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Extending Credit

Trade credit insurance is misunderstood and undersold in Canada, but the market potential is huge. The product also provides brokers an excellent opportunity to offer a value-added service

Canadian companies spend billions of dollars in premium each year to insure buildings, inventory, equipment and other tangible assets against potential loss. Yet many overlook the risks to their accounts receivable, which typically account for 40% of a company’s total assets. But what happens if a company makes a shipment and a buyer refuses to pay, or if a war breaks out and trade permits from Canada are withdrawn, or if a buyer goes bankrupt?

“We have seen many examples in the last five years of very large companies going out of business and leaving in their wake a trail of unpaid invoices,” explains Paul Hare, an account executive at Aon Risk Solutions.

“If a major buyer is unable to pay its obligations, there will be a negative impact to cash flow, earnings and capital [for the supplier],” adds Hare. “In a worst-case scenario, this loss of assets could literally put a supplier out of business.”

Aon is one of just 20 brokerages in Canada dealing in trade credit insurance. At a time when most industries are still feeling the effects of the 2008 financial crisis, insurers and brokers, alike, are pushing to make the case that trade credit insurance should be part and parcel of an entity’s property and casualty programs.

For any company that has a large accounts receivable on its balance sheet, “if they do business on credit terms, if they’re extending trade credit to the companies they sell to, they’re at risk,” says Neil Bhatia regional manager at insurer Euler Hermes.

There is plenty of room for growth. Trade credit insurance currently represents just 1% of the total property and casualty market in Canada. Only 7,000 companies in Canada currently hold trade credit policies. In 2011, trade credit insurance was worth $222 million in annual premium. It’s anticipated there is potential to double that within the next five years and almost quadruple it within a decade to $800 million.

“Self-insurance is our biggest competitor right now,” says John Middleton, president of brokerage firm Millennium CreditRisk Management. “This is a product that is growing in the marketplace, and the penetration rate is still very low. We are actively trying to get other brokers on board to grow the market in Canada.” 

The biggest challenge in Canada for trade credit insurance does not lie in the sectors or in the capacity, it lies in awareness.

What is It?

In much the same way mortgage insurance is designed to protect the bank in the event of a foreclosure, trade credit insurance protects suppliers from buyers who are unable to fulfill their invoice payment obligations.

“The purpose of trade credit insurance is to indemnify a company from a bad debt loss,” says Middleton. “This may come due to insolvency of a buyer, a buyer that has inadequate cash flow to enable payment, or a political risk event which makes a buyer unable to pay.”

But specialists in the industry are quick to point out that trade credit insurance is as much a financial and risk management tool as it is an insurance product.

Companies seeking to extend their capital, for example, frequently choose to borrow against their receivables, which, after all, may be one of their biggest assets. In the current climate of economic volatility, banks and other lenders are more likely to extend and improve credit and margining to companies that have an established trade credit insurance program.

“If I have $10 million in receivables and they’re all in Canada and the US, the bank might lend me $7.5 million or 75% of that,” explains Tom Leonard, chief executive officer at Indemnis, a broker specializing in trade credit. “If I have credit insurance, they may be more likely to give me 90% of the total.”

That’s because, prior to putting a policy in place, insurers do a thorough analysis of a company’s financial statements, examining their credit operations, the creditworthiness of the buyers, the terms of sale, and where a seller is distributing product.

“From a company operations standpoint, if trade credit insurance has helped the insured to establish higher lines of credit with their buyers, it may better position them to take advantage of opportunities to sell their products,” says Brad Hebert, in the trade credit division at Chartis. “Trade credit insurance may allow them to sell on 60-day terms instead of 30-day terms, for example, or to ship more product while it’s in demand.”

While the onus under most policies is on the insured to report past due accounts and other anomalies to the underwriters, brokers and insurers typically offer extensive credit management services to clients. This includes everything from ongoing financial and risk analysis to negotiating repayment plans with buyers in the event of a claim.

“For smaller companies, credit insurance allows them to outsource their credit management in a way,” says Leonard. “Credit insurers have operations in every market in the world, and they do nothing but look at credit risk, who the buyers are and what’s going on in the industry.”

Exporters

Historically, trade credit insurance applied only to exporters, with lenders reluctant or unwilling to margin against foreign receivables. After the Second World War, governments across the developed world established export credit agencies (ECAs) with the mandate to grow export markets by offering government-backed financing, political risk management, bonding and trade credit insurance. In Canada, that mandate was given to Export Development Canada (EDC). With 56.1% market share in 2011, EDC continues to dominate the credit insurance market.

“Canada is an exporting country with a long trading history, so there are no sectors or markets that Canadian private insurers or EDC won’t consider,” says Daniel Primeau, vice-president of program and customer support for the insurance group at EDC. “Looking at the current crisis that continues to impact developed markets, there are great opportunities for Canadian companies to develop a stronger presence in foreign markets, especially in emerging markets. That, in addition to the booming volume of business in commodities, means that there is ample opportunity for all Canadian financial institutions to grow their credit insurance book.”

EDC is one of the last ECAs in the world not operating as an insurer of last resort. Despite its mammoth presence in the trade credit insurance market, many argue that private insurers in this space, Canadian businesses and the economy as a whole have benefited from the capacity of EDC in recent years.

“The big difference is that EDC has the government mandate,” says Carolyn Sloan, national vice-president of sales at Millennium. “They are positioned in the market to promote export sales. They generally have a greater capacity on the credit side, and they have a greater appetite to take risk in export markets that private insurers can’t or won’t touch.”

Sloan says that when the market melted down and there were problems with the auto sector, the private sector withdrew very rapidly. “Where the risk was really bad, EDC was able to provide capacity through the Canada Account, an account established by the Government of Canada to take some calculated risk, so EDC’s mandate was expanded, just as the private sector reduced capacity,” she says.

