On the Frontline of Risk Mitigation
A Policy Application
What can be insured with Receivables Insurance?
Receivables Insurance insures against the risk that a buyer does not pay. It can also cover the risk that a buyer pays very late. A buyer will not pay after he has been declared bankrupt, insolvent, or a similar legal status. Similarly buyers sometimes opt for a bankruptcy protection arrangement, which allows them to delay payments for an extended period. Both instances are covered under a Receivables Insurance policy. Receivables Insurance policies can include a wider range of cover, depending on the circumstances. Some policies consider a delay in payment to also be an insolvency (so-called protracted default cover). If a buyer does not pay, the Receivables Insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.
Receivables Insurance policies are flexible and allow the policyholder to cover the entire portfolio or just the key accounts against corporate insolvency, bankruptcy and bad debts. The most common type of cover is so-called Whole Turnover Cover, which covers all buyers of the policyholder.
The credit risk that is insured has to have a direct link with an underlying trade transaction, i.e. the delivery of goods or services. If no such direct link exists, the outstanding amount is not insurable under a Receivables Insurance policy.
To be insured, transactions may not be subject to disputes. Parties are usually requested to resolve any dispute, prior to involving the insurer.
A domestic credit insurance policy addresses the payment risks from buyers that are established in the same country as the seller. So-called domestic policies usually have low premium rates and a relatively simple structure.
This is the risk that a buyer cannot pay or that goods cannot be delivered due to circumstances outside of your or your buyer’s control. These circumstances usually include war, terrorism, riots, and actions by (local) governments, such as changes in export or import regulations that affect the outcome of the transaction. Some policies also include natural disasters as a cause of loss under this heading. There may be a risk that money cannot be transferred from one country to another due to measures taken in the country where your buyer is based. This is also considered a political risk. Failure to pay by a public buyer is always considered a political risk.
Trade credit insurers that insure export risks normally also offer so-called political risk cover. This is the risk that payment cannot be made due to actions by a foreign government, transfer restrictions, or insolvency of a government buyer. Political risk insurance used to be offered through government backed schemes, either through export credit agencies or companies acting on behalf of their government. In the 1990s private reinsurance companies started to include political risk cover in their reinsurance treaties, making these risks marketable, and eliminating the need for further government involvement. Many Receivables Insurance companies now offer comprehensive political risk cover as part of their standard policy wording.
War disrupts an entire country and often makes it impossible for buyers to pay their bills. War cover forms part of political risk cover, and insures against this risk.
Companies that are generally not worried about not getting paid may have a few large buyers that can cause concern in case they cannot or will not pay. Receivables Insurance policies can be structured to cover only these exceptional losses, without including every receivable the company has.
Companies that are concerned about only a few of their buyers often opt for a Receivables Insurance policy that covers only those buyers. Alternatively high thresholds or retentions in a policy aim to fulfill the needs of those companies that are only concerned about very large losses.
This usually applies to large or complex contracts, although single transaction cover also occurs in other circumstances. This type of cover is particularly useful for companies that deal with only one buyer or that have very few transactions.
Payment from a buyer can be obstructed as a result of strikes, protests, or other civil unrest. With a Receivables Insurance policy that includes the cover of political risks, not getting paid as a result of these occurrences can be avoided.
Buyers sometimes opt for a bankruptcy protection arrangement, known as CCAA in Canada, Chapter 11 in the USA and under different names in other jurisdictions. Such an arrangement allows the buyer to delay payments for an extended period. This occurrence is considered to be an insolvency and is covered under a credit insurance policy.
A change in government in the country of the buyer, may lead to a change in politics. In case the buyer is nationalized, his payment obligation may be subsequently cancelled. Payment can be assured through political risk cover.
The risk or the inability to transfer money from one country to another, and therefore for not getting paid can be insured under so-called political risk cover.
Receivables Insurance policies are drafted to suit your needs. This makes them unique for each customer. A trade credit insurer will always investigate your particular circumstances and wishes. The result is a custom made policy at a corresponding affordable premium. Most trade credit insurers also offer standard policies, which may be more suitable depending on the trade to be insured. Many trade credit insurers have developed particular policies aimed at small and medium sized enterprises (SME). These policies have low administration, and are competitively priced.
All trade credit insurers offer information on their products through their websites. Often policy wording or non-binding quotes can also be obtained on-line. Custom made quotes and policies can be obtained either on-line or directly from the insurer. Brokers, in particular specialized brokers or brokers with a specialized Receivables Insurance department, also offer non-binding indications upon request.
Insurers have different ways of insuring receivables. Policy holders can often choose smaller or larger risk sharing options. Policies that are currently offered can cover domestic sales as well as world-wide sales, depending on the wishes of the customer. Customers can often choose between insuring a single transaction or all their sales. All these factors influence the premium rate widely. Insurers offer a free quote without any obligation, either on-line or from dedicated sales staff.
Receivables Insurance is priced on the basis of standard actuarial techniques. It is sold mostly on a whole turnover basis (whole turnover cover policy) and premium rates are generally given as a percentage of the company’s turnover (including financially sound and weak customers). Obviously, the future turnover is not known at inception and so the premium is not known either. Therefore, a minimum premium amount is usually an integral part of the contract.
