|
HOW TO BUY CREDIT RISK INSURANCE Credit risk insurance is rapidly becoming a preferred financial tool for companies facing a wide range of problems and opportunities. In this article, we'll explore how credit risk insurance can be of value in your business and outline the best approach to shopping for this unique and highly valuable coverage. This article is broken down into 6 key sections, with the intent of helping you understand the process of determining your credit risk insurance needs and then how to buy it. Determine Why You Want to Buy Credit Risk Insurance- summary of benefits of credit risk insurance Locate the Right Credit Risk Specialist to Assist You- why this is important, what to look for Designing a Program to Fit Your Needs- budget considerations, risk retention, establishing coverage limits The Application
Process- what to expect,
turn around time, selecting carriers to solicit Implementing
and Managing the Program- getting started, ongoing management items, how your
credit risk specialist can assist Before actually going to the market for quotes, you would be best served by clearly identifying what your interest in credit insurance is and how you think it will benefit your company. As a custom tailored financial tool, there are many practical benefits to having this type of coverage in place. That said, there are also some common misconceptions about what this type of coverage can be used for. At the most
basic level, credit risk insurance is designed to protect you
from unexpected losses due to the insolvency or past due default
on the part of your insured customers. The limited number of underwriters
who specialize in this unique coverage will in most cases, conduct
credit evaluations on the accounts you wish to insure and approve
them for specific credit limits based on your requests and the
results of their research. Given this active credit evaluation
on the part of the insurer, credit insurance should not be approached
as a tool you can use to grant credit to companies that don't
merit it. Likewise, it should not be sought when you have an imminent
loss that you are looking to shelter. Catastrophic loss protection: Across most industries and companies of all sizes, it is generally true that the top 20% of accounts represent about 80% of the company's revenue. In some cases, the concentration of credit exposure among a few or even one key customer is even greater. Just one sudden, unexpected loss could have a devastating impact on the business. If you consider that your receivables are a concentration of all of your cost and your profit, and that, in many cases, you create them based on nothing more than a customer's promise to pay; you can see that there is a tremendous amount of risk facing your business. Even with customers you believe are "good as gold", the risk of unexpected default persists. Credit insurance is a great tool to remove this catastrophic risk from your balance sheet and cap your company's exposure. Safe sales expansion: It is not uncommon for customers to request more credit than you are comfortable giving them, or to have new customers you aren't familiar with seek meaningful amounts of credit from you. While you may invest in a professional credit practice to review these requests and manage the exposures, if you are limiting sales as a result of concern over the risk, credit insurance is an ideal answer. Many companies use credit insurance to be able to expand on existing credit limits without having to put themselves at additional risk. It is also helpful in covering open credit sales to new accounts where you might have limited information and sales history. It is worth pointing out that using your credit insurance policy to support additional sales you would not have made otherwise will not only allow you to recapture the premium, it will help you drop additional profit to your bottom line. Credit decision support: As mentioned earlier, in just about every case, the underwriters on your credit insurance policy are going to actively research, approve and monitor the accounts you wish to insure. Having an industry specific financial analyst doing this work for you as part of your credit risk insurance program adds a lot of expertise to your credit practice, or provides you, to a certain degree, with an outsourced credit department. This allows you to focus your internal resources more on cash flow management and collections work. If you consider the cost of amassing the information resources, many by costly subscription only, and hiring the additional expert financial analysts, this decision support alone is worth the typical annual premium. Most companies operate on the general rule that as long as the customer is paying timely credit management efforts can be focused elsewhere. Unfortunately, payment history is not a valid predictor of default. Many companies are current on their bills at the time they file for bankruptcy protection or are forced into default. Having the carrier watching your covered accounts and helping you evaluate credit limits on new risks is a great advantage to the program. Borrowing enhancement: If the company borrows against its receivables, credit risk insurance can provide additional protection to the lender so they may be able to enhance the borrowing arrangements. They do this by increasing the percentage they will advance against insured accounts, and/or roping more accounts into the borrowing base- large concentrations, slow payers, export customers, etc. This allows you to maximize the amount of working capital available from the same pool of receivables. If you're in a high growth mode and find yourself in need of more working capital, credit insurance is a great way to resolve the problem. Exporting on open credit: With more companies sourcing customers outside their own borders, the risk of granting credit terms has to be balanced against maintaining competitive terms against other sellers. Export credit risk insurance is one tool you can use to offer competitive open credit terms without the additional risk. Before you talk to a specialist in this field, you should take a look at your business- the customer base, credit practices, risk appetites, etc. and think about how you want the policy to go to work for you and where it can bring value. With this accomplished, you'll be better prepared to have a productive dialog with a specialist who can help you find the ideal solution. Locating the Right Credit Risk Specialist to Assist You Credit risk insurance can be an extremely valuable tool for your company, and one that more than pays for itself in any number of ways as previously