At long last, credit insurance gets its due

Risk & Insurance, April 15, 2005 by John Williams

Historically, U.S. companies tended to purchase credit insurance when the economy was weak to gird themselves against the risk of a customer going bankrupt. In the midst of a stronger economy, however, companies still see value in credit insurance. But buyers should educate themselves on the details of credit insurance before making a commitment.

While some companies may allow their credit and collections managers to purchase credit insurance on their own, most realize the value of having risk managers become part of the process.

Credit insurance is the guarantee of accounts receivable against nonpayment or slow payment. Policies generally cover bankruptcies, liquidations, receiverships or other insolvencies.

International policies generally cover losses due to political instability, currency inconvertibility, embargoes, acts of war and natural disasters.

One of the most common reasons companies purchase credit insurance is that it allows them to increase their sales by expanding credit lines to existing customers and/or adding new customers.

Another benefit is that it can supplement a company's credit analyses through third-party evaluations of your customers' and prospects' credit risks.

If you purchase export credit insurance, for example, the coverage provides market monitoring of countries where you sell a product or a service. It also allows you to sell on open terms with international customers, reducing or eliminating the need for the letters of credit. These are often costly and time-consuming, and can even restrict the growth of your business with certain customers.

GROWING IN POPULARITY

Despite the benefits, credit insurance has garnered only limited interest in the United States. Fewer then 5 percent of U.S. companies even buy credit insurance policies. But such policies have always been popular in Europe, where about 70 percent of companies routinely purchase the coverage.

"One reason for its popularity in Europe is that companies there have always tended to sell their products across borders," says Gene Ferraiolo, a partner with Trade Risk Group in Broomall, Pa., a credit insurance brokerage firm. "In addition, banking and insurance products have been intertwined in Europe for a long time, so it has been easy to bundle credit insurance with loans."

"There has always been cross-border risk in Europe," says Peter L. Aitken, vice president of trade credit for The Chubb Group of Insurance Cos., in Warren, N.J., which issues credit insurance. "On the other hand, the domestic market in the United States tended to be large enough for companies that they didn't need to export."

But that's changing now, says Aitken. That's because more companies have become aware of its availability, and the weak dollar is helping U.S. exports in a world rife with political instability. Also, companies are finding themselves selling to fewer customers due to consolidation, and that creates larger exposures. Accounting scandals and bankruptcies have also rocked large, seemingly secure companies, and Sarbanes-Oxley has left companies more accountable for their risks.

"The reason credit insurance is gaining popularity in the United States, even in these stronger economic times, is that companies are recognizing they have huge risks in their accounts receivable portfolios that need to be managed on an ongoing basis," says Chubb's Aitken.

TWO PHILOSOPHIES

Cookie cutter credit insurance policies don't exist. Each is unique, based on the carrier offering the policy and the needs of the client.

While a qualified broker can help lead a buyer to the right carrier and the right policy, it is important to understand the broad categories of offerings to start with.

First, there are two basic underwriting philosophies, says Mare Wagman, managing director with the credit insurance brokerage firm Cyber Risk Management LLC.

One is the "limits" approach, which quantifies risk ratings for clients. "This is suited to small and midmarket companies that want to outsource their credit decision-making process," he says.

The other is the "excess of loss" approach, which insures against catastrophes and is better suited to clients with complex internal credit procedures.

Policies also have various structures, payment options and custom endorsements. One is a "whole turnover policy" which covers the client's entire accounts receivable portfolio. Another is the "named policy," which covers a client's largest accounts. A third is "single customer" coverage.

In addition, policies can be written to cover domestic business only, export business only, or a combination thereof.

Some policies will just cover bankruptcies. Others can be broadened to cover protracted default situations, where a customer is "stringing out" the client for an extended period.

"Most insurance contracts allow claims in situations where customers are not paying, even though they are not filing for bankruptcy," says Ferraiolo. "This is under the general heading of 'protracted default.'"

Of course, if a debt is not being paid because of a dispute, the insured needs to work out the dispute before insurance would apply.