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It's a jungle out there: recognizing the need for business credit insurance.

Financial Volatility. You hear about it everyday whether it be the economic roller coaster of emerging global markets, countdown to the Year 2000, or the rapid rate of change and cutthroat competition in domestic industries like high-technology and retail. Despite the uncertainties in even the world's most stable economies, companies in North America have a long tradition of self insuring commercial credit risks against the unknown. Unlike their European counterparts who have incorporated business credit insurance into their business strategy for nearly a century, credit managers in North America are just starting to catch on to the advantages of using this little known risk management tool. For a product whose inception is more than 100 years old, North America is still by and large the new frontier for business credit insurance with an overall penetration rate of just over one percent.

A Definition. At its core, business credit insurance provides coverage on the accounts receivable portfolio, protecting companies against the financial blow of unexpected bad-debt losses due to debtor insolvency or slow payment. While businesses insure other key balance sheet assets including equipment, land and inventory, the asset most vulnerable to unforeseen risks is typically left uninsured-and critically exposed. When credit losses do occur, companies are forced to absorb these hits by either depending on non-tax deductible loss reserves, or, depleting bottom line revenues to cover the cost. Instead of playing a guessing game with the payment performance of their clients, business credit insurance enables companies to stabilize cashflow and stay on target with financial projections.

New Opportunities. During the past few years, business credit insurance has gained critical recognition in North American boardrooms, especially for products that provide global coverage on the growing base of export receivables. Traditionally concentrated in only a few industries, business credit insurance now enjoys broad-based interest for resolving an issue on every company's agenda - cost-effective risk management in an uncertain world. The heightened interest in business credit insurance interest can be attributed to several key factors including:

Aggressive acquisition activity by Europe's leading credit insurers within North America

The continued growth in U.S. and Canadian exports and competitive disadvantages of traditional letters of credit

The increased use of Chapter 11 by companies that want to restructure their balance sheets

Uncontrollable credit risks such as economic downturns in the global economy, because of the Year 2000 and conversion to a single European currency.

Together, these timely factors have paved the way for a handful of business credit insurers in North America to increase their client base within more sophisticated mid- to upper market companies and, attract an alternative distribution network including a growing number of insurance brokers and asset- based lenders.

The Benefits that Improve the Bottom Line. At first glance, business credit insurance is the financial safety net for payment on domestic and export accounts receivable. By covering the A/R portfolio against credit risk, credit managers can prevent unexpected disruptions in the cashflow cycle and the unexpected losses that can erode bottom line profits and capital reserves. But the financial and strategic advantages of accounts receivable coverage don't stop there. In fact, many North American companies are successfully using business credit insurance to safely increase sales both domestically and abroad, reduce profit-draining loss reserves and borrow more working capital against one of their largest assets.

Under one annual policy, companies can insure their entire A/R portfolio and use the financial security of this asset to substantially grow their business. With premium averaging less than a half of one percent of sales, a business credit insurance policy typically more than pays for itself through the provision of higher credit lines to good customers. The benefits for new customers include better financing leverage and the direct reallocation of loss reserves to the bottom line.

The Best Prospects. Who are the best prospects for business credit insurance? Forget the old stereotype of only companies with high losses and risky accounts. Any company that sells on open account terms is a logical candidate for business credit insurance. Credit insurance policies are sold to companies of all sizes within nearly every industry sector in North America, especially those with heavy account concentrations and export receivables within the A/R portfolio. Even businesses that have solid credit management practices in place have embraced business credit insurance to back-up their credit decisions and transfer risk off the balance sheet. The simple fact remains that many credit losses are "unexpected" and "uncontrollable", despite efforts by even the most savvy credit managers and financial executives to effectively mitigate risk in the portfolio.

The European Influence. Recognizing this huge prospect potential in North America, Europe's leading credit insurers began an aggressive acquisition strategy for the industry's top local insurers in 1996, bringing with them a wealth of experience and international credit networks. It began with the October 1996 acquisition of North America's oldest and largest credit insurer, American Credit Indemnity (ACI) by the Euler Group, a leading credit insurance company. Close on its heels was the joint venture between Europe's second largest credit insurer NCM Netherland with Maryland-based Fidelity & Deposit to form the Maryland Netherland Credit Insurance Company (MNCIC). And in August 1998, North American giant CNA Insurance has entered into a joint venture with the world's largest private export credit insurer, Coface, S.A., to form Worldwide Credit Managers LLC (WMC). These transplanted European credit insurers are betting on the booming export trade and unknowns like the approaching Year 2000 to prompt unprecedented growth in the use of credit insurance in North America.

