Don’t Get Fooled by Its Name: Credit Insurance is Much More Than an Insurance, It is a True Operational Risk Management Instrument
Article Contributor: François de Hennin, PARIMA Member & Former Global CRO, groupM
Treating credit insurance as a pure insurance product can hinder the ability of companies to extract full value from their policies. The writer argues that credit insurance is a risk management instrument which should be included in the operational process from the onset and that the insurance part of the product is only a small part of the value it can deliver to companies.
Credit insurance is by now a well-established product throughout the business community in Western Europe and ANZ and it is constantly gaining ground in the rest of the world.
“Plain vanilla” credit insurance: The credit insurer provides its clients with credit limits (i.e. maximum allowed exposure, usually the sum of outstanding invoices and work in progress) on the client’s trade debtors (“buyers” in credit insurance terms), and as long as the client (i.e. the insured company) maintains its exposure within the credit limit per buyer, the insurer pays up in case of protracted default, insolvency or bankruptcy of the buyer. Because debtors’ circumstances change, credit limits can and do fluctuate during the life of a policy.
The main issue credit insurance suffers from in many companies is that it is called “insurance”, hence often being set-up and managed as a normal insurance, when it is also (or should, in my view, be also used as) a payment terms and cash generation support tool, therefore should be set up and managed by the treasury department or by the operations department, with the support of in –house insurance specialists, and be part of day to day invoice-to-pay processes.
When Wikipedia defines credit insurance as being “purchased by business entities to insure their accounts receivable from loss due to the insolvency of the debtors”, it confirms it as a pure insurance product, to be used only once default has occurred. This misses all the non-insurance features of the product which are useful long before default and which can be a great help to commercial departments, particularly in their discussions of payment terms.
There are of course a number of standard insurance features in credit insurance:
• Many contractual terms are standard insurance terms;
• Clear process and support documents are requested for a claim to be valid;
• Any risk covered will be indemnified as long as the contractual terms have been adhered to;
• Insuring debtors makes them a less risky asset hence providing better security to lending institutions as necessary.
Nevertheless, some specific – non-standard – features of credit insurance are:
• Credit limits are variable; they can and do change during the term of the policy; in other words, although the perimeter of what is covered is clearly defined in the policy (e.g. total turnover), what risks are effectively covered varies with the credit limits.
• Maximum payment terms per buyer are set by the insurer, and agreeing to longer credit terms with that buyer will render the insurance on that buyer void; this is because allowing a buyer more time to pay not only increases the overall exposure on that buyer, but also means that any signal which a delay in payment might send about difficulties at the buyer will be delayed, and your insurer might be insuring other clients for the same buyer;
• In order to properly asses the risk of each buyer, the insurance company will have direct and regular contacts and interaction with them, i.e. with the insured company’s clients;
• There are processes and specific reporting requested from the insured in relation with its invoicing to payment cycle;
• Credit insurers are acutely aware of the importance of cash for their clients, hence indemnification in case of a successful claim is very fast.
Because of the above, integrating the credit insurance process into the debtors’ management process allows a company to extract maximum value from their credit insurance policies.
Credit limits being determined by the insurer ensures they are not affected by the needs of the insured company, but judged strictly on the security presented by the buyer, and this is being done by professionals at the insurance company who process many buyers and have a clear up-to-date picture of defaults and their reason in similar companies; and the credit insurer is committed to its limit, as when it gets it wrong, it will have to pay up the ensuing claims.
Using the insurer to provide credit limits and maximum acceptable credit terms per buyer allows also the insured company to avoid any discussion or request for financial or other information, often a very delicate request, from their clients: this can be handled directly between the insurance company, a professional third party well versed in the handling of confidential data, and the debtor.
Finally, using the credit insurance at the very beginning of a business relationship, i.e. requesting credit limits from the credit insurer on hot prospects allows potential credit management issues to be identified and resolved early and when necessary integrated in contractual terms.
In short, by considering credit insurance as a risk management tool the product can be a tremendous help to operations and to smoothing the relationship with clients, while providing the expected protection of a standard insurance contract, i.e. protecting a business’ balance sheet and its cash generation ability by compensating it rapidly for its insured debtors’ failures.
About the writer:
As Global Chief Risk Officer of groupm, part of WPP, François de Hennin has set up and managed the world’s largest single credit insurance contract.