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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.

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 Marc 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.

"In general, the insured can report a situation to the underwriter when a customer is 60 days past due," he says. The insured can try to collect on his own, hire a collection agency or send the account to the underwriter for collection. "The insured must act within a certain window, though, before it can be considered a protracted default claim."

If disputes have been resolved, but collection efforts are still unsuccessful, then the underwriter will typically pay off the claim. What about if a customer is staring at bankruptcy?

In the case of imminent bankruptcy, the underwriter will cover the existing business its client has with that company.

"However, it will probably not cover any new business the client may want to do with the distressed company," Ferraiolo says. "The underwriter is, in effect, sending up a red flag to the insured that this customer is no longer a prudent credit risk."

FILLING A NEED

Virtually all credit insurance brokers and carriers will tell you that your company needs credit insurance, just as it needs other types of business insurance. However, there are some situations where credit insurance may not be of any value.

"You probably don't need credit insurance if you have a very broad base of customers and have no significant exposure within that portfolio," says Ferraiolo. "An example would be having hundreds or thousands of customers with none of the accounts any higher than $5,000 or $10,000 in exposure. In other words, credit insurance is best looked at as catastrophic protection."

It may not be useful if you have a lot of high-margin, low-volume accounts. In these situations, you're turning your accounts receivables quickly, and you have a high margin to begin with.

While rates will vary from carrier to carrier from year to year, based on the type of coverage you purchase rates for, domestic coverage will range in general anywhere from 10 cents to 50 cents per $100 of sales. International rates generally vary from 25 cents to one dollar per $100 of sales.

There are ways to keep premiums low. One way is to retain more risk on your own. "The more risk you transfer to the insurer, the higher the premium," says Ferraiolo. "The role of a good broker is to help the client find the balance that is right for them."

An example of risk retention is coinsurance, where the insurer pays only a percentage, such as 80 percent to 95 percent, and the client retains the remaining 5 percent to 20 percent as a copayment. Deductibles are another option. And, of course, keeping claims low should keep premiums low. Buyers who are considering credit insurance, here are several recommendations to get you started:

First and foremost, don't wait until the last minute to try to buy credit insurance, such as when you have a distressed customer.

"Credit insurance should be a proactive purchase, in that you have coverage in place before a customer becomes a credit problem," says Ferraiolo.

Decide how many accounts you want to cover. This could be all of them or just selected ones. Is there an advantage to the former? "Some clients want to cover all of their accounts, using a 'discretionary limit' feature," says Ferraiolo. "This allows the company to grow its business with smaller accounts where initial orders may be relatively small."

Decide whether you want to cover domestic and export business, or just the latter. Many companies, in fact, retain 100 percent of their domestic accounts receivables risk and only cover their export accounts.

"Export insurance is more popular than domestic," says Wagman. "In fact, 40 percent to 50 percent of our clients purchase insurance for export accounts only."

Use A Broker

Don't shop around for an insurance carrier. Instead, shop around for a good broker, who will then help you select the best carrier. A good broker can guide you to the most appropriate carrier for your needs.

In talking with your broker, determine the type of carrier with which you want to do business, in terms of how active you want the carrier to be in your business.

"You may want one that is an active partner in your credit management program," says Ferraiolo. If so, select an underwriter that offers an "explicit policy" which actively underwrites accounts and provides specific credit limits.

However, if you just want "backstop protection" in the event of an excess of loss in any given year, then ask your broker to steer you toward an underwriter that offers an "implicit policy."

Here, you have more flexibility in granting credit to your accounts, but there is more conditionality attached to coverage.

"Here, the underwriter acts as backstop protection, rather than an active partner," Ferraiolo also adds.

JOHN WILLIAMS, an Indiana-based freelance writer and author, is a frequent contributor to Risk & Insurance®.

April 15, 2005

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