International Business. Perhaps the most significant interest in business credit insurance has come from the increasing number of North American companies who sell abroad into both traditional European markets and those of the emerging third world. While domestic credit risk has been highlighted by an increase in the use of Chapter 11 for financial restructuring purposes, selling to foreign debtors ignites an even higher perception of risk in the eyes of North American credit managers. With critical financial downturns and currency fluctuations in Asia, South America and Eastern Europe, international business has well earned its reputation as a financially risky - if exciting - venue of business expansion.

Letters of credit, the traditional means for ensuring payment on foreign receivables, freeze the debtor's working capital until payment is received by the supplier. As more foreign customers demand transactions on open account terms to alleviate this inconvenience, requiting a letter of credit to insure payment can put the North American exporter at a competitive disadvantage, ultimately costing them strategic business relationships abroad.

"Export credit insurance", typically provided under a global credit insurance policy, allows exporters to sell on open account terms without incurring the credit risk. These global policies also cover political as well as commercial credit risks, a feature required by most banks lending against export receivables. In effect, a global credit insurance policy allows companies to sell anywhere in the world as though they're doing business right down the street.

Year 2000 and the "euro". There are two potentially huge credit risks facing North American companies in the next two years, the Year 2000 and the conversion to a single European currency in 1999, the "euro".

Concerns over the computer glitch in the Year 2000 center on the worrisome fact that a majority of North American companies won't know if their customers - and their customer's customers - are Year 2000 compliant until it's too late. Another layer of risk in the euro conversion is diverting Western Europe's information technology resources away from the Year 2000 bug to tackle the pending currency consolidation. As North America's largest trading partner, Western Europe's adaptation to a single currency remains a key concern for thousands of North American exporters. While the world braces for both of these approaching events with apprehension and information technology fixes in the billions of dollars, they clearly demonstrate the need for proactive risk management in the face of the unknown.

For companies who sell on open account terms, they're only as strong as their weakest link. Business credit insurance is the single most competitive, cost-effective tool credit managers can leverage to ensure an airtight risk management strategy in a world of financial volatility - a world that, even for localized credit risk, can hit too close to home.

A Case History

A growing software company located in Utah was originally introduced to business credit insurance by its lenders.

More Working Capital to Grow the Business. As a young company experiencing significant growth, the company was looking for ways to get more working capital using its receivables as collateral. The local bank told the CFO that the company would be able to increase its borrowing base to 90 percent of matured receivables if its purchased business credit insurance. By making the bank a beneficiary of its credit insurance policies, one for domestic and one for export, the company continued to grow without giving up equity.

Better way to conduct business overseas. For its export accounts, the company no longer requires cash in advance or a traditional letter of credit. In many countries, especially in Western Europe, letters of credit are becoming unacceptable because they tie up the buyer's capital until payment is received by the buyer. This company can sell on open-account terms abroad and still not increase its credit risk.

Lower Loss Reserves. The company also was able to lower its loss reserves for bad debts by purchasing fully tax deductible credit insurance policies. The auditors were able to assign a higher degree of collectability to the company's receivables and in turn, free up the non tax-deductible reserves right to the bottom line.

Unexpected Loss Protection. Much of the company's accounts receivable are tied up in a few large distributors. Given the volatility of its business, it would be a financially devastating if one of the accounts were suddenly unable to pay. The company insured every other asset on its balance sheet and it felt it didn't make sense not to insure one of its largest, and most vulnerable, assets.

Laura Burd is a marketing associate with American Credit Indemnity, located in Baltimore. She can be reached at 800/879-1224.
COPYRIGHT 1999 National Association of Credit Management
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Copyright 1999 Gale, Cengage Learning. All rights reserved.

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Author:Burd, Laura
Publication:Business Credit
Date:Feb 1, 1999
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