Managing Trade Risk and Business Credit Insurance

1. Managing Trade Risk and Business Credit Insurance 1 Hour Continuing Education – Oregon

2. Course Objectives • Understand accounts receivable risk and how companies manage their trade credit • Learn how business credit insurance can support your clients’ financial objectives • Examine the resources and channels to purchase both domestic and multi-market credit insurance

3. Account Receivables Risk Which of your clients’ assets are protected by an insurance program? Where does the A/R fall on most companies’ balance sheet? • Typically represents from 40% to 70% of a company’s assets • Most vulnerable to unexpected losses • Likely to be affected by business cycles • Provides cash flow for the business • Only under-leveraged asset with financial lender • Few companies can effectively compete without extending credit to their buyers What amount of loss would seriously impact your client’s annual profit? How many accounts have credit extended over that amount?

4. Risk Management - Business Failures • Bankruptcies are inevitable • Failures come from increasingly unpredictable sources • Management Deficiencies • Complex Financial Restructuring • Regulatory Changes • Legal Maneuvering (Chapter 11) • Product Liability • Political Upheaval • Global Economic Changes • Large Bankruptcies can cause a bankruptcy domino effect with suppliers • Set off chain reaction that trickles down • Demands resources to monitor and manage beyond primary debtor

5. Consequences of Bad Debt Losses • A healthy credit management program customarily budgets for a certain level of expected uncollectible debt write-offs in the financial management of a business. However, evenif an unprotected company is able to withstand an unplanned catastrophic loss or multiple losses to its financials, there are other consequences on earnings and future growth. • If a company’s revolving credit line is secured by its accounts receivable, a write-off of part of those receivables immediately impacts cash flow. The same level of funds is no longer available for the company to run it’s day-to-day operations. • The company may become less comfortable with extending future credit without highly secured forms of repayment, impacting the company’s ability to successfully compete and acquire new customers. • Future growth may suffer if the company lacks the necessary cash to invest in product development, distribution, technology and other areas.

6. How Companies Manage Credit Risk • At its most basic level, managing trade credit involves making decisions on whether or not to extend credit, setting terms of a credit arrangement and collecting on receivables. • Most businesses use a variety of tools to determine credit-worthy customers and to minimize bad debt losses: • Third Party Information – such asmerchantile reports (e.g. Dun & Bradstreet) • People Resources – such as credit managers, risk analysts, etc. • Financial vehicles– such as factors and collection agencies • Risk Mitigation Mechanisms – such as letters of credit, liens and credit insurance

7. What is Business Credit Insurance? • Catastrophic Loss Prevention and Cash Flow Protection • Prevent disruptive losses to one of company’s largest, unprotected assets • Safeguard revenue stream from bad debt loss due to unforeseen non-payment, slow payment or insolvencies due to commercial and/or political risks; assuring continuity of business operations. • Reduce the risk of key account concentration levels • Improve timely collection of receivables, lowers DSO and strengthens cash flow • Cap exposure to bad debt loss and smoothes financial results over the business cycle – unlike an allowance for doubtful accounts - accomplishes this with tax deductible premium. • Financing – Strengthen Lender Relationship • Improve borrowing power and increase available capital by converting receivables into a performing asset. • Eliminate lender’s concern over account concentration • Enable eligibility of foreign receivables • Reduce need for personal security requirements

8. What is Business Credit Insurance? • Sales Expansion • Increase incremental growth opportunities with existing customers by safely extending more credit • Mitigate the risk of expanding sales into more volatile or new markets, both domestically and abroad. • Enhance customer relationships – safe profitable cooperation between sales and credit functions. • Increase ability to offer more competitive terms attract export customer base. • No need for letters of credit and collateral requirements on foreign shipments. • Open terms permit buyers to reserve their own working capital line for other uses. • Improve Financial Monitoring and Operational Efficiency • Strengthen structure and discipline for credit decision making • Improve credit risk intelligence using unparalleled third party evaluations of prospective customers, industries and countries. • Install on-going and consistent key account analysis, supply chain monitoring and back-up support for their credit management program • Increase leverage over troubled accounts by utilizing insurer’s expertise and global resources

9. What Business Credit Insurance “Isn’t” • Financial Guarantee • A Substitute for Prudent Credit Management Practices • Routine Bad-Debt Protection. • Fraud or Trade Dispute Insurance • Accounts Receivable Factoring • Valuable Papers or Accounts Receivable Records Property Insurance

10. Key Indicators of Exposure Vulnerability Factors – Greater Need for Risk Mitigation Vehicles • Sales Concentration – vulnerable to devastating losses when a single industry sector or few customers represent more than 25% of total sales • Rapid Sales Growth or New Customer Risk – increased need to safeguard bottom-line results from sales expansion, which is frequently accompanied by write-offs of new customer receivables • Export Sales – relying upon LOC’s or other trade mechanisms can inhibit ability to attract customers and achieve sales growth. There may also be a untapped opportunity to leverage foreign receivables with lender. • Recent Bad Debt History - reserves for write-offs in excess of 1% of sales may indicate company that has experienced impact of unusual receivable write-offs on their past earnings and cash-flow.

