By Ron Doyle

Credit managers are usually the officers of a company responsible for the administration of a trade credit insurance policy. Why are credit managers normally so reluctant to have a policy? The answer, in my opinion, is that credit managers and underwriters are looking at the same risk from very different perspectives.

The credit manager must always balance the credit risk and the potential to either make or lose a sale. If the credit manager is too conservative, sales are lost, but if a more liberal position is taken, accounts may have to be written off. Credit managers are always under pressure to approve the credit and only the lucky ones have management that will support the conservative position.

Trade credit insurance underwriters, on the other hand, are looking at balancing the risk and premium income on a portfolio of exposure represented by many buyers. Underwriters focus on aggregate levels of risk from many different policyholders. Therefore, if a buyer’s financial condition becomes stressed, the underwriter must assess the risk of a loss of the aggregate exposure of all of the policyholders selling to that buyer. The aggregation factor has increased weight due to the mergers and acquisitions in the credit insurance industry.

The credit manager is looking at a micro risk evaluation, whereas the underwriter is looking at a macro risk evaluation.

The credit manager must decide to release a shipment when perhaps his company may not receive payment. This risk normally involves a fairly short-term horizon of less than 90 days. Underwriters, on the other hand, are often looking at the probability of the buyer failing within the next year. Credit analysts in credit insurance companies tend to give weight to trends. If a buyer is losing money for several quarters, the underwriter may cancel or reduce a credit limit, or conversely, if a company that has been in difficulty shows an improving trend, the analyst or underwriter may wait to see if the improvement continues before reestablishing the coverage.

The credit manager is focusing on the short-term risk, whereas the underwriter is looking at the longer term.

Credit managers base their decision on whether to make the sale or to lose the business. The risk/return decision is clear. If the sale is made, the risk is the loss of the total amount of the receivable or the return is the profit on the sale. This decision is often complicated by the importance of the policyholder maintaining a good relationship with the buyer. If shipments are withheld, a good relationship may be destroyed.

Underwriters look at the total exposure to a buyer as if it were a line of credit for which the premium they receive is the fee. As premium rates have been exceptionally low for the last two years, the risk/return equation for the underwriter is often heavily slanted towards the risk.

Credit managers will continue to make routine "business decisions." Underwriters continue to make decisions in a manner similar to bankers, assessing situations in which the premium can never compensate for a marginal risk.

(Ron Doyle is a founder of Millennium Credit Risk Management – credit and political risk insurance specialists – www.mcm.ca. ICBA is the world’s largest team of independently-owned, specialist trade credit insurance brokerages. Partners combine local service with global coordination to provide credit and political risk insurance solutions for multinational companies.)