Trade credit insurance: what is it and when to consider?
The internet has enabled everyone access to information regarding the basic of trade credit insurance. Anyone who has responsibility over credit management will likely have invested some time and energy to the subject. Ironically, the basic concept of trade credit insurance has remained unchanged since its genesis in the mid-1800s in the USA as open trade began to expand.
Accounts receivable insurance or trade credit insurance is a simple concept: indemnification of losses associated with a customer’s failure to make payment on goods ordered, shipped and delivered. The trade credit insurance carrier pays the supplier when a default occurs.
In the North American there are more than a dozen providers of trade credit insurance, each one having created an impressive web site touting their ware and presenting the common benefits statement associated with the product:
For over 150 years, these providers of trade credit and risk management solutions have helped tens of thousands of businesses grow and prosper. For each business, the decision to invest has been driven by specific events and timed with their own needs.
Over the years I have been asked: when is the best time to invest in credit insurance? Logic would suggest the best time would be as the storm clouds of an economic downturn are forming. If the same logic is to be applied alternatively; the worst time to make the investment would be at the end of an economic downturn or recession.
My observation is that timing should not be dictated by prevailing economic events as the financial and operational benefits are realized throughout these cycles. The expected increase of defaults naturally occurs as the economy slows and the loss payment aspect of trade credit insurance dominates the value proposition. In addition, the insured is also supported by the collection, recovery and bankruptcy administration facilities of the carrier during this period. The central focus is the insurance component; payment of a claim.
Trade credit insurance, however, has equal importance in the economic recovery period for those companies who make the investment to drive the top line. These companies require their sales engine to be fueled. New markets, new customers, higher credit exposures, etc. become the focus of a company during an economic recovery. Utilizing the capabilities of the insurance carrier’s deep database of information, their analytics, and their monitoring services, the insured will better capitalize the rapid sales expansion opportunity in a controlled manner. In addition, sales growth requires capital. Those businesses who invest in trade credit insurance leverage their accounts receivables, inventory and work in progress at higher advance rates and lower effective cost with their financial partners.
Trade credit insurance underwriters act and react much the same as the companies they underwrite. As an economic decline approaches rates harden, risk share is expanded, and credit extension is tightened. These efforts may suggest that there is less value to the insured during this period as less cover is provided while premium rates are higher. The reality is that the underwriter is less concerned about its own financial performance and is focused on its main objective of guiding the insured effectively through the troubled waters. One of the most important benefits of a trade credit insurance program is a restrictive decision. However, few companies hold the depth of knowledge, the analytical capabilities, and global resources of these carriers.
As an economic recovery begins, the underwriters’ rates soften, required risk share decline, and credit limit acceptance increases as the number of defaults abate and the probability of future defaults fall. The value proposition changes as the emphasis becomes aligned with sales growth and away from loss indemnification.
Understanding these simple realities supports the assumption that the ROI remains constant throughout economic cycles. The primary change is associated with the perspective of “loss prevention” versus “sales expansion”. Each aspect of investment assessment continues regardless of the timing of an economic cycle.
All associated benefits and key drivers with investing in a trade credit insurance program remain throughout all cycles. The best time to invest in trade credit insurance is now, without hesitation or application of logic or consideration of economic cycles.
Is there an optimal time to acquire health insurance? Maybe just before you get sick or have a heart attack? What about life insurance, when is it best to invest? Property and casualty insurance? The same answer can be attributed for all perils; the closer you get to actual insurable event occurring, the higher the likelihood your submission gets declined, or adjusted premium rate and risk share increase. The one major difference with all these other insurance lines compared with trade credit insurance is how the trade credit insurance carrier acts as a strategic partner. Whether it’s about asset utilization, cost advantaged improvement of DSO, or the support of managing accounts receivable risks, the trade credit insurer becomes integrated with its client’s long-term strategy of growth and prosperity.
In February 2020, the strength of the US economy was remarkable by most measures and the forecast was optimistic. By late March, driven by factors no one could have ever anticipated and government intervention at an unprecedented level, the greatest quarterly decline in GDP on record was about to occur. Most experts failed to calibrate or effectively time a catastrophic event which would demonstrate the ultimate economic benefit of trade credit insurance; billions of dollars of capital, cash flow and earnings were restored globally.
Trade credit insurance should never be viewed as something to step in and out of based on economic cycles or specific risk circumstances. View it as a required business tool designed to support capital utilization and protection at the same time driving optimal top and bottom line growth.
When is the best time to invest in trade credit insurance? NOW!
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