The Hidden Benefit of Credit Insurance: a loss can be avoided when your broker discovers why coverage is unavailable

By Ron Doyle

It appears 2010 was actually a good year for credit risk. Underwriters had fairly low loss ratios, well below those of previous years and commercial bankruptcies were also down. However, it appears that the number of companies filing for creditor protection, while they reorganize, is continuing to be steady in North America, and the latest trend, similar to the General Motors case, is to have all of the reorganization, including Debtor in Process Financing, in place before the actual filing. This feature allows companies to enter and emerge from protection quite quickly. The big losers are normally the unsecured suppliers because all of the secured lenders are privy to the restructuring plan and they protect their position.

In reviewing the Creditors’ List in several large recent cases under the Companies Creditors’ Arrangement Act, CCAA, in Canada, it was apparent to me that many companies were continuing to sell to these buyers without credit insurance and without adequate financial information on the buyer.

If the suppliers that had large unsecured exposures knew that credit insurance was available and didn’t insure, shame on them. If they didn’t have financial information on the buyer, or even if they did, and continued to ship, shame on them. In the cases reviewed, some of the unsecured exposures were over a million dollars Canadian, and from the result, it is apparent that the exposed suppliers should have been focusing on how to mitigate the risk.

Credit insurance coverage is not always available in regards to some buyers. The reasons for the lack of coverage are:

• The underwriter has credit or financial information on the buyer and has made the decision that the buyer is not creditworthy for the credit limit requested;

• Because the underwriter may have a number of policyholders selling to the buyer and reporting their experience, the underwriter may be aware of payment problems developing;

• The underwriter may have exposure covered on the buyer and based on the information it has, it is not prepared to increase the credit limit it is covering; and

• The most common situation is the credit limit requested is material and the buyer won’t release financial information to either the supplier or, in confidence, to the underwriter. The lack of cooperation by the buyer is often a negative signal in itself.

The benefit of credit insurance is obvious if a major insured buyer files for protection or bankruptcy. In a matter of weeks, or even days in some cases, the policyholder or its bank will receive a payment from the insurer covering the insured portion of the debt. The payment and the support of the cash flow has, in a number of cases, been the difference between the supplier going bankrupt or continuing in business.

The hidden benefit of credit insurance is often looked on negatively by the supplier, in that coverage was not available on the buyer. However, if the supplier is using a specialist credit insurance broker, the broker will find out the reason for the lack of coverage. If it is due to a non-creditworthy buyer, and this opinion is shared by a number of underwriters, this is valuable information for the supplier, upon which it can base its sales decision and if possible, how to mitigate its risk.

Input prices are increasing, fuel prices are increasing, and the world is becoming more unstable, while exposures are increasing. Particularly in export transactions, the smart company will use credit insurance for its obvious and less obvious benefits.

(Ron Doyle is a founder of Millennium CreditRisk 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.)

Comments

[Andrew]

thanks for sharing your ideas Ron! although I can't agree 2010 was a good year over all, due to some problems in some region. for example, Baltic States. Atradius and Euler Hermes simply left Latvia without prior warning. Although the market is recovering.

Also uninsured buyers can be monitored by credit reporting companies to cover some risk.