Credit Insurance Can Save Your Skin
Sydney Morning Herald
Tuesday March 25, 1997
TWO TRADE insurance companies are targeting the small business sector with credit insurance packages aimed at businesses with annual turnover below $2 million.
The packages, offered by Trade Indemnity and FAI Insurances, offer simplified policies featuring lower levels of cover at reduced premiums, making credit insurance (also known as debtor insurance) more affordable and easier for small businesses, the insurers say.
In other respects, they are similar to existing credit insurance policies offered to larger businesses by four insurance groups: Trade Indemnity, FAI, Sun Alliance and the American International Group.
Like the traditional policies, the new small business packages offer cover against non-payment of debts by customers or clients either through a debtor insolvency or through "protracted default" (in practice, where a debtor skips and cannot be found).
An excess applies, after which the insurer will cover a percentage (80 to 90 per cent) of the remainder of the outstanding unpaid debt, up to an agreed maximum insurable amount.
Cover is for trade debtors only - individuals aren't covered, nor are government bodies (which don't go bankrupt).
Reflecting the limited sales volumes of smaller businesses, the insurable sum limits are smaller than in the traditional packages (for which the upper limit is open-ended and negotiable).
Trade Indemnity's package, Tradecover, allows cover up to $120,000 for a premium of $3,000-$8,000 while FAI's package offers cover of up to $150,000 for a premium of $3,000-plus.
And whereas with traditional larger packages debtors may be insured collectively (that is, on a "whole of turnover" basis) or selectively (anywhere from one or two to 15 debtors), the small business packages cover only those debtors you choose to nominate.
Export trade credit insurance is another form of credit insurance that the four majors traditionally handle.
They do this either by extending a standard domestic package to include cover for insolvency or protracted default of an overseas debtor, or by offering a separate export credit insurance policy.
Export credit insurance offers exporters additional cover for contract repudiation (where a buyer refuses to take the goods) and "political cover" (disruptions to payment due to war, unrest, riots, strikes and so on).
However, export insurance isn't included in the new small business packages. The reason for this is that at the smaller end of the market, premiums are higher the smaller the amounts of cover involved. Most small businesses prefer to go to the government owned and funded Export Finance and Insurance Corporation, which offers similar cover but at more competitive premiums. In fact, EFIC is the major export credit insurer for big and small businesses alike.
So which businesses need credit insurance? According to Mr Brian Padbury, a director of specialist credit insurance broking firm Business Debtorinsure , it would suit those which:
* Are in industries where there is a high risk of debtors defaulting (eg retail, building).
* Are highly leveraged (where interest cover must be protected).
* Are dependent on one or two key customers.
* Have a high exposure to recently established customers with no trading history.
It is also a popular product with businesses which are borrowing on the basis of their business cash flow rather than against hard assets like real estate.
Lending institutions are reassured if that cash flow is protected, he says.
Debtors are an asset as important as any other. "Most businesses insure their buildings and equipment but forget to insure their debtors," Mr Padbury says.
And by allowing a business the confidence to increase its level of sales with certain customers, credit insurance may generate enough additional revenue to more than pay for the premiums.
There are few disputes when claims are made - insurers pay out 90 per cent of claims and do so within a few weeks of the claim being lodged, Mr Padbury says.
Others are more circumspect about the need for credit insurance. Mr David Young, manager of business asset finance at the Commonwealth Bank, says that although credit insurance - along with other means of protecting cash flow such as factoring - is becoming increasingly important in lending, the number of businesses required to have it as as a condition of a loan is small.
Mr Geoffrey Sharpe, partner in entrepreneurial services at Ernst and Young, says that while there is a place for this type of insurance, you need to be aware of some pitfalls.
One is that the insurer will examine the financial situation of the nominated customers and if they perceive the customer as risky they will either decline to cover them or set the sum insured at a low level. If you then go ahead and trade with that customer (or trade with an approved customer over the agreed amount) and they default, you'll have to bear the loss (or shortfall) yourself.
The insurer will also require monthly details of your transactions with an insured debtor, including outstanding debts and any sales over the agreed maximum insurable amount.
If you make a claim and are found not to have correctly supplied this information, you may be in technical breach of the policy and may not get the pay-out, though the industry says technical breaches are rare.
Furthermore, he believes the premiums are not cheap, given the limits on the sum insurable and the excess (the amount you have to pay yourself before the policy kicks in) which also applies. In the case of the small business packages the excess is between $1,500 and $5,000, depending on the insurer and the level of cover you want.
According to Mr Sharpe, while there is a place for credit insurance, it shouldn't be a substitute for good credit management. If you have good management systems in place, it may not be necessary, Mr Sharpe says. He says good management means:
* Thoroughly researching your potential customers before you trade with them, including doing credit checks and obtaining bank references.
* Not giving overly generous terms.
* Setting debtor limits and sticking to them; even if it means stopping supply when you get get to that limit.
* Making sure statements are sent to the correct addresses, on time, and are followed up.
But Mr James Melrose, national manager credit insurance at FAI, says there is a limit to how much financial information you can gain about your customers.
And what of those customers who have just started trading for whom there is no trading history available?
Even businesses with a solid trading history can get into difficulties unexpectedly.
In these circumstances, credit insurance may be the only thing that saves you.
Ernst & Young's Geoffrey Sharpe agrees that can be a sensible option where a customer's trading history is unknown.
In that case, it becomes all the more important the smaller your business is.
For example, a debt of $50,000 affects a $1 million turnover business much more than one with a $5 million turnover, Mr Sharpe says.
But you need to look closely at premiums, excesses, and levels of cover offered by the insurer, he says.
Credit insurance packages are available direct from the insurers, though most are sold via a handful of specialist brokers specialising in credit insurance.
© 1997 Sydney Morning Herald
Share This