Trade Credit Insurance Eases Collection Risks

By Gary S. Mogel

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

The way to attain the security of knowing that receivables will be paid, whether the check is in the mail or not, is trade credit insurance, they said.

Thomas Raspanti, a trade credit insurance specialist broker and president 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 the risk of not being able to collect their accounts receivables due to the insolvency, default, or slow payment of their U.S. and foreign customers,” Mr. Raspanti explained.

“Export or international coverage is similar to domestic in that it pays if debtors (in this case foreign debtors) can't, but it also has a political risk component,” said Mr. Raspanti. “For example, a foreign customer may be able and willing to pay, but cannot due to a trade embargo, currency inconvertibility, license repudiation, or some other event beyond its control.”

Price increases in the trade credit insurance market are moderate–currently ranging from 15 to 30 percent for most types of business, according to Peter Aitken, vice president of trade credit for 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 economic and political risks companies face,” Mr. Aitken noted.

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

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

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

“Trade credit insurance can come into play if there is a bankruptcy, forced liquidation, offer-of-compromise, or other non-payment situation as defined in the policy,” Mr. Raspanti said.

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

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

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

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

Insurers in the trade credit arena have different underwriting approaches, Mr. Raspanti said, noting that differences can relate to what's being covered.

“A client can decide to cover the entire receivables portfolio or 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, it must be done in a manner that does not adversely select against the underwriter. Otherwise, the insurer may be reluctant to quote or may quote terms that the prospective insured finds unacceptable,” he said.

“For an initial quote, the underwriter may analyze the top 10 debtors, and then if the client is interested in the coverage, research the credit portfolio deeper. At some point, it is the client's credit-granting procedures that are being underwritten and not every individual debtor.”

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

“The point is that the insured client should not continue to ship goods to an already distressed debtor.” Coverage would cease as to new orders, not ones already shipped before the cancellation date, 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 increased level 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 debtors defaulting is concerned, Chubb's Mr. Aitken pointed out. However, other Middle East countries where U.S. companies do have debtors may be affected by the war and experience political or payment problems, he added.

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

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

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

Western Europe, which is also experiencing its share of bankruptcies, was cited as another problem area by Ms. Pillay. Asia in general (especially China), Mexico and high-inflation Latin American countries were also mentioned as risky areas for trade credit.

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

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

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

Mr. Raspanti offered insights into why trade credit insurance is not yet as well known as it should be among insurance and risk management professionals.

“Coverage is generally sold to the finance side, and less so to the risk management side. Programs are often put together without ever seeing the risk manager.” The coverage is more common in Europe than in the United States, but continues to gain recognition here, he said.

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

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Trade Credit Insurance Eases Collection Risks

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