21 May 2020

Trade credit for turbulent times

While trade credit insurance has been in existence for decades, the threat of a global recession has heightened the necessity for businesses that provide goods and services on credit terms to strongly consider trade credit cover.

Crombie Lockwood Head of Trade Credit and Surety, Jac Heale, says trade credit insurance has become vital as corporate insolvencies are likely to become both larger in nature and more frequent.

“The number of insolvencies globally is rising, and this affects New Zealand massively because our key trading partners are on the potential edge of recession. This results in credit risk for exporters,” says Jac.

With the Covid-19 pandemic now affecting every aspect of commercial performance at a global level, Jac says all credit insurers are temporarily putting a block on new business for certain industries (such as forestry, for example), with new policies for export businesses requiring additional scrutiny of their anticipated customer base.

“The situation is developing rapidly, but credit insurers are working hard to give information insight to their policy holders as the current crisis materialises.

“Trade credit policies do not generally have a blanket exclusion for pandemic situations. However, there is greater importance to notify insurers where a possibility of insolvency may follow for certain customers.

“This requires greater integration with the credit insurer and acts as an opportunity to lean on the insurer to manage withdrawal or scaling down from certain markets in an orderly fashion.”

Traditionally in New Zealand, Jac says that the number of insolvencies experienced has been flat. Historically there used to be many sub-contractors or small “middlemen” traders going insolvent. In the past insurance only played a small part because most businesses could weather the losses as minor bad debt write-offs on their balance sheet.

However, the insolvencies which have happened in the past two years have been much larger and with a greater degree of fallout.

“What we’ve seen over the last couple of years are a series of market leaders or key companies within a supply chain going insolvent. This has a much more painful and longer-lasting ripple effect,” says Jac.

“And it’s at this point that insurance plays an instrumental role. More businesses are looking to transfer the large debtor’s risk that is emerging because they themselves can’t withstand the sudden shock these insolvencies deliver to the entire supply chain.”

With companies once considered “blue chip” exposed to the threat of a global recession, the domino effect on their suppliers has a profound impact in the marketplace. Even companies with the soundest credit control processes in place can’t avoid the risk of a customer defaulting on a payment.

“That’s why we advise our clients to mitigate their credit risk exposure and use the risk transfer market through trade credit insurance protection,” says Jac.

What is trade credit insurance?

“Trade credit insurance allows a business to transfer the risk of non-payment to an approved credit insurance underwriter. This in turn allows the business to make more informed decisions around their buyers’ credit worthiness, as well as giving them the ability to offer more competitive credit terms to new customers.

“Trade credit insurance also means a company’s liquidity and cashflow is better protected, as are shareholder assets.”

Trade credit insurance policies are generally written on a 12-month basis, covering goods and services delivered and despatched to approved customers during the year. The policy covers the holder for up to 90% of the amount owing and is also a planned tax-deductible cost.

Jac says companies can insure their whole debtor ledger, select nominated debtors or one specific debtor. Cover can be available for pure domestic (New Zealand only), pure export (overseas customers) or a combination of both.

“Credit insurance requires constant monitoring to ensure credit limits are adequate,” says Jac.

“We work closely with clients and underwriters to ensure that all aspects of the policy are complied with. Having a good relationship between the client, the underwriter and the broker is extremely important. It’s good for the underwriter and the client to be in contact regularly and for the underwriter to understand the challenges the client’s business potentially faces.

“With robust trade credit insurance in place though, that client stands a better chance of weathering the storm in the event of a debtor’s insolvency.”

Client Advisory