Credit insurance is a
financial tool that offers tremendous competitive advantages
for asset based lenders who understand how to use it.
If you haven't heard of it before, or if you think you
may have heard all there is to hear about it, following
are a few new approaches you may not have considered.
In a competitive environment,
or in situations where you are simply searching for
ways to meet your client's increasing capital requirements,
we have found credit insurance consistently provides
the optimum solution to safely putting more capital
in the client's hands. Maximizing capital availability
will win you the deal every time. The real trick is
doing this without compromising your internal credit
underwriting guidelines. In all of the competitive situations
we have encountered, the lender who used credit insurance
to increase availability ultimately offered the client
a more attractive program and won the deal.
As a firm that specializes
in all forms of domestic and export credit insurance
and political risk insurance, we help lenders use these
programs to solve several very specific risk issues
when structuring receivables based borrowing arrangements
for their clients. In addition to the obvious basic
credit risk mitigation benefits the policy offers, credit
insurance also provides an added layer of expert due
diligence and ongoing monitoring of covered accounts
to further strengthen the client's credit practice and
protect the lender's interests. Many of the carriers
also provide collections and bankruptcy litigation support
at rates lower than the typical cost.
Even if you are comfortable
with the risk profile of a client's customer base, there
are still a few deal breaking issues that can impact
a transaction. Here's how you can use credit insurance
to resolve them:
OVERDUE
INELIGIBLES
In many industries, like
automotive or project oriented business sectors, it
is not uncommon for a fair percentage of total accounts
to fall beyond the standard 60 or 90 day eligible window.
This may result in a reduction of available working
capital of 20% to 40% or more. Receivables that extend
beyond the window are not included in the borrowing
base, and the client loses access to the capital tied
up in these accounts.
Credit insurance can be
structured to protect accounts from protracted default
(past due) problems up to 180 days from invoice date.
This protection allows lenders to keep accounts in the
borrowing base for a much longer period of time, with
obvious benefit to the client. Should the covered accounts
ultimately default, the carrier will reimburse the loss
according to the terms of the policy.
PURCHASE
ORDER PROTECTION
Most lenders have difficulty
providing advances against purchase orders. While credit
insurance does not address any performance issues you
may have with your client, assuming you are confident
in their ability to do their work and deliver, credit
insurance can provide protection to advance against
the initial contract. We have met several companies
operating well below capacity, and turning away orders
because they lacked the capital to fund the jobs upfront.
Credit insurance can be
structured to protect the client and lender against
default by a customer on a custom prepared product or
service even before the work is complete and the customer
invoiced. This purchase order protection is an ideal
way to hedge the risk of taking a loss on an account
that has not yet been converted into a receivable. It
also provides your client with capital right when they
need it most- when they get a new contract.
ADVANCE
RATE INCREASES
Because of the potential
for bad debt losses possible in any given account portfolio,
advance rates are limited. We regularly use credit insurance
to protect lenders who wish to increase their advance
rates. As an example, a policy with a simple 10% coinsurance,
where the carrier agrees to pay .90 on the dollar for
all eligible losses, enables the lender to increase
the advance rate to 90% and still be covered for their
full exposure. The client retains 10% of the risk, and
the carrier absorbs the remaining 90%. Considering that
the typical advance rates in a good deal average just
80%, the extra available capital from even a 10% advance
rate increase can be substantial. Credit insurance can
allow advance rate increases that make a marginal deal
good and a good deal great, in the client's eyes.
COST OF
FUNDS
The natural reaction when
considering credit insurance is that it will add another
cost burden to a deal where price is always a key issue.
What we have found is that for a cost averaging just
10 to 30 basis points on covered annual sales, the premium
for credit insurance does not add measurably to the
cost of the transaction. Further, the rates required
for the lender to properly price for the risk is greater
than the policy premium and lower cost of funds possible
with the coverage. In several instances, we have structured
policies for lenders competing against non credit insured
offers. The program utilizing credit insurance provided
greater eligibles and advance rates resulting in more
capital, and the lender's cost of funds did not have
to include a premium for the credit risk, so the total
cost, even with the policy, was lower. This makes for
an easy decision on the client's part.
A slight basis point reduction
in the cost of funds will more than offset the policy
premium, and as the receivables turn and the portfolio
is leveraged multiple times during the year, the cost
of credit insurance is spread extremely thin. The client's
return on the additional funds employed, provides a
substantial return on the premium investment.
With the right policy
structure behind your deal, you can bring tremendous
value to your clients, while increasing your loan portfolio
and reducing your exposure to potential losses.