11. Key Indicators of Exposure Vulnerability Factors – Need for Credit Risk Mitigation Vehicles • Special Order Goods – If custom-made orders are greater than 30% of company’s total sales, the business is at greater financial risk because inventory can not easily be sold to second party without loss or heavy discounts. • Longer Terms of Sale –open credit terms of more than 60 days increase amount and duration of credit risk (uncertainty of getting paid) • Financing Receivables • Limited Financial Capacity – thin profit margins/highly leveraged companies • Low Risk Tolerance – senior financial executives, especially with public companies, actively seek to avoid earnings volatility • Overburdened Credit Management Capability – prefers to supplement credit decision making with external resources.

12. Options to Manage Short-Term Credit Risk • Self-insurance – establishing bad debt reserves or captive program to offset deficit should customers be unable to pay • Offers flexibility to respond to issues – with nominal coverage exclusions • May create liquidity problems, especially for unforeseen losses. • Impacts capital allocation of balance sheet and may reveal operating weaknesses • Requires investment in credit management systems, information acquisition, analysis and monitoring, and finally audit controls • No alternative “bad cop” to soften conflict resolution with clients who are slow to pay.

13. Options to Manage Short-Term Credit Risk • Credit Insurance – commercial insurance product that indemnifies a company against non-disputed losses from non-payment or slow payment of commercial trade debt • Program flexibility – designed for an entire A/R portfolio or segment of customers • Accommodates both sizeable and smaller exposures; rated and unrated companies; delivered products and trading operations. • Recovery triggered by defined events • As credit quality deteriorates, cover may be restricted or cancelled (depending on insurer) • Business maintains control of customer relationships; bearing cost of protection so customer(s) may be unaware that coverage has been purchased.

14. Options to Manage Short-Term Credit Risk • Put Option – the right to sell a named trade receivable at a set price within a defined period of time if an insolvency or other specified event occurs. • Loss occurring with limited trigger for recovery, i.e. insolvency (shipment and loss event must occur within “put period”. • Typically available for public high-risk buyers (or buyers with public debt) that traditional credit insurance market will not cover • Backer is an investor – untested market in terms of claims settlement in event of catastrophic occurrence • Extremely expensive compared to other forms of credit protection.

15. Options to Manage Short-Term Credit Risk • Factoring – Unless it is a non-recourse agreement, factoring is usually a financing tool rather than a risk transfer mechanism. This option is typically used by companies with temporary cash-flow problems or unusual cash demands that do not have access to traditional financing sources. A factor usually purchases a company’s accounts receivable at a reduced amount of the face of the invoice. • Immediate access to cash in exchange for a % of the receivables value plus a fee • Many factors offer invoicing, collections and other bookkeeping services for companies looking to outsource their entire accounts receivable function. • Not all factors assume the risk of non-payment for invoice they purchase • Considerable margin erosion • Loss of control over customer relationships • Asset is removed from balance sheet restricting line availability

16. Lesson 2: Overview of a Business Credit Insurance Policy

17. How Does A Policy Work? • Unlike other types of business insurance, once a company purchases credit insurance, the policy does not get filed away until next year’s renewal, but rather relationship becomes dynamic. • Policy can change often over the course of the policy period and the company’s credit manager plays an active role. • Requests for additional coverage on a specific buyer • Request for coverage on a new buyer • Many established credit insurers are “limits underwriters”, meaning the company’s more significant buyers are analyzed individually and assigned a credit limit for coverage. • A company’s less significant buyers may be insured under a blanket type of cover, known as a “discretionary credit limit” or DCL.

18. How Does A Policy Work? • The ultimate goal of credit insurance program is not to simply pay legitimate claims as they arise, but rather to help a business to avoid forseeable bad debt loss altogether. • It is credit insurer’s responsibility to proactively monitor the company’s buyers throughout the policy period to ensure their continued credit-worthiness • Gather financial information about private and public companies from variety of sources, including visits to the buyer, financial statements, data supplied by other policyholders that sell to the same buyer, public records, bank references etc. • When data signals that a company’s financial position is deteriorating, the insurer notifies its policyholders that sell to that buyer of the increased risk, and establishes an action plan to mitigate and avoid loss.

