Credit Insurance

K V Satheesh Kumar

Vice President

 

Credit Insurance offers one of efficient and cost effective ways of managing credit risk for any enterprise. The credit risk can exist on trade receivables internationally or even on account of domestic sales. Most trade whether domestic or exports are carried out on credit terms and one of the major risks that the enterprise may face is the overdue payments or protracted default against sales invoiced.

 

As far as exports are concerned, about 70% of trade from India is carried on open account sales, primarily non-recourse in nature. The balance 30% is on Letters of Credit of various kinds and/or other forms of recourse to credit. These forms of recourse have their own rigidities and costs making the entire process of securing credit terms tedious, time consuming and having a price attached.

 

Credit Insurance offers a cover for open account sales or even an alternative to other forms of recourse on credit terms. In its raw form, it covers the insured against default of payment by customers. There are of course terms and conditions to the insurance and exchange of information before the cover is actually granted and service provided in case of a default.

 

Sales of companies to its buyers “on credit” can be divided into the following broad categories:

• Exports Sales

• Domestic Sales

While domestic credit may be more controllable in nature since the transaction takes place near the point of sale, it is the exports risk which is of prime concern to a seller and have many ramifications mainly trans border for them.

 

 

 

 

 

Export Credit:

The risks associated with Export Sale can be classified in following two categories: Commercial Risk: these can be in the nature of:

1. Protracted default or delayed payments by debtors

2. Insolvency of the buyer

3. Non acceptance of goods by the buyer

4. Trade disputes

 

Credit insurance covers the risk at item 1 and 2 above, while other risks are not of insurable nature.

Political Risk: can be any activity- political or economic difficulty preventing or delaying payment of a transaction and can be in the nature of:

1. Natural disasters

2. Cancellation of import license of the buyer

3. Protracted default on state owned entities

4. Measures taken by host country to prevent payment of transaction

 

These risks are subject matter of insurance and can be considered for risk evaluation and coverage.

 

Credit Insurance:

Credit insurance provides insurance against:

• Trade Receivables

• Business-to-Business Transactions

• Short Term Credit Risk

• Portfolio

 

The benefits of credit insurance are in the form of:

• Risk Mitigation

• Enables development of new markets against protection provided

• Expert advice since buyers are analyzed for credit worthiness

• Allows conversion of other recourse terms like L/C to open account sales thus allowing    seller better leverage in pricing

• Enhances financing since the policies can be assigned

• Efficient collection of debts

• Complements credit management of the seller

 

Same advantages can be culled out for domestic sale of the seller. However the process is more tedious and in the absence of sufficient information on buyers, insurers are cautious in accepting covers.

 

We would like to highlight here again the various advantages of Credit Shield Insurance:

 

Ï    It covers the most basic risk of the business i.e. Credit Sales. BCS covers losses on account of non-payment by your buyers either due to protracted default or insolvency

Ï    It provides cover for Export Sales as well as Domestic Sales

Ï    It works as a Receivable Management and Recovery Tool monitoring your receivables 24x7 and there by nullifies the administrative as well as legal cost in case of default by a customer

Ï    It works as a Marketing Tool as it helps in increasing the sales to new as well as old customers and in Geographical expansion.

Ï    It increases the Competitiveness of the insured as you can give the credit to the customers thereby reducing the cost for the customer

Ï    It reduces the Bad Debts to almost Zero.

Ï    It also works as Financing Tools in the sense that it reduces the cost of borrowing and increases the banking limit as banks feels more comfortable and secured.It opens  additional avenues of finance like Factoring, Channel Financing , etc.

 

We would like to also quote an example of Credit Shield as how it works: (This is an hypothetical example)

                                           

                                                    Without Credit Shield            With Credit Shield

Current Sales                                    Rs 100                                      Rs 100

Increased sales due to BCS                NIL                                        Rs 110   (10% Growth)

 

Less Variable Cost  (75%)               Rs 75                                       Rs 82.50

Less Fixed Cost                               Rs 10                                       Rs 10

 

OP                                                    Rs 15                                       Rs 17.50                             

Bad Debts (2%)                                Rs  2                                        NIL

Cost of BCS (let's say 0.50%)            NIL                                        Rs 0.55

 

OP (after Bad Debts)                         Rs 13                                       Rs 16.95                        

 

However indirect benefit like reduction in administrative cost for monitoring of receivable, chasing the customers in case of default, legal cost, etc are additional.

 

We welcome all the readers of our website to connect with the author for further information at mailto:kvsatheesh.kumar@adityabirla.com