Mitigating Techniques for Commercial Risk/Credit Insurance-Mitigation
|Unit 3.5- Mitigating Techniques for Commercial Risk
Introduction | Commercial Banks | Loans | Letter of Credit | Draft Collection | Accounts Receivable | Governments | Factoring | Forfaiting | Banker's Acceptances | Credit Insurance | Summary | Resources | Activities | Assessment
Credit Insurance - Mitigation
You carry insurance on your car such that, in the event of an accident, you can get your car repaired or replaced without having to pay for all the expense of the repair or replacement. Export credit insurance is similar. It is an insurance protecting the exporter in case a credit-related non-payment should arise unexpectedly. It is not a means of payment.
Sellers consider credit insurance when selling into a part of the world where there may be political or commercial turmoil. For other sellers, credit insurance may be considered when selling for a first time in a part of the world where concerns for profit may outweigh the buyer’s concern for nonpayment.
By insuring commercial transactions, a company safeguards against the potentially devastating effects of a loss caused by the insolvency or protracted default of one or more of its customers. For international trade, external factors such as import and trade restrictions can also interfere with the successful completion of the contract of sale. A seller may be faced with a buyer’s insolvency, bad debts or even bankruptcy.
Credit insurance protects a seller against a wide range of commercial and political risks and can provide a competitive edge by enabling a seller to
- expand sales
- protect a seller’s balance sheet against bad debts
- boost borrowing power, since lenders will have a “comfort level” with this protection
- stabilize cash flow
- enable new markets to be developed.
Credit insurers require a seller to be part of the credit decision. A seller has to satisfy the credit insurer that he/she has adequate credit controls in place in order to be paid in the event of a default.
Insurance coverage is available for legally enforceable indebtedness and usually commences when goods are "shipped or delivered." However, for many companies, business is complex and requires flexibility from the insurer, so one common variation for insurance is pre-delivery cover (or work-in-progress). If goods are tailor-made, the policyholder may not be able to resell them if the original buyer has become insolvent or the contract is frustrated before delivery. The policyholder is therefore exposed to the risk from date of contract. The extent of cover provided varies between insurers but will normally begin on the effective date of the contract, with claims calculated in relation to costs incurred in the manufacture of the product before the date of loss.
Business credit insurance covers a company's accounts receivable, which can, typically, represent more than 40% of its assets. This protection insures against unexpected bad-debt losses outside of the insured's control as a result of commercial and/or political risks, such as insolvencies, protracted default, repudiation, acts of war and government regulations or restrictions.
Credit insurance covers trade credit, insuring accounts receivable which are generally defined as short-term (360 days or less) and not secured by other guarantees. With a credit insurance policy in place, the company can be certain that valid ( non-disputed) accounts receivable will be paid by either the debtor or the insurer.
With most comprehensive export credit insurance policies, exporters are protected against both credit and political risks. Insurance companies will normally insure between 80 and 90% of the commercial (credit) risk and 85 to 100% of the political risk in a transaction.