19. Policy – Purchasing a Policy • Submit a completed and signed application • Business Description • Terms of Sale • Sales History and Bad Debt Experience • Sales Volume • Current Past Dues • Names and Addresses of Key Buyers • Export – Breakdown of Sales Distribution by Country with Terms of Sale • Brief Summary of Company’s Credit Procedures • Provide a copy of the company’s current Accounts Receivable Aging Report. • Once policy is active, ongoing administration may include reporting to the insurer past due exposures/invoices for buyers at the end of each calendar month in order to keep coverage active.

20. Lesson 3: Methods and Channels to Acquire Credit Insurance

21. Types of Insurance Providers • Private Insurers • Privately owned, but may also act on government’s behalf for foreign receivables • Provides pure cover, insurance to business or a lending institution • Public Export Credit Agencies (ECA’s) • Country created, state owned export credit agency acting on behalf of governments in the countries where they are located. • In some countries, export credit agencies also provide financing support • Cost is frequently more expensive than private insurers. Often avenue used to obtain coverage for high-risk buyers that is not available in private market. • Examples: EX-IM Bank or Export-Import Bank of the U.S., JEXIM or the Export-Import Bank of Japan, and EDC (Canada).

22. Euler Hermes Chartis/AIG Foreign Credit Insurance Agency (FCIA) Atradius Compagnie Francaise d’Assurance pour le Commerce Exterieur (COFACE) QBE Specialty Insurance ACE HCC Insurance Holdings Inc. Zurich Examples of Private Global Insurers

23. Public Export Credit Agency: EX-IM Bank Established in 1934, EX-IM Bank is an independent government agency of the United Sates headquartered in Washington D.C. with sales offices in NYC, Miami, Chicago, Houston, Los Angeles and D.C. • Mission – support U.S. exports in order to create and sustain U.S. jobs with reasonable assurance of repayment. • Non-competition with private sector • Products must have at least 51% U.S. content, including labor but excluding mark-up • Mandated Initiative • Small business (85% of transactions) • Africa • Environment • Minority Business • Available Products • Working Capital Guarantee • Short and Medium Term Insurance (Single buyer and multi-buyer policies available) • Medium and Long-term Loans

24. Benefit Summary – Credit Management Solutions

25. Who Can Benefit from Credit Insurance? • Any company that sells to other businesses on short-term open credit terms of 180 days or less. • Concentration of trade receivables • Thin profit margins • Growing sales due to market expansion and/or merger/acquisition • Export sales • Manufacturers, wholesalers, distributors, and service providers with annual domestic or export sales of $3 million or more. • Broad range of target industries including but not limited to: • Machinery and Equipment • Metals • Pharmaceuticals • Life Sciences • Food Products • Electronics/Technology/Computers • Chemicals • Energy/Oil & Gas • Transportation/Global Logistics Firms • Telecommunications • Paper & Packaging • Consumer Goods

26. Benefit Summary – Credit Management Solutions Reduce Credit Risk and Improve Financial Planning • Strengthen the balance sheet and safeguard sales and gross margin. “The lower the gross margin percentage , the more sales and production required to replace a bad debt.” • ASK – What amount of loss would seriously hurt your company’s financial stability or yearly profit? How many accounts are over this amount? • ASK – What percentage of total or current assets does your customer’s accounts receivable represent? • Secure the company cash flow and avoid the domino effect – a large portion of business failures are directly attributed to uncollectible accounts • Reduce bad debt reserves and free up working capital to be invested more productively

27. Benefit Summary – Credit Management Solutions Enhance Financing • Improve accounts receivable margining. • ASK – Does your company rely on financing, collateralized by your receivables, to fund working capital needs? • ASK – Do you export products? Would you be interested in a way to include foreign receivables in your lending base? • Reduce cost of borrowing • ASK – Are you happy with the rate you pay with your current lender? Is your operating line substantially used at this time? • Reduce bank security requirements • ASK – Do you provide a personal guarantee to your bank? Do you feel significantly over-secured at your bank?

28. Benefit Summary – Credit Management Solutions Expand Sales • Expand sales to new, unknown or higher-risk customers and new markets to which sales are currently restricted. Credit insurance is a tool to increase incremental sales. The higher the gross margin percentage, the greater the contribution from incremental sales • ASK – Are there any new or higher-risk customers to which you are restricting sales? • Improve export sales by selling on less restricted payment terms (no need to require Letters of Credit) • ASK – Do you have export sales? If so, which countries and under what payment terms? • ASK – Could selling on open account terms make you more attractive to your potential client base and improve your competitive position?

29. Benefit Summary – Credit Management Solutions Complement Credit Management Function • Partnership with Credit Management • Access to Risk Management System, Analysts and Evaluation Intelligence • ASK – Does your company currently utilize external resources in your credit process? Which sources? • ASK – How well do you know your customer’s customers? Do you evaluate potential exposure to failures in the supply chain that may adversely impact your customer’s ability to pay (domino effect)?

30. Thank you for your attention.