Where credit insurance is known, insurers have been working hard to overcome a certain level of public scepticism.

“A few years ago when the world turned upside down credit-wise (2008-‘09) it was a very difficult period for all the credit insurers,” says Bhatia. “Coming out of that has been really a tough go for everyone. If you were a company that had credit insurance in place before the crisis, and you had a bad experience, you have a bitter taste in your mouth. If you were a company that didn’t have credit insurance and came out unscathed, you’re probably thinking, ‘Why do we need this now if we’ve already been through the worst of it?’ ”

Although insurers did decrease capacity in certain sectors during the financial crisis, the industry still paid out several billion dollars in legitimate claims worldwide.

“We were reducing coverage because the risk was increasing,” says Ian Miller, country manager for Canada at insurer Atradius Credit Insurance. “But frankly, that’s what companies should have been doing, too, is reducing exposure because of increasing risk. Did we really back away? Or did we recognize the risk and pass that knowledge onto our insureds?”

Room for Growth

Despite EDC’s dominance, private insurers have continued to garner increasing percentages of the trade credit insurance market which has grown by more than 75% since 2001. For its part, EDC has demonstrated willingness to work with the private sector to expand the reach of credit insurance in the Canadian marketplace. Six years ago, EDC partnered with private insurer Coface to extend its trade credit offerings to clients that operate in both foreign and domestic markets. EDC has since developed a separate underwriting department entirely focused on partnerships with private insurers, offering reinsurance backing to increase the capacity of the private sector to boost Canadian operations overseas.

But many believe future growth will come from servicing suppliers that fall outside of EDC’s mandate.

“EDC can typically only cover exports,” says Miller. “Exporting companies only make up 40% of our economy, so 60% of Canadian companies are not eligible to be serviced by EDC, and many of them are not being serviced at all.”

Miller is a founding member and the current chairperson of the Canadian Credit Insurance Association (CCIA). Formed in December, it is currently made up of representatives from all parts of industry—including EDC—with the mandate to collectively expand the industry.

“The biggest challenge in Canada for trade credit insurance does not lie in the sectors or in the capacity, it lies in awareness” says EDC’s Primeau. “It starts with the brokers—with expanding the trade credit broker network in Canada. A lot of brokers are not even aware that this product exists.”

Brokers like Millennium have already started wholesaling trade credit insurance to other P&C brokers on a commission-sharing basis. Sloan notes that while companies may opt out of trade credit insurance, it’s in every broker’s best interest to make sure clients understand that it’s available.

“Clients may ultimately decide to self-insure as they do now,” says Sloan. “But if they do, it makes more sense that it be an informed decision.”

The 12-member CCIA is in the process of creating a website to educate brokers and lenders—which are key to referrals—on the benefits of trade credit, as well as the diversity of coverages and options available. At the same time, the CCIA is inviting these parties—even those that don’t specialize in this space—to join the organization.

“Credit insurance is for small and medium enterprises, middle market enterprises, and the Fortune 1000,” says Hebert. “It’s spread across every industry and every size of business. One of the biggest mistakes a broker can make is to not have that two-minute conversation with their clients on trade credit.”

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Trade Credit Primer

Cancellable vs. Non-Cancellable

Cancellable policies are the most commonly-purchased in Canada. Typically, insurers rate and monitor the creditworthiness of a company’s top ten buyers. When there is a rapid deterioration of a buyer or a particular market, insurers reserve the right to reduce or cancel coverage within the policy period. Insureds pay premium as a percentage of annual revenues. In the event of non-payment, the onus is on the insured to prove that the buyer actually owes money. The insured must also attempt to collect 100% of the amount owing prior to making a claim.

Non-cancellable policies give a greater certainty of coverage, and more discretion to the insured. There is a greater degree of risk-share, which forms part of the deductible. Non-cancellable policies are designed for companies that have solid credit management systems in place, because it’s up to internal credit managers to monitor past due accounts to ensure they meet the requirements of the policy. There is generally a provision in the policy that coverage will be suspended on accounts that become 60-days past due.

Single-Buyer Policies

In the event that a company has a buyer that makes up a large percentage of its accounts receivable, there is the option of drafting a policy to cover that single entity.

Discretionary Credit Limits

Within trade credit insurance policies, buyers must be accurately itemized in order to be monitored by the insurer. But clients generally have a clause built into the program which allows them to approve credit to new buyers, following the procedures and credit limits pre-determined by the insurer.

Premiums

Premiums are generally based on a percentage of anticipated annual revenues. They can vary widely from industry to industry, but generally fall between 0.1% and 1% of sales. Industries like food, which have short payment terms, would typically have lower premiums. EDC offers an enviable pay-as-you-go option based on actual monthly sales, but premiums for EDC coverage tend to be higher than those from private insurers. 

Broker Role

More than just monitoring policy renewals and seeking the best coverage, specialty brokers in this space act as an extra set of eyes to oversee their clients’ credit management processes, including ongoing risk management of buyer finances. In the event of non-payment, brokers will often assist clients in attempting to collect funds from clients, help to establish proof of non-payment, or help them to negotiate repayment options.

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 Market Share Data

2010

TOTAL

OrganizationDirect PremiumsMarket Share (Total)
EDC

Euler H.

Coface

Chartis

Atradius

Exec. Risk

GCNA

$120.9

$32.2

$33.5

$7.4

$5.1

$4.5

$1.7

58.9%

15.7%

16.3%

3.6%

2.5%

2.2%

0.8%

 $205.3100%

Source: Atradius

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Copyright 2012 Rogers Publishing Ltd. This article first appeared in the September 2012 edition of Canadian Insurance Top Broker magazine.

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