atlantic write both styles of business."

"The use of LCs is extremely unfriendly to the customer," says Michael Ferrante, president of Coface North America Insurance Co., based in New York. "When you ask a buyer to pay up front or post a bond, you are essentially saying you don't trust him. LCs also limit trade because they cut into the buyers' credit." Coface is a subsidiary of Natexis Banques Populaires and the Banque Populaire Group.