Why Some Lenders Find No Value in Trade Credit insurance

I recently wrote a post on Why SMEs Don’t Insure their Most Important AssetReceivables which covered Euler Hermes new Simplicity product.  Certainly one way for SMEs to eliminate payment risk is to sell receivables on a non-recourse basis.  But using credit insurance is another option and only a very small number do.  Banks and Factoring companies frequently purchase credit insurance to cover portfolio risk, passing those costs on to the borrower.

But drilling deeper as to why more companies do not buy credit insurance, I will quote Kevin Humphrey, from Arthur J. Gallagher & Co, “Trade credit insurance should continue to grow in the US, but the “hockey stick” acceleration in growth that many people have predicted has always been hampered by a variety of issues that I group into a few clusters: 1) Cultural 2) Underwriting 3) Claims (“Disputes”)

I would probably add it is not a straightforward product to buy or price, but that’s another issue. I would like to explore the claims issue. I asked Euler Hermes what happens to a small business when buyers fail to pay.  How do they define “fail to pay”?  How do they verify it? As we know in regular business, a buyer owes money, time passes, payment is not made.   When does this protracted delay become a defacto default is a critical question.  Euler Hermes responded as follows:

 "​Simplicity, as well as most trade credit insurance policies, are generally for short-term accounts receivable. If a policyholder’s buyer becomes insolvent, they can file a claim after 30 days whether or not their invoices are overdue. For the most part, policyholders file all other claims 90 days after the “First Overdue Date” – the original date on which any receivable due from a buyer first becomes overdue. Policyholders may be asked to submit some supporting documents including A/R aging, purchase orders, invoices and proof of delivery, which help expedite the claims and collections process."

Trade credit insurance only provides protection for bankruptcy of obligor. And becoming insolvent can be very different than “failure to pay”.  Most trade credit claims are filed 90 days after an overdue date, but funding providers who provide some form of short term liquidity on average are funding an invoice for 60 days or less.

I asked an invoice finance specialist his views on credit insurance, and he made some interesting points based on his experience as a lender over many business cycles:

    • First, 99% of delays in his experience are for a dispute, it’s not a credit insurance issue.
    • Second, average transaction terms are under 50 days, so even if there is a delay, a financier would have to predict if account debtor is going to go bankrupt in the next 60 to 90 days.
    • Credit insurance adds to price

So the concept of “protracted default” versus outright insolvency is a challenging one. And while insurance can provide peace of mind, remember you are only as good as the claims process.

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First Voice

  1. Larz Soper - ARI Global:

    Utilizing a specialty broker who only focus in credit insurance helps negate fears of claims being mishandled or “Process” as stated in the article. A good credit insurance broker will have access to the entire market place making sure all suitable carriers are brought into the quoting process. A brokers job is to limit the amount of conditions that exist in a policy as they differ by carrier. He or she should have direct access to the a claims specialist with each specific carrier and help guide you through the claims process in an effort to protect your filing rights and avoid delays. What this article doesn’t address is credit insurance is sought out by financials institutions primarily as a mechanism to increase lending. Utilizing the underwriter clout that many insurance carriers have and their ability to gain information such as financials can mean the difference between lending against receivables on a specific debtor or saying no and loosing a sale. The profit generated from just one meaningful account could potentially cover the policy cost. In addition, having a very quick response time for on-boarding a new debtor to lend against receivables and the ability to potentially sell beyond an “in-house credit limit” that exist without the use of credit insurance are also advantages.

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