Trade Credit Insurance Eases CollectionRisks

By Gary S. Mogel

Bill collection risks for businesses and management, bestembodied in the shopworn phrase “the check is in the mail,” have aready insurance antidote available, according to experts.

The way to attain the security of knowing that receivables willbe paid, whether the check is in the mail or not, is trade creditinsurance, they said.

Thomas Raspanti, a trade credit insurance specialist broker andpresident of Cyber Risk Management LLC in South Plainfield, N.J.,notes that there are basically two types of coverage.

“Domestic trade credit insurance protects clients against therisk of not being able to collect their accounts receivables due tothe insolvency, default, or slow payment of their U.S. and foreigncustomers,” Mr. Raspanti explained.

“Export or international coverage is similar to domestic in thatit pays if debtors (in this case foreign debtors) can't, but italso has a political risk component,” said Mr. Raspanti. “Forexample, a foreign customer may be able and willing to pay, butcannot due to a trade embargo, currency inconvertibility, licenserepudiation, or some other event beyond its control.”

Price increases in the trade credit insurance market aremoderate–currently ranging from 15 to 30 percent for most types ofbusiness, according to Peter Aitken, vice president of trade creditfor the Chubb Group of Insurance Companies in Warren, N.J.

Business appears to be picking up, despite (or maybe because of)the slumping economy. “There is greater awareness of the economicand political risks companies face,” Mr. Aitken noted.

And the market for trade credit insurance is not just for largemultinational companies. “We have clients from $5 million totalsales and up,” said Ranjini Pillay, vice president of AIG eBusinessRisk Solutions in New York City. In fact, it is sometimes thesmaller companies that most need the protection because they can besignificantly harmed by the failure of one or two big customers,she noted.

Ms. Pillay related how, when AIG first started writing tradecredit insurance in the mid-1970s, the main clients were themultinationals with sophisticated credit management procedures. “Upuntil about three years ago, AIG was only writing at high levelsand reviewing clients' top 10 debtors, in effect reinsuring thecredit managers' decisions,” she said.

Then, she added: “The product range was broadened, and advancesin technology allowed us to write the smaller risks. AIG now offerstrade credit insurance to all companies, from multinationals tosmall- and medium-size enterprises.”

“Trade credit insurance can come into play if there is abankruptcy, forced liquidation, offer-of-compromise, or othernon-payment situation as defined in the policy,” Mr. Raspantisaid.

He noted that, “When the insurer pays a claim and the customeris bankrupt, the insured client assigns its right to the defaultedreceivables over to the insurer, which will either wait out thebankruptcy proceeding or sell the receivables at a discount.

“In the case of slow pay or protracted default, the insurer mayfirst serve as a collection agency for the insured.”

“One thing you have to realize is that no debtor wants to getinto a trade credit insurer's database as being a problem payer,”Mr. Raspanti explained. “That can substantially impact the debtor'sability to transact business on open account credit terms.”

Mr. Raspanti stressed that there is no coverage under tradecredit insurance if the payment is merely disputed–such as adisagreement between the insured company and customer over theamount owed, or a complaint about the goods or services being paidfor. “Disputes, charge-backs, deductions and such that happen inthe normal course of business are not covered,” he said.

Insurers in the trade credit arena have different underwritingapproaches, Mr. Raspanti said, noting that differences can relateto what's being covered.

“A client can decide to cover the entire receivables portfolioor segregate certain debtors, such as by having a 'key accounts'program covering the top 10 or 20 customers.”

“When clients segregate their accounts receivable portfolio, itmust be done in a manner that does not adversely select against theunderwriter. Otherwise, the insurer may be reluctant to quote ormay quote terms that the prospective insured finds unacceptable,”he said.

“For an initial quote, the underwriter may analyze the top 10debtors, and then if the client is interested in the coverage,research the credit portfolio deeper. At some point, it is theclient's credit-granting procedures that are being underwritten andnot every individual debtor.”

Mr. Raspanti adds that “some programs allow the underwriter tocancel coverage on a going-forward basis on specific debtors if theinsurer discovers that the debtor is in financial difficulty.

“The point is that the insured client should not continue toship goods to an already distressed debtor.” Coverage would ceaseas to new orders, not ones already shipped before the cancellationdate, Mr. Raspanti said.

Other factors at play, experts in the trade credit market said,are global economic and political conditions.

“A global political environment characterized by an increasedlevel of economic uncertainty,” according to AIG's Ms. Pillay,“affects many companies' credit and payment decisions.”

Because business activity with Iraq was already illegal for U.S.companies, the war won't harm them as far as Iraqi debtorsdefaulting is concerned, Chubb's Mr. Aitken pointed out. However,other Middle East countries where U.S. companies do have debtorsmay be affected by the war and experience political or paymentproblems, he added.

As far as underwriting new and renewal business in thewar-affected region, Mr. Aitken said that each insurer has its ownterms and conditions, and that coverage has not dried up.

It has mainly been the recent spate of bankruptcies of companiesof all sizes that has most affected the market for trade creditinsurance, according to Ms. Pillay. “The highest bankruptcy ratesare in the United States and this has increased the demand fortrade credit coverage,” she said.

Last year's accounting scandals have influenced how carriersmake insurability decisions, Mr. Raspanti indicated.“Understandably, the underwriting landscape changed when thecredibility of [the] basic information [that] underwriters relyupon came into question,” he said.

Western Europe, which is also experiencing its share ofbankruptcies, was cited as another problem area by Ms. Pillay. Asiain general (especially China), Mexico and high-inflation LatinAmerican countries were also mentioned as risky areas for tradecredit.

Chubb's Mr. Aitken cited Germany and France as “high-riskeconomies” due to unemployment and bankruptcies. In Latin America,he noted that Argentina and Brazil could present problems due topotential currency devaluations, which may hamper firms there frompaying in U.S. dollars.

In Asia, economic conditions in Japan and currency problems inIndonesia have affected trade credit insurance, he said.

“North Korea is another country where it has been illegal forU.S. companies to do business,” Mr. Aitken said. So while U.S.companies should have no defaulting debtors there in the event of amilitary conflict, other countries in the region may beaffected.

Mr. Raspanti offered insights into why trade credit insurance isnot yet as well known as it should be among insurance and riskmanagement professionals.

“Coverage is generally sold to the finance side, and less so tothe risk management side. Programs are often put together withoutever seeing the risk manager.” The coverage is more common inEurope than in the United States, but continues to gain recognitionhere, he said.

Reproduced from National Underwriter Edition, April 7, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved. Copyright in this article as anindependent work may be held by the author.