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Export Credit Insurance: An Analysis

By Manoj Kumar,

President & Managing Partner, Bancassurance Consultants Worldwide Ltd. (BCWL)
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This article was published in Asia Insurance Post in the November 2000 issue.

Manoj Kumar

Export credit insurance has truly proven to be one of today's greatest hidden keys to global growth and export success. As barriers fall, and the world truly becomes a much smaller place, export businesses come as a rare growth opportunity for all businesses alike. This growth potential abroad, and competitive pressures to secure market share are two key forces pushing more and more companies into the export arena. However, it also brings many inherent risks of the trade including the unexpected customer defaults.

The risk of an unexpected customer default is a driving reason why lenders limit advances on pledged receivables. Prudent lending practices dictate that lenders extend themselves only to a certain point, since the potential for default in the receivable base can place an undue repayment burden on the borrower. Obviously, this limits the amount of working capital available from a given group of accounts.

A more cost-effective alternative is to hedge the risk in pledged receivables, allowing a safe increase in the advance rate. A financial instrument known as accounts receivable insurance, which is commonly used in Europe and in the United States for over 100 years, can be used to transfer the risk of unexpected credit losses from the company's books. By eliminating this potential for loss, it is possible to more fully leverage the pledged receivables and increase advance rates by a beneficial percentage.

As an example, a company with $15 million of pledged receivables is currently allowed to advance 80%, providing $12 million in available working capital. Assume additional growth opportunities require an additional $4 million. By insuring the receivables against unexpected customer insolvencies and protracted default, the advance rate can safely be increased to 85%. This provides an additional $750,000 of working capital. As the receivables turn, say six times for this example that increased availability provides additional working capital at every turn, resulting in $4.5 million in additional funds accessible to the company. Further, by guaranteeing payment on the receivables, the lender enjoys the benefit of advancing against a "riskless asset".

The end result is an immediate increase in working capital, increased sales, and increased future sales revenue, while the company preserves remaining assets for future financing needs. This approach is a win-win opportunity for the company and their lender.

According to the latest figures from the Association of British Insurers (ABI), UK domestic and export sales amounting to 18% of gross domestic product were supported by credit insurance. British credit insurers supported £188bn ($290.5bn) worth of trade worldwide in 1998. Another estimate is that credit insurance covers about 25 percent of total exports in Europe, compared with 1 percent of US exports.

Export Credit Insurance has two basic components - Commercial risk and Political risk protection. While economic risks remain significant and encompass insolvency, bankruptcy and protracted default; political risks have not declined either despite the end of the Cold War. On the contrary frequent political upheavals have created an atmosphere of uncertainty in the minds of the potential exporters.

Insolvency: Its True cost

Consider a situation. The customer is insolvent or bankrupt with no hope of recovery. Either way (depending upon his specific credit policy and procedure) the next step would suggest that the account balance be written off to bad debts and life goes on. Unfortunately, removing the principal amount owing from the ledger does not always represent the true cost of the bad debt when one considers the impact on other aspects of the business.

With the advent of just in time delivery, many suppliers perform an essential customer service by ordering or manufacturing, in advance, products specifically required by the customer. If these products are customer specific, they will ultimately have to be written down as obsolete or sold at considerably less than market value. This is often accounted for differently and never really tagged as part of the bad debt, although it arguably could be.

Annual budgets look ahead and sales forecasts cascade down to individual customers. Product sales and margins are predicated on the retention and growth of these identified customers. A bad debt removes this opportunity from the mix and the void must be filled from among the existing accounts or a concerted prospecting effort must be undertaken to find a volume/margin replacement. If neither is found, these lost sales become very measurable.

Bad debts are financed out of a bank line. The reduction of bank availability because of this loss would mean funding for specific projects, like new product development. Programs may have to be curtailed. Companies need to continue to advance and remain competitive. The impact of not having access to these resources will have a much longer-term effect on the overall business.

While bad debts typically fall within the domain of the credit department, the true cost of losing a customer has both short and long-term consequences for the company. Therefore, recording the principal loss is in reality an understatement, if these others factors are not recognized in some form or another. In a competitive situation, this may make the difference between securing the contract or losing the business.

Even in more developed nations, financial security can be a real problem. There were about 200,000 bankruptcies in Western Europe last year, Bankruptcies in Italy surged to nearly 19,000 in 1994 from 14,000 in 1993, while in Germany, they jumped from 20,000 to 25,000 in the same period. A country can be both politically stable and economically uncertain.

Political Risks

Export credit insurance often is marketed in tandem with political risk insurance, which covers payment risks related to the country of the buyer. This encompasses non-payment by the buyers due to transfer difficulties, government moratorium, contract frustration, war, currency inconvertibility, asset expropriation, political violence and so on.

