Trade Credit Insurance

Exporting credit risk.(Fore front)
Date: 2010-05-01

By Braun, Kerstin

During his State of the Union address in January, and on several occasions since, President Obama called for a doubling of American exports within the next five years. Increasing exports would help create an estimated two million jobs and ensure the United States’ place in a growing global economy, according to the administration.

The potential is indeed enormous. More than 95% of the world’s population and 75% of the world’s spending power is now located outside the United States.

Yet despite these lucrative markets, most American companies have avoided exporting, largely for two reasons. First, they do not feel that they need to. Already located in the world’s largest economy, they believe that there is plenty of potential for growth right here. Second, exporting is complex. Sending products overseas means dealing with different governmental bureaucracies, languages and legal systems as well as additional taxes and unexpected tariffs.

Perhaps worse still, there are a host of risks such as currency risk, market risk, transportation risk and political risk to name just a few. Then, of course, there is the greatest risk of all for exporters: credit risk. Will your overseas customers pay? Will they default or go bankrupt? And what happens if they do?

Traditionally, U.S. companies have managed trade credit risk in one of two ways: channeling payments through the U.S. Export-Import Bank or requiring their overseas customers to provide letters of credit. While both of these methods have stood the test of time, they present some serious drawbacks to companies eager to compete in today’s foreign markets.

The Export-Import Bank, while efficient, is a large government institution that moves at a deliberate pace and requires that goods contain at least 51% domestic content. Letters of credit require the involvement of two banks, a great deal of administration and careful adherence to elaborate and time-consuming processes that need repeating with every transaction. And because letters of credit tie up a customer’s bank account, demanding one can put a U.S. company at a competitive disadvantage.

If you were a customer evaluating suppliers, and one was willing to give you 60-day credit terms while the other asked you for a letter of credit, which would you choose? With plenty of foreign competitors, customers can simply take their business elsewhere.

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Much also depends on the part of the world to which a company is exporting. In Asia, state banks support this system and absorb the fees involved. But in other parts of the world, primarily in Europe where cross-border trade has been common for decades, letters of credit are considered downright archaic.

For this reason, companies that export typically rely on a popular risk management tool: trade credit insurance. For a small premium, exporters can insure their accounts receivable. With payment assured, they can concentrate on sales and provide new and existing customers with better terms. Better terms mean more sales. And trade credit insurance is quick, affordable, tax deductible, and policies can cover either a single deal or all transactions with a customer over the course of a year.

Trade credit insurance is sold either directly or through brokers, with global premiums written totalling just under $7 billion. Europeans account for the lion’s share with $4.8 billion. The American market currently stands at only $800 million. Demand is up sharply, however, and some estimate that U.S. premium income will double in just three years.

To underwrite trade credit risk, insurers must have an intimate knowledge of local conditions. They are experts in areas such as political risk (is the government stable?), sovereign risk (can the government pay its bills?), currency risk (is money traded fairly and efficiently?) and transparency (are the courts fair?).

Then, of course, there is the question of customer creditworthiness. What is their payment history? Have they ever defaulted? Have there been judgments? What is their condition today? The larger credit insurers collect and constantly update the credit histories of millions of foreign companies. If the insurers will not cover them, you probably should not do business with them either.

With interests aligned as they are, the relationship between exporters and trade credit insurers usually goes beyond just trading risk and often evolves into a partnership. With their knowledge of what your business has to offer and their understanding of local markets, trade credit insurers are in a unique position to provide valuable market intelligence.

Most of the larger insurers maintain staffs of economists and industry experts that monitor a nation’s market conditions and business sector performance. They know where there may be a need for chemicals, electronic parts or medical devices. Likewise, they know where markets are contracting or where the political climate may be deteriorating.

Exporting companies also find that purchasing trade credit insurance improves their financial profile and borrowing power. Lenders are more likely to advance working capital at a lower cost when receivables are protected. Lower interest rates enable exporters to pass the savings on to customers.

In addition to making sure exporters get paid, some credit insurers even provide their customers with accounts receivable management services. Essentially, they become a company’s foreign credit and accounts receivable department.

Kerstin Braun, Ph.D, is executive vice president of Coface North America Insurance Company.