Multinationals want to benefit from their buying power. They look for seamless cover across borders, but with local service in local currency and local language. At the same time group exposures should be constantly monitored. Multinational Receivables Insurance programs are offered by many trade credit insurers and provide just that. These often include single wording with policies issued in different languages and/or currencies to suit the needs of the different subsidiaries.
Many trade credit insurers offer policies aimed at small and medium sized enterprises (SMEs), which contain simple language, are competitively priced, and have low administration. Often these policies are available on-line, directly from the insurer.
The maximum liability amount is used to limit the loss that can be sustained through one single policy. If the total loss of a policy occurring in one year exceeds the amount of the agreed maximum liability, the actual loss for this policy is limited to this amount. The maximum liability is often defined as a multiple of the earned premiums in a given policy contract.
A whole turnover Receivables Insurance policy includes all buyers and insures against non-payment. Because of the spread of risk, premium rates are usually competitive. The entire buyer portfolio is constantly being monitored, and suppliers are advised about the state of every buyer.
The failure by a buyer to pay the contractual debt within a pre-defined period calculated from the due date or extended due date of the debt.
There is no clear definition of what credit management is. It is usually regarded as assuring that buyers pay on time, credit costs are kept low, and poor debts are managed in such a manner that payment is received without damaging the relationship with that buyer. A Receivables Insurance company does all that. Either directly or in conjunction with a company’s credit department. An approved credit management policy can offer assurances to a financing bank, which may facilitate financing.
Suppliers that deliver goods and/or services on credit will have to manage this credit risk to ensure that payment is received on time. Several tools come to the aid of today’s credit manager. These can be used as additional security to existing credit management procedures. If no procedures are in place, these tools can assist in setting these up.
One of the most important credit management tools is reliable up to date buyer information. A supplier only sees one side of his buyer. Independent information is essential for efficient credit management.
A buyer may be sound, but the country he is in may be experiencing problems. Country reports detect trends and alert exporters before serious problems arise in a particular country.
Suppliers need to manage their outstanding receivables. This can be done through complex financial solutions. Alternatively companies can insure against bad debts through a Receivables Insurance policy, obtain detailed market intelligence, implement ledger management, factor, or seek professional help in recovering debts.
Pro-active debt collection procedure has a high success rate. A buyer may be in difficulty, but the supplier can still control payments, provided professional debt collection procedures are in place. Most Receivables Insurance companies either offer debt collection services, or have partnered with specialised collections firms.
By transferring receivables, this financial technique makes it possible for companies to fund all or some of their invoices and thus cover their operating capital requirements; obtain cover against their customers’ insolvency; obtain payment of receivables with shorter payment terms; obtain information on their customers’ financial soundness; outsource or vary their administrative expenses; and optimize current assets and liabilities.
Outstanding receivables are usually the largest or second largest item on a trading company’s balance sheet. Bad debt losses can affect liquidity and profits. Even worse, they can spell a company’s mean financial ruin. Late payments or non-payments therefore pose a considerable threat to future liquidity of that company if no measures are taken. By insuring these receivables against non-payment or late payments, the company ensures its cash flow. Companies that have their business financed by a bank can assign their Receivables Insurance policy to their bank as a security.
The most common reason for not getting paid is that a buyer goes bankrupt before payment is due. Through a Receivables Insurance policy a company can assure payment, either from their buyer or from their insurer. Bankruptcy, or its equivalent depending on the jurisdiction, is a recognized cause of loss in Receivables Insurance policies, and triggers the start of the claims and collections process.
Receivables Insurance covers against the risk of not getting paid following insolvency. Normal payment ceases when a buyer is declared bankrupt, when a receiver is appointed, or when a bankruptcy protection period is announced. These and similar occurrences are regarded as “insolvency”.
There can be several reasons why a customer does not pay. A Receivables Insurance policy insures against the fact that your buyer is declared bankrupt or has agreed to a bankruptcy protection arrangement. Your customer can just be slow in paying. Efficient collection can help out in this case. In some cases your customer has paid, but it is not possible for the money to reach your bank. Or your customer has never received the goods you have sent, and does not pay for that reason. You can insure yourself against these risks by including so-called political risk cover.
If a buyer is late in paying his bill, an established collection procedure is called for. Most companies have internal guidelines on how to deal with late payers. However, sometimes these efforts do not have the desired effect. In these instances it can be helpful to employ a professional collection agent. Recovery approaches include telephone calls, written demands, and visits to the buyer’s premises. Most Receivables Insurance companies either offer debt collection services, or have partnered with specialized collections firms.
DOMESTIC & EXPORT RECEIVABLES INSURANCE
Receivables Insurance covers payment risks resulting from trade with buyers. If the seller or policyholder decides to only insure his trade with buyers situated in his own country, the cover is referred to as domestic credit insurance. This type of cover usually insures against non-payment as a result of insolvency (bankruptcy). It can also insure against the risk that payment is not received after an agreed period (usually 6 months) (protracted default).
