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How Credit Insurance Works.

Byline: Treasury & Risk Staff

Utah Metal Works is a Cyreverse wholesaler' of non-ferrous metals destined for recycling. The company purchases metal mostly from manufacturers, demolition companies, and construction businesses in the Salt Lake City area. It grinds, chops, cuts, and sorts, then packages the recyclable metal in a way that prepares it for direct melt.

The companies that buy this material range from small local foundries to corporate giants halfway around the globe. A decade ago, Utah Metal Works accepted the risk that some of its trade receivables might default. But as commodity prices rose and the business expanded both domestically and abroad, the company turned to trade credit insurance to protect itself in the event that a customer fails to pay. Treasury & Risk sat down with Chris Lewon, co-owner and operator of Utah Metal Works, to discuss why credit insurance seemed like a good solution for mitigating receivables risk in a commodity-based business.

T&R: Before you began insuring your trade receivables, how did you manage credit risk?

Chris Lewon: In the 1990s, we used credit insurance. Deductibles were very high and our insurer at the time would only underwrite the largest companies, the companies we were not very concerned about. It was hard to get coverage for customers that were smaller than, say, Alcoa. And when we really looked at the premium costs and the size of the deductibles, we realized the risk sharing wasn't worth what we were paying for it.

This was when commodity prices were on a lower cycle (which we're headed to again), and we decided at that juncture to self-insure. We had a bad-debt reserve that we funded. Typically, we would heavily fund it early in the fiscal year and take a bad-debt expense. Then we'd keep our ear to the ground and watch what was happening with our exposure to certain customers. The biggest challenge of this approach was that our credit department was limited in scope because having an extensive credit department was not really in our wheelhouse. Essentially, we limped through the late '90s and early 2000s.

T&R: What led you to reconsider credit insurance?

CL: Well, everything changed in the mid-2000s when commodity prices took a huge run-up. The numbers went through the roof. And our typical sale, which is three truck loads of material, rose from $60,000 or $70,000 to $150,000 on an average cost basis. At around the same time, we learned that premiums and terms for accounts receivable insurance had improved from where they were in the '90s. We had the ability to buy a 90-10 policy where the insurance company would take on 90 percent of each receivable and we'd retain 10 percent as a co-insurance. The insurance was priced per $100 of sales. And all of our customers would be eligible for coverage, not just the large global businesses.

We decided to buy trade credit insurance from Euler Hermes, which basically meant they became our credit department. We could have hired a credit manager to do nothing but check customers' credit ratings, but instead we're getting a credit department with a lot more depth of expertise. Plus, we're getting insurance that will cover 90 percent of any loss on an insured receivable.

T&R: So, if someone applies for credit with Utah Metal Works, how do you work with Euler Hermes to make that decision?

CL: We use an online tool to request credit limits for our customers, and Euler Hermes responds with an amount for which we are covered based on the company's risk profile and ability to pay. When the answer comes back, somebody within Utah Metal Works still has to look through that information. And it's not a perfect world. Sometimes we question the decision, and sometimes Euler Hermes might not have enough information on the company because it's privately held or because it's not willing to share certain financial information with a third party. In those cases, we will often help get them the information they need.

T&R: How does it help for Utah Metal Works to get involved?

CL: When I talk to some of these folks that we're trying to do business with, a lot of the time I can show them that the credit limit request process is actually beneficial to them. We're not the only company they may want to do business with, so it's in their best interests to establish more credit for themselves and to expand their credit ratings.

T&R: Do you ever extend credit to a customer that Euler Hermes has denied?

CL: We do still make credit decisions on our own. It's rare for us to offer credit completely unguarded, but we sometimes go over the amount Euler Hermes has established as a credit line. That's generally when we either have a history with that customer or have knowledge of others doing business with them. Even when we don't completely follow Euler Hermes' recommendations, it's helpful to have the comfort level of knowing they've done their risk assessment on the companies we're doing business with.

T&R: Has having credit insurance helped your business grow faster over the past nine years?

CL: For sure, particularly when the commodity markets took off. When that started, we were really at a loss for how we could grow and do the amount of business we wanted to, without taking on an incredible amount of risk. Fortunately, with this kind of insurance we can grow in a fairly managed way. That's really the key to any rapid ascension in sales--being able to justify that growth. It's great if you sell product, but if you're not also paid for it, it's all for naught. In the 2009 financial crisis, our credit insurance policy with Euler Hermes helped keep our business stable.

T&R: Has it also made it easier to grow abroad?

CL: Once material is to a state where it can be melted easily, it can travel farther distances to make it to the best end consumer. Since 2000, China has been the 800-pound gorilla in our market; Chinese manufacturers are buying a tremendous amount of material to make into new product. And now the up-and-comer that everyone is watching is India. We do a lot of business in both of those countries.

To answer your question, I don't know that credit insurance has made it easier to grow in China and India, but it's helped me sleep a little better at night knowing that as we expand, we're going to be paid in a timely manner. We know we're protected in case one of our customers faces an unexpected catastrophe, or if something changes downstream that affects our customer in ways we couldn't have anticipated.

T&R: Does credit insurance also help with borrowing?

CL: Yes, definitely. We use lines of credit, and working with a credit insurer gives us a tool to show that we are taking appropriate steps to manage the credit risk of our customers. It puts our lender at ease to know that this insurance guarantees we'll get paid, which will help them get their money back from us as well. That's a tremendous advantage. Teaching a banker what your business does, and what type of performance is reasonable to expect from your accounts receivable, takes a lot of time. If you can just show them your receivables are insured, it gives them a tremendous amount of protection.

T&R: So it streamlines the process of getting a line of credit?

CL: It does. And as things change in the market, it helps them maintain a comfort level in doing business with you. Borrowers' receivables represent a major risk that lending institutions may not understand very well. Having credit insurance can definitely help you get access to capital that might otherwise have eluded you.
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Publication:Treasury & Risk Breaking News
Date:Oct 29, 2015
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