noted. However, as a custom tailored program, there is no standard "off the shelf" policy you can buy that will automatically be the right fit for your specific needs and circumstances. Further complicating the matter is the fact that there are only a few providers specializing in this type of coverage, and they each have their own risk appetites, underwriting philosophies and contract wording. Ideally, you will seek the assistance of a credit risk insurance specialist. When looking for someone to help you shop for this type of coverage, you want to be sure that you are dealing with a specialist who meets the following minimum qualifications: -Has as their primary if not exclusive focus, the implementation and management of credit insurance. -Is licensed to do business in your state and is in good standing with state regulators. -Has appointments to represent and is in good standing with all of the providers in the market, and preferably has what is known in the industry as "direct writing" authority. That is, they work directly with the carrier's underwriters vs. having to go through other representatives of the carrier. -Has established staff, resources and procedures to support both shopping for the policy and assisting with ongoing policy management. Specialist brokers who deal exclusively with credit insurance are more likely to have a deeper understanding of each carrier's philosophy, risk appetite and contracts. They will be able to lead you to the ideal solution in the least amount of time, and ideally save you unnecessary paperwork and money. Most brokers do not charge any additional fees, and under insurance industry regulations, the premiums quoted through your credit insurance broker are priced the same as if you were to secure them directly from the carrier. While some of the carriers do have their own agent networks, dealing with a competent specialist broker opens you up to more market options, and objective expertise and decision support. Your broker's loyalty is to you and to helping you maximize the value of your investment in credit insurance. It is important to note here that in the US marketplace, there are less than 10 traditional credit risk insurance markets to go to, and several would be considered more specialized vs. mainstream underwriters. In light of this, you will want to select one broker partner to work with. If you solicit more than one broker, you will find they end up going to the same carriers. One competent broker can effectively cover all of the market options for you, and you will avoid a lot of unnecessary confusion and complications that would arise if you try to put more than one broker to work on your behalf. When talking with a specialist broker, you should expect to find someone who is interested in understanding your perceived needs and uses for credit risk insurance, and who is interested in learning about your company and the direction management wants to take the business. The best specialist brokers are the ones who do the most listening and ask a lot of questions. Since every policy is custom tailored for each client's needs, the more your broker knows, the better the job they can do for you. Your specialist broker can provide you with detailed information on credit insurance, including the various carriers' financial standings and ratings, specimen policies and help you with comparative analysis of the options available to your business. In terms of ongoing support, your broker should also be able to assist with account research, coverage requests, claims filings, helping you understand the minimal reporting requirements some carriers have, negotiating renewals and shopping for account coverages you may need outside your primary policy. In short, your specialist broker is your outside expert and partner. Designing
a Program to Fit Your Needs Once you have given careful thought to where credit insurance fits into your business, and you have your specialist ready to help you, before marching off to underwriters with an application, it is best to work with your broker to map out how you want the policy to look. Your broker can assist you in understanding the underwriter's perspective so that together, you can design a policy that meets your needs and represents a fair opportunity for the carrier as well. First, we'll examine a few basic policy parameters, then look at some more detailed items you'll want to consider prior to submitting an application. Premium. Always the first item of interest, the policy premium is a logical first parameter to examine. Because the policies are custom tailored and there are numerous factors that affect the premium, providing you with estimates in an article of this nature would be misleading. Suffice it to say, for a small fraction of a percent of covered annual sales, an amount easily recaptured through any of the proactive benefits of the policy, you can insure your portfolio or any meaningful segment of it. The ultimate premium that the carrier charges will be priced based on a number of factors including: default rates in your industry, your loss history, customer credit quality, the spread of risk and the deductible and coinsurance levels in the policy. Risk retention: These come most commonly, in the form of deductibles and coinsurance. Carriers use either or both to allow for risk sharing. This risk retention assures them you have a vested interest in continuing to manage your exposure, while also allowing you to minimize your premium. Deductibles are typically a one-time per annum first loss position you have to satisfy before claims payments start. Coinsurance is a percentage of the loss that you retain on each account, and typically ranges between 10% and 20%. One general rule in designing your policy is to use a coinsurance level less than or equal to your gross margin. This allows you to be sure you are covering your cost while avoiding paying additional premium to insure your profit. A deductible can be used to lever down the premium to a certain point. You can maintain a small reserve to cover the deductible or take it out of your cash flow at the time of the first loss. Coverage limits: Your underwriter will review and approve specific coverage limits on the customers you wish to insure. While you can always request limit increases or submit new accounts as often as you need to throughout the policy term, you will need to start off with that initial list of accounts you want to insure at the present time. In selecting the accounts, it is important to not try to guess which accounts should be insured and which do not pose any default risk. The policy is designed to protect against