Credit insurance is an insurance that guarantees businesses against the risk of non-payment by its buyers through a variety of causes of loss.
Insurers distinguish between the protection of specific transactions (capital goods, turnkey contracts, etc) that have long credit periods, and short-term credit insurance (ie those with credit periods of less than 180 days). The observations that follow relate to short-term credit insurance.
Business more competitive
Short-term credit insurance is based on the principle of spread of risk: the insurer requests that the policyholder cover all of its buyers (or at least a significant number of them) to ensure an adequate spread of risk. The insurer then provides protection against buyer default.
Credit insurance can cover a wide range of transactions, but in reality most credit insurers cover trade debts related to the delivery of merchandise or supply of services generally for credit periods of up to six months.
The credit insurer takes 85% or 90% of the risk, and the portfolio is managed through the analysis of the buyers and by the setting of credit limits. Sometimes, policy-holders are given a discretionary limit, that is, the authority to set credit limits up to certain amounts, but to do this, the credit insurer must be satisfied with the credit control procedures used by the policy-holder.
Premium rates generally are calculated either as a percentage on the turnover insured or on the buyer balances outstanding. There is a risk component and a service component in the premium: it includes the cost of bad debt protection, setting credit limits and debt collection. It is worth noting that this service element is considerably more developed in credit insurance than in most other types of insurance. Some of the main advantages of credit insurance are the positive effect that credit insurance can have in helping businesses be more competitive by selling on open account, the selection of better (more solvent) trading partners and the preservation of relationships through professional debt collection techniques.
Traditionally insurers have distinguished between domestic credit insurance and export credit insurance, although these share the same principles. However, this distinction is fast disappearing as the differences between losses arising from commercial and political risk become more blurred. In the future, credit insurers are likely to talk only of buyer non-payment risk (which is what most policy-holders want).
Credit Insurance Makes Access To Finance Easier
In recent years there has been a dramatic upsurge in the number of companies using credit insurance as a means of raising working capital. This is particularly the case in export finance. Banks are familiar with assessing the worth of domestic trade debts: the security value of foreign debt, however, is often beyond their comprehension. For that reason exporters have difficulty in raising finance on foreign receivables. A credit-insured receivable makes access to finance easier.
Much of the developing closeness between bankers and insurers is due to a gradual acceptance by the banking sector that they view risk differently to insurers. Banks lend on the basis that there never will be a loss; insurers underwrite on the basis that there will be sustainable losses. This has led to partnerships between banks and credit insurers, whereby the insurers underwrite the debtors and the banks lend on the receivables, secured by an assignment of the credit insurance policy.
This concept in some cases has been developed to a further level, whereby the bank becomes the policy holder and adds end-debtors to its policy for insurance protection. This provides the means for the bank to be more at ease in knowing that policy terms and conditions are being complied with and the financing is more secure.
The Short-Term Credit Insurance Market
The size of the short-term credit insurance market amounted to approximately US$4.1 billion in 1998. Western Europe continues to be the traditional heartland of credit insurance, but other regions such as Asia are among the fastest growing markets for this product.
Over the last few years, credit insurance has been under significant pressure from external forces to change - both on the supply side and the demand side.
On the demand side, customers have sought improvements in quality of service, particularly in relation to the rapidity of response times on credit limit requests. Also, as companies have expanded internationally, they have sought an international service from their suppliers, including credit insurers.
On the offer side, credit insurance is directly influenced by the rapid growth of new technologies. Widespread, easy access to corporate information - regardless of location - has put great pressure on credit insurers to increase the added value of their services.
In both supply and offer, we also must note the pressure on costs that increased internationalization has produced. Credit insurers have sought to gain bigger international exposure, provide greater financial capacity and seek economies of scale as a means of cost reduction.
Accordingly, the industry has seen a concentration of key players that has taken place over the last few years. This has been achieved either through acquisition or through the creation of a network, such as the CreditAlliance created at the initiative of Coface, and now present in over 40 countries.
