As a trade credit insurance broker, I often get asked why clients should use both, trade credit insurance and a commercial credit reporting bureau. In this article I refer to Creditorwatch , as a preferred partner for DAS Insure, but not discounting other Commercial credit reporting bureaus.
Trade credit insurance, although a very old product from the early 19 century with a widespread use in Europe, remains a discretionary product in Australia. This year is the year this could change as we are coming out of the dormant insolvency process during Covid (Zombie companies surviving on governmental support) and are entering a phase of economic and geopolitical uncertainty.
What is trade credit insurance and how does it work?
Trade Credit Insurance also called Debtor Insurance protects one of your largest assets, your accounts receivables. If you provide your products and services on credit terms, you are exposing yourself to the risk of slow-payment (Protected Default) or non-payment (Insolvency).
At DAS Insure we often start our conversation with new clients with a couple of questions to gain an understanding for the risk of buyer default and impact on their business. Does the 80/20 rule of thumb apply to their business, i.e., do they generate 80% of their turnover with 20% of their clients? What policies and procedures are in place for establishing credit limits and payment terms for new buyers. Are existing buyer limits monitored and reviewed on a regular basis. How are overdue debts handled. Then we investigate their profit margin – and how their business would be affected if one of their larger clients could not pay.
If a business has a profit margin of 20%, a written off debt of $100,000 requires an additional turnover of $500,000 just to get the business back to where they started. This does not count for the time and money spent chasing the debt and potential cash flow issues this caused. If the debt would have been insured, 90% of the amount would have been paid out, after deduction of a small excess. Did you know that most insurers pay up to 100% of debt collection fees and legal fees for an insured debt? This is important, as some clients do not default into insolvency, but rather are extremely slow payers. The construction industry is the typical example, as suppliers depend on being paid by the builder.
A freshly overdue debt has more success of being collected, and trade credit insurers do support this process. You benefit from their in-house expertise to collect the debt, they contribute to the costs up to 100% and a trade credit insurance claim is avoided. Should the debt be 120 days overdue from the original due date and non-collectible, the trade credit policy could be called upon. This is called a Protected Default claim, for undisputed invoices that are overdue for 120 days or more from due date.
Trade Credit Insurance is what I call a ‘living policy’, nothing you purchase and file away, until the claimable event occurs. Unlike other insurances, e.g. a fire protection policy, which unfortunately cannot warn you that a fire is louring ahead- trade credit insurance does exactly this- it warns you if the payment behaviour of your insured buyers on record is changing. Empowering you to adjust your credit limit, payment terms and exposure for these buyers in question.
Trade credit insurers, like commercial credit reporting bureaus, have the power of mass data. They have access to overdue notifications from their clients, which trigger a notifiable event. There is a ranking of severity depending on the type of notifiable event, it could be as simple as a commercial dispute or as severe as a payment plan that has not been followed through, or legal action has commenced. In addition, insurers use complex AI technology to monitor and search for negative reports from banks, collection agencies, ASIC, ATO and local newspapers etc. These warning flags are often the first signs that a company might encounter severe payment issues, prior entering into administration.
Allow me to get technical for a moment:
When choosing a type of cover for your credit insurance, the options vary- from insuring all buyers, domestic buyers only or key accounts. depending on your internal credit management procedures, your risk spread withing your debtor’s ledger and the terms you allocate, the insurers offer you a discretionary limit- under which you can apply your own due diligence and are still covered. Above the discretionary limit, each of your buyers will be named on your policy with a specific limit tailored to cover their maximum amount outstanding (invoiced and work in progress). Your insurer will monitor the named buyers and notify you if they have any concerns.
Beneath your discretionary limit, you can apply your own trade experience to ensure cover, demonstrating satisfactory trading experience. Alternatively, you can use approved sources to gain cover, e.g. trade references; a bank opinion from the insured Buyer’s Bankers; audited or independently reviewed financial statements. A resource that is often favoured for new buyers is a written report from an independent commercial credit reporting bureau. The requirements differ slightly amongst the trade credit insurers, but generally the report needs to state that it supports the amount of credit to be granted by the Insured.
In addition, the Insured can use a ‘Nothing Adverse Recorded’ report from a Credit Bureau to gain cover for buyers up the Discretionary Limit. A Credit Bureau would issue a written report of a full search of the national litigation records on the Insured Buyer and its directors, partners, or proprietor.
Furthermore, an independent resource like CreditorWatch can be instrumental when negotiating cover with the insurers Insurers reserve the right to adjust their exposure on a buyer during the policy period, the reasons can vary. The Insured can make their own judgment and continue trading as they see fit; knowing that they are partially uninsured. It is crucial and something your broker should push for, that the insurer is transparent as to why the cover has been reduced To gauge how commercial a client should be in granting a credit limit that is suddenly uninsured or only partly insured, an independent report from CreditorWatch has proven most useful.
In my experience, when diving deeper into some cases and with the insight of additional information from an unbiased and independent source like CreditorWatch, we were able to revise the insurer’s decision or work on a compromise. We call this process working on the limits, again, demonstrating that the insurance is also a risk management tool with changing variables. The overall goal is to optimize credit management decisions and find the right balance between profitable growth and long-term client relationships. (Think about the battle between Accounts and Sales when establishing an internal credit line).
Reports from CreditorWatch are a powerful resource to gain insurance cover beneath the discretionary limit, or to negotiate cover for named buyers above the discretionary limit. Further benefits for Trade Credit Insured clients can be as follows:
CreditorWatch offers a Data wash, or Portfolio Health Check of your debtor’s ledger. A clean data portfolio presents a better credit management. Insurers value this especially when initially applying for trade credit insurance. It will assist in the application process and ensure that the request for cover is on the correct entity, not on a trust or outdated ABN. Once the policy and discretionary limit is established, an annual review will assist with the compliance requirements under the discretionary limit.
Should there be a concern for buyers beneath the discretionary limit, the monitoring services for such critical buyers are a great addition to the insurance cover.
Using the CreditorWatch logo on letters of demand has let to faster payments as companies dread to have a payment default registered against them. This is effective for smaller amounts which are under the threshold for the insurance excess. Some insured wish not to disclose to their buyers that they have Trade Credit Insurance in place.
Critical suppliers to the business can be monitored as well, a holistic approach is recommended as supply chain issues have increased.
PPSRLogic, that simplifies the way you create, manage and renew PPSR registration is a fantastic tool to ensure there are no compliance errors or lapsed registration issues when being called upon for a trade credit insurance claim.
To conclude, trade credit insurance is taken out by many companies who do not have claims on a regular basis. They value the benefit of using trade credit insurance as an active credit risk management tool, knowing that they protect their profit margins, by allocating their resources to profitable buyers with a low risk of default. It is especially these types of companies who value and invest into a modern suite of risk management tools, that would combine the best of two worlds.
CreditorWatch’s dynamic data platform and extensive range of products is a perfect fit for DASInsure’s trade credit clients.
Babette Bottin, Director of DAS Insure Pty Ltd November 2022
Disclaimer: This article reflects on DAS Insure’s experience and should not be taken as personal advise. Talk to us to investigate if Trade Credit Insurance could be right for you.