Monday, March 26, 2012

Trade Credit Insurance: Catalyst To Export Diversification

Trade Credit Insurance: Catalyst To Export Diversification

Exporters all over the world face the risk of non-payment for goods bought by their customers overseas. The sale of goods and services are exposed to risks which are not immediately under the control of the supplier. Managing these risks is a priority for businesses.

In addition to increased risk of non-payment, international trade presents the problem of time between the product shipment and its availability for sale. The accounts receivable is like a loan and represents capital invested, and often borrowed, by the supplier.

Bad debts can bring down a company to its knees. A simple insurance policy can make all the difference and this is where trade credit insurance becomes very relevant.

Trade credit risk insurance is an insurance policy and a risk management product that is offered by private insurance companies and governmental export credit agencies (such as the Nigerian Export-Import Bank) to business entities wishing to protect their accounts receivable from loss due to credit risks, such as protracted default, insolvency, bankruptcy, etc. It is, therefore, a protection against unusually large losses from unpaid accounts receivable.

Trade credit insurance protects against customer non-repayment and hedges against commercial and political risks beyond their control. Compared to a letter of credit (LC), trade credit insurance is easier to set up, more secure, and oftentimes less expensive.

It is customary to define short-term export credit insurance (ST) as insurance for trade transactions with repayment terms of one year or less, while medium to and long-term export credit insurance (MLT) covers trade transactions of more than one year (typically three to five years and occasionally up to fifteen years). MLT business is usually insured on a transactional business, covering sales of capital goods and services with repayment terms of over several years.

There are many benefits of trade credit insurance: (i) Sales expansion: if receivables are unused, a company can easily and safely sell more to existing customers or go after new overseas business that was otherwise considered risky; (ii) Ignores finance terms: banks will often lend more against uninsured receivables; (iii) Export on open account: the product provides global competitiveness advantage to trade on open account terms (i.e. buy now and pay later) without the worry; (iv) Provides times for the customer to generate income from sales before paying for the product or service; (v) Reduces credit risk related losses; (vi) Improves profitability of business; (vii) At the macroeconomic level, it helps to facilitate international trade flows and contributes to global economic growth; (viii) It enhances economic stability by sharing the risks of trade losses with trade credit insurers; (ix) In the absence of trade credit insurance, and in order to avoid credit risk-related losses, suppliers would have no choice but to rely on either full pre-payment for goods and services by buyers or to seek a third party which is willing to take the credit risk for a price; and (x) The product also provides peace of mind to the supplier as well as market intelligence on the financial viability of the supplier’s customers.

Trade credit insurance works by individual credit limits for each customer. The limits are pre-set and customers can trade within the limit for a specified period without further reference to the insurer. The customer can request for an increase in the limit at any time. The trade credit insurance can be paid in one payment but many insurers offer monthly payment, some interest-free.

There are many types of credit insurance: (i) Whole turnover cover (which is the most common): This is a comprehensive credit insurance policy that covers the whole business and allows the business to offer credit up to a pre-set limit. The premium paid is based on the turnover of the business. This is common with ST transactions. (ii) Critical customer cover: This allows a business to have insurance cover against a number of named customers (usually up to 10). The business will be fully responsible for the remaining customers not covered by the credit insurance. (iii) Specific risk cover: This allows a business to have insurance against a single customer or a large contract. Premium is based on the contract value or the turnover of the customer over the policy period. (iv) Export trade credit insurance: The policy offers insurance against non-payment of overseas customers. It can also insure against political, social and economic instability, insolvencies, and defaults, etc.

How does trade credit insurance work? Very simple: you ask the credit insurer for a credit limit on each of the customers with whom you trade above and at agreed level. Below this level (usually referred to as your Limit of Discretion or Discretionary Limit), you do not need to ask for a credit limit.

Provided trading is done within the set parameters and sticks to the terms and conditions of the policy, the exporter can be covered (up to the limit of cover agreed) if one of the customers defaults.

The process of insuring accounts receivable must, by definition, involve a thorough understanding of a supplier’s trade sector, risk philosophy, business strategy, financial health, funding requirements, and internal credit management process.

Throughout the life cycle of the policy, the supplier may, for instance, request for additional coverage on an existing buyer. It must be noted, however, that credit insurers do not cover losses where there is a valid dispute between the supplier and the buyer.

In the late 1980’s, global trade credit insurance premiums increased to over $10 billion. This massive growth cannot be said to have occurred in Nigeria. For decades, export credit insurers, public and private, have worked in the background oiling the wheels of international trade, largely unnoticed by the wider public. In mid-2008 when the global financial crisis struck, the crucial importance of trade finance and credit insurance to support international trade flows became glaring.

The level of awareness of this product is still very low in Nigeria due to ignorance and lack of awareness. It must be noted, though, that the Nigerian Export-Import Bank is set up specifically to deliver this product to Nigerian exporters. The bank is now fully re-engineered and re-invigorated to provide this service to Nigerians.

Exporters in Nigeria, especially non-oil exporters, would find this product very attractive and supportive of their export business. This would, no doubt, boost non-oil export in Nigeria and facilitate diversification of the productive base of the economy, generate foreign exchange and enhance job creation.

The value of credit insurance as a risk mitigation tool in cross-border trade has gained in global recognition which has led to increased demand for the product. Higher risk awareness and higher product awareness will bring opportunities for existing credit insurers, public and private, and for new entrants.

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