Trade receivables management, protection and financing are becoming ever more complex in the age of mass customisation, intense competition and globalisation.
The world of credit risk has many facets and events unfolding around the globe, with the US subprime market and fear of recession spreading, certainly have an impact on the Australian domestic market and the view of its exporters. Coupled with Australian interest rates being at a ten-year high, and recent executive surveys revealing growing negative sentiment on the back of statistical evidence of an increase in payment defaults, the credit and liquidity markets remain fragile.
In this environment, management of a significant company asset like the accounts receivable is being addressed by a number of global credit insurance underwriters. They provide products that deal with the key issues of payment default, management, and financing of the accounts receivable. They offer insurance and finance-based solutions that effectively remove most of this risk from the balance sheet of the insured or their interested financial partners. This is achieved on the basis of well-managed and executed credit risk control, and offloading of non-payment risk to a well-rated risk carrier.
Credit insurance in its most vanilla form covers the risk of non-payment—usually on insolvency but often with specified political risks cover for cross-border transactions—on payment terms up to 90 days, with 90 percent indemnity and usually a small non-qualifying level to eliminate subeconomic losses from the claims process.
However, over the last few years the market has evolved substantially, offering all companies the opportunity to work with the insurers to develop a bespoke solution often not only addressing the payment default risk but management of the entire accounts receivable flow from ‘birth to grave’. The most advanced insurers can offer:
* Company information;
* Support the ‘birth’ of a new credit account with background information and a credit rating incorporating a recommended limit amount on debtor;
* Commercial credit reports on offshore companies;
* Company, sector, and country ratings;
* Receivables management;
* A seamless integrated approach to receivables management;
* Global collection coverage: in the event of adverse information, notified default or insolvency (‘the grave’), mobilise recovery and collection teams to minimise the potential loss and maximise the salvage/dividend and do this anywhere on the planet at nominal cost to the insured client;
* Regular updates on account progress;
* Performance-related fee structures;
* Online/web based services and electronic communications;
* Receivables protection using insurance solutions;
* Trade credit insurance;
* Political risk insurance;
* Single counterparty risk insurance; and
The latest enhancement, and possibly the most significant, is the ability to offer funding through invoice discounting or factoring, integrated with the credit insurance cover of all or part of the account receivable. This offers limited recourse funding against these secured debts and the underwritten buyers on such a portfolio attract 100 percent indemnity for all qualifying claims amounts.
Leveraging the sales ledger is increasingly seen as an easy and convenient way to raise additional finance, offering an unencumbered and alternative form of security to borrow against. It also represents a self-funding mechanism to achieve management buy-outs and fund acquisitions and capitalise on large opportunities. Plus it’s a solution for managing liquidity and cash flow and improving financial ratios, including the debt to equity ratio, return on export, return on assets and so on, and an optimal cost-to-income ratio, replacing fixed cost overheads with variable outsourcing costs while retaining core competencies and outsourcing generic functionality.
Globalisation has created a complex web of domestic and cross-border trading and investment, often supported by similarly complex corporate structures. Identification of one’s real contracted counter-party is not always as straightforward as expected and may involve an intensive period of contact and investigation before any financial commitment to supply goods or services is contracted.
The sophisticated trade credit insurance market arguably represents one of the largest aggregate and contemporary company databases in the world. The significant difference between information and credit risk opinions from the insurance underwriters and a pure mercantile agency is that, more often than not, the insurer providing the analytical and investigative report on a target company will also be carrying that company as an insured risk. Therefore, in the event of default or insolvency, the insurer may well pay one or multiple claims to insured clients on defaulting or insolvent debtors. With a vested interest in accurate, timely, up-to-date credit risk analysis and management, an underwriter is an essential partner in effective risk management, especially in a deteriorating market cycle.
Larger buyer defaults have an unacceptable impact on the balance sheet for most companies, and profit and loss has become the focus of another of the credit insurer’s product suites, the so-called ‘catastrophe’ cover contract. This specifically targets those accounts receivable deemed to have a critical impact on the wellbeing of the business. These contracts don’t require the full portfolio of accounts receivable to be underwritten, focusing more on the major accounts. Premium spend is often kept in check with a larger loss retention by the insured, creating a mezzanine layer of insured risk above the ground level of loss, often described as the aggregate first loss. These types of insurance contract are for the company with a larger, stronger balance sheet that is able to sustain some losses but unwilling to accept any large ones.
Longer tenor transaction, such as equipment leases up to five years, can also be underwritten with a number of financial institutions offering facilities underwritten by one of the global credit insurers. These same risks can also be underwritten as single counter-party risks for domestic and offshore debtors.
For the exporter, the ultimate component to conclude the comprehensive management of credit risk along the supply chain is the global collection service. When a buyer defaults, even a well-known debtor, the exporter may now be dealing with an unfamiliar jurisdiction. Some suppliers’ collection services, for example, offer insured clients the ability to hand this process over to the underwriter for a nominal administration fee, for qualified claims. They will then pursue the debt in cooperation with the company and cover all costs, including legal, to minimise the loss and maximise recoveries.
The age of mass customisation, intense competition, and globalisation has accelerated the evolution of the once simple trade credit insurance to become a component of the overall management, underwriting, and financing of the trade receivable.
—Hamish Osborn is the national commercial manager for Coface Services, Australia. For more information, go to www.coface.com.au