unexpected losses and as such, you should only be looking at the size of the exposure, not the perceived credit quality of the account. It is often the accounts that appear "good as gold" that carry the largest balances and can hurt you the most if an unexpected default occurs. Additionally, you want to provide the underwriters with a balanced spread of risk that will allow them to give you their best pricing and terms. With these three key items addressed, your specialist broker may recommend additional coverage endorsements based on the nature of your business. These should be discussed and itemized in the quotes that you receive. You will also want to clarify items like your maximum terms of sale, lead times in filling customer orders and note any specially purchased materials or custom work that might require additional coverage. Once you and your broker have a better picture of how the policy will look, it is simply a matter of completing the application. Your broker will submit it to the appropriate markets for you. The Application Process Your credit insurance policy will be quoted based on the information you provide in your application, and that application will be bound into the policy as your underlying representations in the agreement between you and your insurer. Accordingly, it is important that you provide as complete an application form as possible. In most cases, the form is no more than 4 pages of basic questions about the business, along with tables for listing the coverage limits you want and reporting significant past due accounts. For the typical domestic credit insurance application, carriers can provide full quotes with account underwriting decisions in about two weeks. This varies depending on the number of accounts and underwriting backlogs. Your broker should follow-up on your behalf to make sure that the quotes are returned in a reasonable timeframe. Applications for export coverages can take longer due to the longer lead times in underwriting overseas accounts. In terms of selecting carriers to solicit for quotes, it is important to understand that there are only a small handful of carriers who specialize in this type of coverage, so in some cases you may only have one or two viable options to consider. As mentioned earlier, to avoid confusion and delays you should select one broker to work with, as they should be able to provide you with access to the few carriers who might be a fit for your needs. Do not hesitate to ask your broker about the carriers they recommend for you. When the underwriting process is complete, you should receive the quotes as presented to your broker by the carriers. It is then time to evaluate the offers and determine who represents the best fit for your specific requirements. Evaluating
Offers While the coverage is fundamentally similar, the carriers all differ widely in how they structure and administrate their policies. So, after covering the basics of premium, risk retention and coverage limits, you will want to take the time to understand how each carrier differs on some of the areas where the policy has to be customized to fit your needs (special terms of sale, export sales in different currencies, work in process coverage on custom goods, etc.) From your perspective as a buyer of credit insurance, you want to evaluate the carriers and their offers based on three key categories- the carrier's financial strength, their contract wording and the policy terms and coverages they propose. You will find that virtually all of the carriers specializing in this type of coverage are either monoline insurers specializing exclusively in credit insurance, or are niche operations in very large, multinational property and casualty companies. AM Best, S&P and/or Moody's ratings are readily available. The top providers are highly rated, investment grade companies. Financials are publicly available for your review as well. Your broker can assist you with in securing this information. Contract wording is where you will find the major differences between the carriers. Your broker can provide specimen policies and wording for any key endorsements for your review. Among the things you will want to understand are how they define insolvency, what the claim filing deadlines and requirements are, what reporting requirements are part of the program, what their cancellation provisions are, how they treat collections on past due claims and how recoveries are shared. All of these items vary widely in some cases, so understanding how one carrier operates does not necessarily mean that you can expect the same from a different set of underwriters. The quotes, if you receive more than one offer, will have some fundamental similarities, but you should take the time to go over these differences with your broker. Comparing premiums and deductibles and/or coinsurance has to be done in light of what the carriers are offering on coverage limits and policy conditions. Credit insurance is not a commodity product that can be shopped on price alone. The goal is to find the program that best matches you needs based on how you want to put the policy to work. As custom tailored programs, you should expect that some fine tuning of the initial quotes may be necessary to bring the policy offers in line with your requirements. Implementing and Managing the Program Once you feel you adequately understand what you are buying and have the policy fine tuned as much as possible to match your needs, you will simply need to issue the policy and pay the premium. It typically takes about two weeks for the policy to arrive. On an ongoing basis, you can expect to have to maintain monthly past due reports in some policies. You will also want to monitor your account exposures in the event you need to add new accounts or increase the coverage limits on existing accounts. You will want to note key policy requirements like claim filing windows, and review the forms needed to request coverage, report past due accounts and file claims. Many carriers offer you the ability to manage these activities directly online, but your broker should also be available to assist where needed. Credit insurance is a tremendous financial and risk management tool. With the right broker partner and carrier, you can enjoy protection on one of your company's largest assets, safely expand your sales, improve your borrowing arrangements and take advantage of expert decision support and credit guidance. Going Further If you recognize the benefits credit risk insurance may be able to provide for you, don't hesitate to contact us. Global Commercial
Credit Copyright © 2004 - 2005 Global Commercial Credit |