Export credit insurance: the risk management tool with an edge.
Within the past five years, many U.S. exporters have discovered what Europe's leading exporters have known for decades - export credit insurance is the key to sales and profit expansion with a guaranty against commercial loss. Export credit insurance provides coverage on foreign receivables assuring that the exporter will be paid even if the customer can't. The growing use of export credit insurance by American exporters continues to level the competitive playing field by offering open credit terms in an otherwise risky business.
The primary question on any exporter's mind is "How and when will I get paid?" While there are several methods of payment for export transactions, they vary widely in cost and protection against customer default. Without export credit insurance, the seller often has a difficult time collecting payment in the case of customer default. The reasons are specific to exporting. American exporters are conducting business under a different set of standards and business laws; each country will have its own norms for payment and collection cycles, as well as guidelines for unsecured creditors collecting under bankruptcy.
The more adventurous exporter might grant the buyer open credit terms while the most conservative exporter insists on cash in advance for incoming exports. Selling on open account poses a significant risk to the seller. Although open account encourages a high transaction level, it inevitably ties up the seller's capital until payment is received.
At the other end of the spectrum, cash in advance is the safest method for the seller. Safety comes at a high price however. By demanding cash in advance, the customer may find the transaction with the seller less attractive even if by paying cash in advance the customer receives a discount from the seller. Ultimately, this method of payment will undermine the seller's ability to effectively compete as customers seek alternative suppliers offering more liberal terms.
Although both methods have serious disadvantages, together they illustrate the ideal situation for any exporter the ability to fully exploit foreign business opportunities with certainty of payment.
Investing in export credit insurance frees exporters from concerns of how and when they will get paid for what they sell, instead, they can concentrate on increasing sales to foreign accounts without the threat of added credit risk. Private-sector export credit insurance is a clear winner in terms of profit and convenience when compared with other traditional export risk strategies. These strategies include credit coverage through the U.S. Export-Import Bank or a letter of credit from foreign and domestic banking institutions.
By providing coverage against commercial loss, export credit insurance allows exporters to confidently extend credit lines to new and existing customers abroad, generating greater sales and increasing profit for the bottom line. Protection against loss dissolves the common tension between sales representatives who recognize key business opportunities and credit managers who must monitor the credit worthiness of foreign customers.
Consider this scenario. One of your top sales representatives lands a substantial deal abroad with an established customer. While this client usually purchases between $25,000 and $50,000 per order, he now needs a shipment worth five times that amount. If you can't cut a deal that suits his immediate needs, your overseas competitors will. Adhering to company credit standards means the deal must be thrown out - along with the potential profit. With the deal at $250,000, a 20 percent variable gross profit margin could yield a $50,000 profit. Still, an unforeseen credit problem could hurt the company and your career.
Export credit insurance offers an innovative solution to this dilemma. Would you be willing to spend $5,000 to ensure a $50,000 profit? You could look forward to retaining 90 percent of the variable gross profit margin that would have been lost if you weren't able to grant higher credit terms to your foreign account. But this advantage doesn't stop after the first deal. Multiple sales to foreign accounts are covered in one annual transaction. This translates into protection for future shipments as well as a dividend. For your customer, one annual policy saves them time and expense.
While export credit insurance is widely used in Europe, more and more American companies are realizing the benefits of insuring one of their greatest assets their A/R. One of our clients, for example, has found American Credit Indemnity's Export Credit Insurance an invaluable part of exporting to Germany and Switzerland. "Our foreign customers want their goods yesterday," comments CFO Ron Verilli of Connecticut-based American Computer Resources. "That doesn't leave us any time to deal with the frustrating red tape involved with letters of credit."
In addition to expanding sales and reducing transaction time, export credit insurance enables exporters to substantially increase their borrowing efficiency. Asset-based lenders are far more likely to advance working capital against foreign receivables protected by export credit insurance. By taking advantage of this lending preference, exporters can grow their businesses both at home and abroad without relying solely on sales expansion.
Hofmann Laces, Ltd., a Cableskill, New York fabric manufacturer, for example, has found that export credit insurance provides "peace of mind" protection in the exciting if unpredictable world of exporting. Although exports account for less than 5 percent of its annual sales, Corporate Credit and Collections Manager Gabe Galietta cites exports as a prime area for potential growth. "Any account locations where ACI provides coverage, we purchase credit insurance over a letter of credit. We've found it to be less expensive and more convenient as we attempt to expand our business abroad."
Also consider the information factor: Export credit insurance provides credit comfort when information on foreign markets and customers is incomplete or unreliable. Export credit insurers can advise exporters on which foreign accounts pose a serious payment risk and the variances in foreign payment schedules that can affect cash flow.
Given the wide range of benefits, many exporters assume that export credit insurance must be an expensive investment. In fact the opposite is true. We estimate that a typical export credit insurance premium with a good spread of risk and 10 percent coinsurance runs a mere one half of one percent of annual export sales. This tax-deductible premium pays for itself many times over in the form of expanded sales and increased working capital.
If export credit insurance facilitates sales expansion and credit protection, why did it take so long for U.S. exporters to catch on? While export credit insurance is not new to the United States, the modern era of export credit insurance provides greater value than did its surviving predecessors. One example is the government-operated Export-Import Bank (Ex-Im). Founded in 1934, the Ex-Im Bank finances trade initiatives and provides export insurance against credit risk in foreign countries. Although it will cover most markets in the world, Ex-Im insurance has its limitations.
A government institution in both charter and process, it requires that export products and services covered have at least 51 percent U.S. content. In addition, the Ex-Im Bank is not permitted to provide commercial cover without also providing political risk coverage even if the export destination is a stabilized market, resulting in typically higher costs than if just commercial credit were purchased.
Another established risk strategy used by exporters is securing a letter of credit from the customer prior to the shipment. In its most comprehensive and expensive form, a letter of credit is an irrevocable commitment by both an overseas and confirming U.S. bank to pay the seller once documents are delivered, thereby removing any risk of customer non-payment.
While a letter of credit does protect against customer default, it must be secured before each individual export transaction. This stipulation results in time-consuming paperwork and extra expense for the buyer whose credit lines are tied up during the transaction process. Again, added expenses for the buyer can greatly reduce an exporter's competitive edge over other vendors. In addition, letters of credit demand a strict compliance to contractual details. For example, if the exporter is subject to unexpected deviations from shipping procedures, a letter of credit may be no guarantee of payment to the seller.
For American exporters who strive to compete on a level playing field with their European competitors, export credit insurance is a profitable solution. Insurers will tailor the policy by evaluating your foreign accounts and devising a coverage strategy that is right for you. Once the policy is issued, the carrier will pay for all covered credit losses up to the full face value of the policy. You will also have the option of adding foreign customers during the life of the policy as your business needs change.
Export credit insurance alleviates the competitive disadvantages of conducting business abroad, allowing you to sell as if your customer were right next door. With the ability to substantially expand sales, obtain more working capital, and protect your foreign receivables against an unexpected customer default, you don't have to risk it all to be competitive.
Laura Burd is a sales and marketing associate at American Credit Indemnity, Baltimore.
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|Date:||Jul 1, 1995|
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