Amidst a persistently tough economy, companies continue to battle cash flow conundrums. This is exacerbated by ‘bad debtors’ – in fact, late payments and insolvency are two of the most commonly cited causes of long-term damage to business growth. The result can be irreversible damage to a company that’s unable to recover its uninsured losses. While larger businesses partner with trade credit insurance solution providers to assist in managing trade-related debts, SMEs tend to self-manage the risk and miss out on the numerous benefits credit insurance cover can provide.
Trade credit insurance assists the growing number of companies hoping to expand their businesses locally, across Africa and beyond. There are multiple risks to opening credit to overseas markets – especially when it comes to collecting defaulting debtor payments. Additionally, businesses find it tougher to source information on their foreign clients’ solvency. The lack of transparency around in country legal systems and proceedings in foreign courts provide further challenges when faced with default. That is where trade credit insurers play a big role – both in taking on the risk and providing the intel that potentially warns of it.
In a recent panel discussion hosted by Santam, Pieter Dingemans, National Practice Leader: Trade Credit Marsh; Steve Smith, Head of Credit Insurance Division: Santam Structured Insurance; and Jansen Harper, Managing Director: Credit Innovations, discussed why credit insurance is key for both larger and smaller businesses and how it helps with companies’ expansion plans. Here are some of their points:
What trade credit insurance covers:
In a nutshell, trade credit insurance traditionally covers business to business transactions done on credit terms – and just for trade. This incorporates payment defaults, business rescue and liquidation. The insurer will assess the risk of the client’s whole book or individual debtors and will only take on ‘good risk’ companies/ buyers.
Why small businesses should consider trade credit insurance as well:
While large corporations with strong balance sheets can better withstand big losses, smaller businesses will find it harder to recover. That’s why small businesses, especially, need credit insurance. There are several credit insurance products designed specifically for SMEs that need less administrative-intensive solutions. These are tailor-made for companies that don’t have a full credit management team.
Another benefit of credit insurance for small businesses is the fact that the insurer does the risk assessment and passes on this information to the client – so the insurer acts as an alarm warning of prospective bad debtors, which is often based on information an SME simply wouldn’t be privy to.
Finally, having the support of credit insurance covering one of its biggest assets – its debtors – improves a company’s risk rating, which can potentially get the business better banking rates and higher liquidity.
What happens if there are late payments?
If someone does not meet trading terms, then the insurer will embark on mitigation to try to get the debtor to pay. If that proves unsuccessful within a set period, then the insurer will pay out the insured, in line with his or her policy. The insurer will then continue to try and mitigate the loss.
How expensive is trade credit insurance?
At the end of the day, the risk depends on the credit quality of buyers a policyholder is dealing with. The level of risk determines the premium rate.
Policyholders would usually alert an insurer when considering a new trade partner. The insurer would then do a risk assessment based on its financial information about the potential trade partner’s trading history. The insurer would then tell the policyholder whether it’s happy with the risk. If the insurer refuses to cover the risk, then the policyholder is alerted to the fact that it’s a potentially risky trade partner. That way the policyholder can use the insurer as an ‘alarm’ for ‘bad’ prospective trading partners.
There’s a black swan effect in business. Some companies fail fast and unexpectedly. As insurers conduct continuous risk assessment on buyers they can see when other companies are reducing their exposure to these buyers. That gives a signal to the insurer that the buyers’ risk is deteriorating – which allows the insurer to advise its policyholders to lower their exposures to – and potentially stop trading with these buyers.
Why trade credit insurance is essential for companies expanding across Africa and overseas:
Often, companies underestimate the cost of collecting debts in overseas countries. They tend to know less about the debtors they’re dealing with, and they don’t necessarily understand the legal systems of the countries they’re expanding into. Across the board, dealing with foreign debtors is simply more expensive. For insurers, it’s a longer process as they have less readily accessible information to assess risk, and there’s a more intensive and complex mitigation process to salvage debt. Foreign credit insurance coverage also tends to be more extensive than domestic coverage because it includes things like political risk when goods are rejected, etc.
It’s important for policyholders to note what kind of business risks they need to cover in the countries they’re expanding into. It’s also important they’re aware that some foreign markets are ‘riskier’ than others, so come with higher premiums. In line with insurers’ annual ‘political risk map’ there are certain countries where it’s very difficult or impossible to get any cover at all.
Credit insurance and factoring:
Factoring is the process of selling off a debtor book to an institution for immediate access to cash. There is an argument that factoring and credit insurance are complementary – factoring is finance while trade credit insurance is a risk mitigator. Together, the two can benefit a business that’s struggling with working capital. Another thing to consider is that many of the entities that offer factoring seek credit insurance for themselves on their debtors.
Big or small, companies need to be responsible for their own risk management, so should be extremely circumspect about who they’re doing business with on credit terms. Insurance should form part of a greater risk mitigation strategy – with the insurer taking on the risk the insured can’t afford to keep.