Better to Receive

In the early 1990s, there was one major underwriter of receivables insurance (also known as trade credit or accounts receivable insurance) and two minor insurers based in the United States with insignificant activity in the Canadian market.

Fast forward to 2014 and there are seven insurers – all with significant Canadian offices and all aggressively competing for growth. In just over 20 years, gross written premium has grown from approximately $15 million to $20 million to in excess of $200 million.

The upward trend for receivables insurance continues in 2014. To the end of June 2014, the value of premiums in Q2 compared to Q1 rose 87.5% to $105.3 million. The number of receivables insurance polices in effect increased quarter over quarter by 5.9% to 6,833.

The figures are provided by the Office of the Superintendent of Financial Institutions and Export Development Canada.

Still, it is estimated that Canada’s market penetration with companies that could buy receivables insurance is less than 10%, and this segment still remains relatively unknown, especially to commercial insurance brokers.

In European countries where receivables insurance has been heavily sold for 40 or more years, however, penetration rates are in the range of 30% to 40%.

Accounts receivable often account for upwards of 40% of a company’s assets. Other assets – such as plant and equipment, and inventory – are always part of the basket of assets that are insured, and yet receivables are the most liquid asset, often posing the biggest threat to a company’s existence should a loss occur.

There is a mystique to this product, but there should not be. Its premise is simple and the benefits tangible and measurable.

COMPETITION ON CREDIT

Most products and services are sold on what are called open account terms. That is, the supplier extends credit to the buyer of the goods by offering a defined period of time to pay for the goods. This time period could be 30, 60 or 90 days.

Credit is important because it is a competitive tool for trading companies. Competition takes place as much on the basis of credit as it does on price. This is because for most companies, cash flow is crucial.

A company will always look for a period of credit from its suppliers to help improve cash flow. However, this will, in itself, affect the cash flow of that supplier.

Credit is, therefore, simply a business necessity. The problem comes when the payment does not arrive when agreed. The company that has given the credit will have made the assumption that the sale has been made, or the service provided, and, therefore, payment will be made. In fact, it may have borrowed money from a lender on that basis.

If that payment is late, or is never made, the company will suffer, and potentially could go out of business.

To avoid that, there are two basic commercial risks covered by receivables insurance:

Late payment – Late payment is a growing business risk. Not only does it affect the company’s finances and balance sheet, it also affects it in terms of the time spent chasing the payment.

Insolvency – Insolvency of a buyer is even more devastating for companies. In such an event, it may prove impossible to recover any, or a substantial part, of the debt, meaning the debt will have to be written off. This is money that the company has already assumed it had, and it will, therefore, have to create considerable new business in order to make up for the bad debt.

The receivables insurance policy also excludes certain risks and losses. In general, these are as follows:

•non-payment related to a dispute between the buyer and the seller;

•non-payment caused by the supplier’s own failure to meet its obligations under the contract or to comply with the law;

•inter-company trade transactions;

•trade transactions with private individuals (i.e. business to consumer, or B2C);

•late interest or penalties to which the supplier may be entitled;

•banking costs (unless it is contractually agreed the buyer is liable); and

•losses caused by nuclear disasters.

COMBATING BAD DEBTS

Bad debts can have a snowball effect and their effect can grow out of all proportion to its size. As such, for brokers and credit and risk managers, it is a relatively simple proposition: Do we insure one of our biggest and most important assets?

The benefits of receivables insurance are where brokers and buyers of insurance should really be focused. There are a number of benefits with the most obvious being the financial protection that cover can provide.

Receivables insurance will cover the unpaid debts of insolvent companies, and will cover any unpaid debts after a certain period. Receivables insurance will, therefore, protect a company’s cash flow.

Beyond protecting cash flow, there are other benefits that apply to all buyers of receivables insurance regardless of industry sector, and regardless of whether or not companies export. These can include the following four areas:

1. Financing of loans

Banks and other lenders are concerned that they should only lend to companies that are secure and not in any danger of becoming insolvent and, therefore, defaulting on their loans. Banks are becoming more and more interested in receivables insurance, a policy for which can be assigned as collateral to a bank or other lender.

Banks want to lend more, but there are certain rules concerning lending that require companies to meet certain criteria. Receivables insurance can help companies meet those criteria, and banks, therefore, increasingly regard receivables insurance as a useful tool to help them increase their lending. Basically, receivables insurance helps banks to lend more on a secure basis.

2. Balance sheet protection

Many companies today are concerned with balance sheet protection. This is becoming a major driver in all areas of insurance, as companies reduce the amount of insurance they buy at the lower levels. Self-insurance is becoming popular, but there is still concern over the possibility of a major incident causing a hole in the balance sheet that would have to be explained to either the parent company or to shareholders. As such, catastrophe cover is purchased in order to protect the balance sheet.

3. Improved credit control

Credit information services can act as a credit management department for a company, providing information on trading partners. With this information, the company can then decide whether or not to trade with a company, and whether or not to offer credit. This can be an invaluable service, providing up-to-the-minute financial information on companies worldwide.

4. Increased sales

Receivables insurance can allow the credit manager or credit management department to provide positive benefits for the sales team, and can increase sales by using it to offer better credit terms and, thereby, win business.

Even before any orders are made, the credit manager will be able to show the sales people the areas that should be explored because the risk-reward potential is greater, because these companies are more secure and more able to pay. A company can then offer to open credit to a buyer rather than having to demand letters of credit or the like.

A reasonable question to ask of any receivables insurance policy is, do claims get paid?

During the Great Recession starting in 2008, the global receivables insurance industry had annual gross written premiums in the $7.5-billion range, and for some of those years, loss ratios were in the 100%-plus range.

Receivables insurance makes a vital contribution to tra de, protects a valuable asset class, can be leveraged to enhance cash flow and helps companies grow.