Credit Insurance Blog

Credit and Risk Assessment Process of the Trade Credit Insurance Underwriter
by Joe Ketzner

strategic chess pieces

The Credit & Risk Assessment Process

Trade Credit Insurance has been a commercially viable product since the mid-1800’s. However, the use of the word “insurance” provides little insight into the actual working of the services and products provided by these underwriters.

To emphasize this point: a short story about a young man who left the safe confines of a commercial bank in the Spring of 1973 to embark on a career with the largest and oldest trade credit insurer in North America.


Background


Some background; the young man had previously worked as an accounting clerk in the finance department of one the country’s largest and earliest established railroads performing the usual debit/credit functions that comes from the transport of product between seller and buyer. Once university studies had ended, he left the railroad and joined one of the most esteemed trust companies in the nation at that time. He was again deep into the process of balancing numbers and transactional accounting.

On April 16, 1973, having grown bored with the accounting routine, he began a career as a “Credit Processor” with the American Credit Indemnity Co. He had applied for a “financial analyst” position found in the local paper’s classified section.

His first day of orientation quickly provided a glimpse that the actual business of trade credit insurance was related to financial analysis, risk assessment and account monitoring, and less about insurance. This probably explains why the word “indemnity” is in the name and not insurance.

The young man learned that the Credit Processor’s primary responsibility was to build as well as gather, aggregate and analyze as much financial, credit, banking and background information on each customer (buyer) the trade credit insurer (seller) was seeking to cover. At his disposal was access to more than 30 specialized commercial credit reporting agencies. Beyond Dun & Bradstreet, many sector specific agencies existed in which mercantile reports were acquired and evaluated. Industries as diverse as chemicals, lumber, furniture, paper, produce, leather, shoes, etc. each providing basic historical and current trade payment information on a buyer.

Because over 90% of the buyers being analyzed are private, many of these mercantile agencies lacked meaningful financial disclosure. The CP would reach out directly to the buyer for current financial information utilizing the leverage the underwriter holds by providing cover to multiple suppliers on the buyer. These financials were not typically something the supplier would possess. When the financials were obtained, the data was analyzed to determine critical ratios such as debt to worth, working capital, cash & A/R to current debt, etc.

Specific trade references may have been researched, but typically the emphasis was directed to information provided by sources other than those advanced by the buyer. However, the buyer’s bank would be interviewed or contacted by mail to acquire information associated with the buyer’s balances, loan facilities, and opinion of the principal’s character. This was conducted within the guidelines put forward by the Robert Morris Associates regarding the exchange of information between banks and credit granting organizations.

It became evident that the act of insuring payment from the buyer was a secondary mission to understanding the buyer’s overall financial health, it’s default probability and likelihood of payment for the goods and services acquired. The primary mission of the insurance carrier was to quantify the upside and downside sales opportunity of each buyer going forward. The insured credit limit was never intended to be a static figure.

Ultimately, the complete buyer assessment could not be made on the basis of the financial, banking, and credit information acquired. The full assessment would be analyzed in concert with industry performance and trends, economic cycle, geo-political events and the buyer’s ability to have sufficient financial flexibility to weather a storm.

While many aspects of risk analysis were emphasized, the two most critical focal points were: cash flow from operation (CFO) and external financing flexibility. The importance of understanding debt servicing as a central risk to a company’s solvency was emphasized. All aspects would need to be constantly monitored as external factors could quickly change the company’s ability to access capital or the cost associated with financing the business becomes burdensome.

Each day new data would arrive at the buyer level, but also at the macro level which might impact the company’s risk profile. Both in terms of risk of non-payment and sales opportunity, the buyer was being constantly monitored. Any enquiry was rarely executed in isolation. The CP quickly learned that when a specific request to ensure a credit line was being assessed, the aggregate exposure was being evaluated. If there were seven sellers each requiring a $1m credit limit, the analysis was associated with a $7m exposure and the buyer’s ability to manage this level of trade exposure.

The depth of the resources available in this risk and financial assessment process extends far beyond the typical capabilities of the seller. This includes the monitoring capabilities as the seller tended to manage at the DSO level; the trade credit underwriter maintains surveillance on the buyer’s financial performance, it’s borrowing capacity, the sector’s trend, the geo-political influencers, and the broad economic trends. Cover would be adjusted according to the supporting data.

Trade credit insurance has evolved over the past 150 years; the partnership of risk management and sales support remains the central value proposition to the seller. Sales optimization and asset protection can only be realized through the joint management of a buyer’s credit & risk assessment process. From that first day, first week, and ensuing months of training; the young man learned that he was not in the credit insurance business, he was in the credit management business. He became an extension of his client’s credit and risk management department fully integrated with a common mission to grow sales, improve their operational performance and protect their capital, cash flow and earnings. Each client had their respective credit, receivable and risk management departments extended by the global reach associated with thousands of well-trained professionals who specialize in credit, financial and economic assessment.

That young man was me.

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