Receivables Insurance covers payment risks resulting from trade with buyers. If the seller or policyholder decides to only insure his exports, i.e. his trade with buyers situated in other countries than his own, the cover is referred to as Export Credit Insurance. There are many additional risks if payment is due from a buyer in another country. Not only is it more difficult to determine the buyer’s current status, many instances may occur that prevent payment taking place. Riots, war, exchange restrictions or changes in import regulations can determine whether payment can be expected or not. An Export Credit Insurance policy addresses all these and other risks.
Export risks often include so-called political risk. Political risk is not insured in domestic policies. In the past this distinction was of importance, because political (export) risk cover was normally only obtainable through government programs, either offered by an Export Credit Agency (ECA) or through a private company with a reinsurance arrangement with their national authorities. The result was that the customer needed two separate and different policies: one for his domestic trade and one for his exports. This resulted in extra administration and the need to be aware of the different conditions and requirements in each policy. For many years cover has been available from the private market for both commercial as well as political risks. This means that customers can now insure their domestic and export credit risks in one single policy. Particularly in the case of multinational traders this is of value as the distinction between export and domestic risks is often irrelevant for these enterprises.
The trade credit insurer issues a credit limit for every buyer with whom the policyholder trades. The level of the limit is set at the maximum amount that can be owed by the buyer at any time. Limits are granted at a lower level, if the underlying information justifies this. The granted credit limit is the maximum insured credit line for a specific buyer and the policyholders can trade on an insured basis within the approved credit limit throughout the policy period without further reference to the insurer. If a discretionary limit has been agreed, exposures up to that amount do not have to be agreed by the insurance company but are covered based on the payment experience of the policy holder.
The insurance company has the right to reduce or cancel a granted limit at any time, usually as a result of negative information. This allows the exposure to be brought down in a timely manner, as negative news (such as deterioration in payment behavior) is known immediately. A new limit will apply to all deliveries that are made by the policyholder to the buyer after the date of the trade credit insurer’s decision to reduce or cancel a limit.
Trade credit insurers are not always aware of the identity of all the insured buyers or debtors of their clients (specifically the smaller ones). Policyholders are normally given a discretionary amount up to which they may trade under the cover of the policy without notifying the insurer. Any exposure exceeding this discretionary amount is known by the underwriter and confirmed by means of a written credit limit.
Trade credit insurers are not always aware of the exact usage of the granted credit limits, although average usage is known, and high risk exposures are actively monitored.
Fundamental differences between the banking and the Receivables Insurance business exist not only with respect to the contractual relationship between the institution and its credit user but also with respect to the risk taken. A trade credit insurer does not issue a credit to a company, but issues a conditional insurance policy.
Mastery of sophisticated financial analysis and data management techniques is a key success factor in Receivables Insurance, as is global-scale service provision. Multinational trade credit insurers have local teams based throughout the world to evaluate the financial position of buyers worldwide on a daily basis.
The risk is diluted through insurance techniques and risk sharing, by moving a larger or smaller part of the risk to a reinsurer. Insurance techniques are used to mitigate the risk and avoid moral hazard & adverse selection. These include assuring an adequate spread, regionally as well as over sectors, dynamic risk management, agreed maximum liabilities as well as risk sharing agreements and debt collection.
A Receivables Insurance policy is a conditional insurance contract between two parties that cannot be traded. A financial guarantee is unconditional, usually on-demand, and transferable.
A trade credit insured risk is always directly related to an underlying trade transaction, which is either the delivery of goods or of services. The correct fulfillment of this trade transaction is essential for trade credit cover to exist.
A financial guarantee is independent and does not rely on any third contract.
Trade credit insurers insure against the risk of non-payment. Most insurers also offer additional products, such as collections services, buyer/country rating, portfolio assessment and securitisation.
A factoring company buys receivables. It may also be used to outsource some of the activities of the credit department. The purchase of receivables ensures payment at a fixed date and makes it possible for companies to fund all or some of their invoices and thus cover their operating capital requirements; obtain cover against their customers’ insolvency; obtain payment of receivables with shorter payment terms; obtain information on their customers’ financial soundness; outsource or vary their administrative expenses; and optimize current assets and liabilities.
A factor company does not provide cover against non-payment on its own. Many factor companies partner with Receivables Insurance companies with regard to providing this cover.
Marketable Risks is a term used in the European Union and refers to those country risks, which are covered by private Receivables Insurance companies without the support of their government. Consequently, Non-Marketable Risks are those country risks for which no cover is available in the private market. Nowadays few country risks are non-marketable. Trade credit insurers determine their position on each country in the world, by underwriting the risks in the country in question based on its economy, stability, currency and payment statistics. As a result, only countries that are at war or that can be considered to have failed economies are usually off cover, and therefore non marketable (e.g. Iraq, Zimbabwe). Country risks are reviewed continuously which can result in changes, making previously non-marketable risks marketable. The reverse is rarely the case, and is usually the result of armed conflict or economic meltdown.
Following an IASB amendment regarding IFRS 4 Insurance Contracts and IAS 39 Financial Instruments, Receivables Insurance contracts can be accounted for under the Standard for Insurance Contracts (IFRS 4).This will be reviewed in phase 2 of the IASB project.