Buying both Coverages is prudent, especially when dealing with companies operating in developing economies or uncertain political climates. Some European carriers, such as Germanyís Gerling Group and AIG, have devised dual coverage policies. It may be wise to purchase both policies from the same insurance carrier. You donít want to debate with two different carriers whether a loss was caused by a bankruptcy [requiring credit insurance] or an insurrection [political risk insurance].

Some carriers donít yet provide political risk insurance, but can coordinate coverage through another insurer. CNA, for example, arranges selective political risk coverage through Unistrat, a New York based political risk insurer owned by French insurer SCOR.

Limitations of Letter of Credit

Foreign buyers are not willing to commit their working capital to back Letters of Credit like they used to. Their position is, Weíre a good risk. If you want to do business with us, youíll have to do it on open credit terms like everybody else.

The cost of a letter of credit can be significant. Banks in the United Kingdom often charge 1.5 percent to 2 percent per month of the face value of the credit extended; banks in Brazil charge as much as 6 percent. Letters of credit also have an impact on a Companyís available credit for internal business purposes. If a company has a $1 million credit line, and it buys $300,000 in products on a letter of credit, its overall credit availability is reduced considerably. Even though the company hasnít really used the money, it has run down its credit line and hurt itís ability to run its business.

Letters of credit are not headache-free for sellers either, creating tremendous paper work and other problems. Letters of credit are stringent about product delivery dates and frequently specify when a product must be shipped and/or received. If a manufacturer misses a scheduled date because of a production glitch or other error, the letter of credit must be amended, requiring another trip to the bank that issued the letter of credit, and paying another fee.

Export credit insurance, on the other hand, creates no burdens for product buyers. The seller purchases the insurance to cover nonpayment of account receivables. Although this creates cost for the seller, the benefits more than compensate for the cost. If you are exporting and insisting on letters of credit as payment, you are probably losing business to your competitors who are offering open terms. If this is the case, you should look into export credit insurance as an alternative to letters of credit.


Credit insurers incorporate a number of factors in deriving the premiums they charge, including the financial stability of product buyers and the country in which the buyer resides. The latter is important for political considerations, which can affect the debtorís commercial obligations. Other underwriting considerations include the terms of sale and credit, for instance, net 30 days or net 90 days, and the terms of transactions involved. The insurers also incorporate a coinsurance share on the Insured between 15 to 25% and impose a wait period of 6 to 12 months before the bad debts can be claimed.

Typical credit insurance program costs 1/10% to 3/10% of covered annual sales for domestic receivable policy, and slightly more for export programs. The return on additional funds employed in the business assures the company a sizable return on the initial investment. In the initial paragraphs, the $4.5 million of additional capital reinvested in the business at a 30% return on funds employed yields as incremental return of $1,350,000, from a premium investment of approximately $150,000. Additionally, the policy allows the company to replace reserves with a tax-deductible premium that places a firm guarantee of payment on the accounts, and eliminates the need for excess reserves.


By financing its receivables, a company enhances its cash flow, that is, it gets cash from the bank immediately rather than waiting for shipments to be delivered and customers to pay their invoices. The customer also benefits. Rather than pay the exporter, it pays the lender on favorable six-month or eight-month terms, giving it cash flow benefits and an opportunity to establish a relationship with his bank. The lender, meanwhile, receives interest on the financing and monthly payments, and in the event of default, has the credit insurance policy to back up payment of the loan. It a "win, win, win" situation for all parties involved.

By integrating export credit insurance into a foreign sales strategy, exporters are provided with enormous flexibility and creativity in how they can structure a deal. No longer is the company out there for 90 or 120 days waiting on a receivable. The receivable is sold to the bank at the time of shipment, thereby moving the foreign receivable off the companyís balance sheet. The end result is greater working capital for the client.

Because the bankís loan is backed by the credit insurance, it is possible to provide higher advance rates at less risk and perhaps include more receivables in the borrowing base. The insurance provides comfort, making it a larger, safer loan for the lender. From that perspective, all parties benefit.

Exporters can also use the policy to replace any reserve against doubtful accounts. The reserve is then moved to the bottom line, increasing profits. It helps in expanding sales due to favorable credit terms and reduces the risk of exposure to non-payment by your buyers. It increases borrowing power by naming the financial institution as "loss payee" to provide the bank with security for lending and by investing in credit insurance thereby getting more favorable loan terms. It also stabilizes cash flow by reducing unexpected or catastrophic bad debt losses.


Despite the existence of credit Insurance for the last 100 years many companies are still unaware of the product's existence. As competition in the global marketplace heats up more and more customers demanding open credit, insurance companies are responding to the market dynamics and many new carriers are entering the market with a wide variety of new and improved programs that can be customized to each situation.

Financing a companyís receivables - backed by credit insurance - is developing as a new export strategy for many companies.

Note: This article is copyright intellectual property of "Insurance Professional, i.e.". Any part of this article may be reproduced only with the express reference to the author, i.e. "Manoj Kumar, ACII, CPCU" and the website. It will be helpful though not mandatory if the author is notified about the reference.

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