International products
Modern international management methods show a preference for "horizontal" structures, with autonomy for local subsidiaries. For international credit controllers at parent company level this poses problems in understanding several different insurance policies and how best to negotiate premium reductions.
To overcome this, insurers must be able to offer their customers local services for overseas subsidiaries and at the same time maintain a global "umbrella" cover for the parent. "Globalliance", the international product offered by the Credit Alliance, allows a multinational to have identical policies, issued in all the main foreign languages, with local service for claims and underwriting.
For example, a Hong Kong-based multinational can have a policy in English, its subsidiary in Chile can have an identical policy in Spanish, and its distribution company in Tokyo can have the same in Japanese, all with local service. No other credit insurer can provide this service on such a scale.
And Now E-Commerce
E-commerce certainly will continue to take a greater share of international trade. It is dramatically speeding up every step of the supply chain. Companies today, online, are able to source product and find new suppliers, advertise their products, order - and with services such as TradeCard - manage the traditional documentation paper trail.
However, two questions have to be answered in this world where any business can deal immediately with another, even if they are on the far side of the world. These are: "Who is my potential client?", and "Is it safe to deal with them"? Those questions are not new. However, what is new is that they demand an immediate answer - if not, e-commerce cannot work. And in Asia, which has a fast-developing e-commerce environment, we will ignore this at our peril.
Of all the indicators or estimates, one truly reflects the internet revolution: the growth of internet users. Between 1995 and 1999, the number of internet users more than tripled to reach 130 million and the computer industry almanac forecasts it will reach 350 million by the end of the year and 770 million by 2005.
Internet use in the Asia-Pacific region is rapidly growing. It is estimated that about 25% of internet users will be located in Asia Pacific by 2005.
For once, all the experts agree on the rapid development of e-commerce over the next years. Although most of the current media focus is on B2C (business-to-consumer) e-commerce, it should be noted that 90% of the value relates to B2B (business-to-business) transactions.
The success of e-commerce depends on trusting every participant in the chain:
* The internet service provider (can I access when I need to, is it secure?)
* The portal (can I find what I am looking for?)
* The counterpart (are they really who they say they are? Are the products really what they offer?)
* The logistics (am I going to receive my orders on time and in good condition?)
* The payment (is my transaction financially secure?)
Already, many e-businesses are solving reliability and system security problems. They have access to vast online product catalogues from hopeful suppliers, have resolved some major issues regarding identity and online signature through powerful PKI certificates (public key infrastructure) and the formation of "communities". However, one gap has yet to be filled: the financial security of transactions.
The internet does not solve the problem of financial security. On the contrary, it makes it more complex, as companies must decide at once with whom to do business. In a business model where transactions are instantaneous, companies cannot afford to lose time in assessing a potential client's creditworthiness. Decisions must be immediate, and the amounts of B2B transactions are above credit card limits.
What are the solutions to financial security?
Alone amongst credit insurers, Coface Group has been working for more than two years on the issue of how to help their clients cope with the new world of e-commerce and it believes that it has found the answer.
Financial markets were the first to be faced with the challenges of immediate and secure assessment of debt; they mostly met them through ratings.
Today E-Commerce Faces The Same Challenges:
* Immediate and secure trade debt risk assessment
* A product, easily available (web access, low cost), with the same meaning everywhere
Information disclosure concerns in Asia?
Disclosure, especially when it relates to financial information, has always been a concern to Asian companies. E-commerce, even more than other business models, requires complete transparency if one is to succeed. Nevertheless, that key information which is vital to a business cannot be made freely available to everybody. There is need for a third party in which a company can have total confidence.
Conclusion
The credit insurance companies that anticipated the changes in their industry and prepared for it by forming strategic alliances have done well. This is primarily because of economies of scale. The smaller insurers could not maintain or develop the costly databases, international networks and new e-commerce products on their own and thus compete effectively.
Richard Burton is general manager, and Nicholas Stum risk manager with Coface Hong Kong.
