INTRODUCTION

Credit:

A contractual agreement in which a borrower receives something of value now and agrees to
repay the lender at some later date. When a consumer purchases something using a credit
card, they are buying on credit (receiving the item at that time, and paying back the credit
card company month by month). Any time when an individual finances something with a
loan (such as an automobile or a house), they are using credit in that situation as well.

Credit Insurance:

Credit insurance is an insurance policy and a risk management product offered by private
insurance companies and governmental export credit agencies to business entities wishing to

protect their accounts receivable from loss due to credit risks such as protracted default,
insolvency or bankruptcy. This insurance product is a type of property & casualty insurance,
and should not be confused with such products as credit life or credit disability insurance,
which individuals obtain to protect against the risk of loss of income needed to pay debts.
Trade Credit Insurance can include a component of political risk insurance which is offered
by the same insurers to insure the risk of non-payment by foreign buyers due to currency
issues, political unrest, expropriation etc.
Trade credit is offered by vendors to their customers as an alternative to prepayment or
cash on delivery terms, providing time for the customer to generate income from sales to pay
for the product or service. This requires the vendor to assume non-payment risk. In a local or
domestic situation as well as in an export transaction, the risk increases when laws, customs
communications and customer's reputation are not fully understood. In addition to increased
risk of non-payment, international trade presents the problem of the time between product
shipment and its availability for sale. The account receivable is like a loan and represents
capital invested, and often borrowed, by the vendor. But this is not a secure asset until it is
paid. If the customer's debt is credit insured the large, risky asset becomes more secure, like
an insured building. This asset may then be viewed as collateral by lending institutions and a
loan based upon it used to defray the expenses of the transaction and to produce more
products. Credit insurance is, therefore, a trade finance tool.

CREDIT INSURANCE
Trade credit insurance is purchased by business entities to insure their accounts receivable
from loss due to the insolvency of the debtors. The product is not available to individuals.
The cost (premium) for this is usually charged monthly, and is calculated as a percentage of
sales for that month or as a percentage of all outstanding receivables.
Trade credit insurance usually covers a portfolio of buyers and pays an agreed percentage
of an invoice or receivable that remains unpaid as a result of protracted default, insolvency or
bankruptcy. Policy holders must apply a credit limit on each of their buyers for the sales to that
buyer to be insured. The premium rate reflects the average credit risk of the insured portfolio of
buyers. In addition, credit insurance can also cover single transactions or trade with only one
buyer.

Credit insurance was born at the end of nineteenth century, but it was mostly developed in
Western Europe between the First and Second World Wars. Several companies were founded in
many countries; some of them also managed the political risks of export on behalf of their state.
Credit insurance indemnifies the policyholder against loss resulting from the non-receipt of
payment in respect of a transaction approved by the credit insurer. Such transaction must provide
for the supply of goods or services on credit terms by the policyholder to a buyer. The non-receipt
of payment must be due to the buyers insolvency/liquidation or protracted default or, where
export transactions are involved can also be due to repudiation or political causes of loss38. A
simple example: A yarn manufacturer supplies his product to a textile-mill on 120 days terms of
credit. The credit insurer has insured the transaction. The textile-mill goes insolvent. In terms of
the credit insurance policy the Protracted default means non-receipt of payment after a specified
period from due date.
Repudiation refers to the importers unlawful refusal to accept the goods/services supplied by
the exporter. Political causes of loss consist of: a) the refusal of the importing country to allow the
exported goods to enter unless such import prohibition already existed at date of export; b) the
inability of the importer to transfer the purchase price to the exporter due to the importing
countrys shortage of foreign currency or other regulation disallowing the transfer which came
into force after shipment of the goods; c) non-receipt of payment due to strike, civil commotion,
war or other similar disturbances.
Investopedia Definition:
Credit insurance can be a financial lifesaver in the event of certain catastrophes. However, many
credit insurance policies are overpriced relative to their benefits, as well as loaded with fine print
that can make it hard to collect on. If you feel that credit insurance would bring you peace of
mind, be sure to read the fine print as well as compare your quote against a standard aterm life
insurance policy.

HISTORY OF CREDIT INSURANCE

During the 1990s, a concentration of the trade credit insurance market took place and three
groups now account for over 85% of the global credit insurance market. These main players
focused on Western Europe, but rapidly expanded towards Eastern Europe, Asia and the Americas
While trade credit insurance is often mostly known for protecting foreign or export
accounts receivable, there has always been a large segment of the market that uses Trade Credit
Insurance for domestic accounts receivable protection as well. Domestic trade credit insurance

provides companies with the protection they need as their customer base consolidates creating
larger receivables to fewer customers. This further creates a larger exposure and greater risk if a
customer does not pay their accounts. The additions of new insurers in this area have increased
the availability of domestic cover for companies.
Many businesses found that their insurers withdrew trade credit insurance during the late2000s financial crisis, foreseeing large losses if they continued to underwrite sales to failing
businesses. This led to accusations that the insurers were deepening and prolonging the recession,
as businesses could not afford the risk of making sales without the insurance, and therefore
contracted in size or had to close. Insurers countered these criticisms by claiming that they were
not the cause of the crisis, but were responding to economic reality and ringing the alarm bells.
In 2009, the UK government set up a short-term 5 billion Trade Credit Top-up emergency
fund. However, this was considered a failure, as the take-up was very low.

FEATURES OF CREDIT INSURANCE

1. Captive Insurance:
Select-Risk Cover: A multi-debtor structure that excludes lower-risk obligors from the
insurance policy. Generally, prospective insured s can expect many underwriters to decline to
quote on a select-risk portfolio or to receive higher premium rates or risk retention in cases where
quotes are provided. However, insurers sometimes quote aggressively on select-risk portfolios if
the remaining spread of risk is attractive.

2. Whole-turnover cover:
A multi-debtor credit insurance structure that covers all of a company s open account sales.
Many insurers will decline to quote select-risk portfolios over concerns with adverse selection.
For whole-turnover export policies, most insurers are amenable to treating Canadian sales as
domestic and therefore to excluding them at the insured s request. However, adding Canadian
sales to an export program can help to make the portfolio more attractive to underwriters and
improve the policys premium rate factor. Because whole-turnover programs maximize the
spread of risk and generate higher premiums for insurers, clients may expect to receive more of
the insurers capacity on higher risk credits than might otherwise be provided on a select-risk
portfolio.
Key Account Cover: A multi-debtor structure that insures only the largest customers, e.g.,
customers with credit exposures above $500,000, the top ten customers, etc.

3. Catastrophic Cover:
A multi-debtor structure with a sizeable deductible (either per-loss or first loss annual aggregate
deductible) written into the policy. These structures would only result in indemnification in years
where significant accounts receivable losses occur. Insured companies receive the benefit of
significantly reduced premiums and approval of marginal credits because they retain high levels
of risk.
First-Loss (Ground-Up) Cover: A multi-debtor insurance structure traditionally offered by
Coface, Atradius, and Euler Hermes. These insurers have substantial underwriter staffs and large
databases of information on obligors around the world. As such, they have the ability to
underwrite all or the majority of the customer credit limits needed by the insured. Because they
have more control over which obligors are covered, these insurers may provide coverage with no
(or low) deductibles.

3. Excess-of-Loss Cover:
A multi-debtor insurance structure traditionally offered by FCIA, Ex-Im Bank, Chartis, Houston
Casualty, QBE, Ace, and Lloyds of London syndicates. If comfortable with the prospective
insureds credit management and credit procedures, these insurers will provide a high level of
discretionary credit authority that allows the insured to underwrite the majority of the customers
for coverage based on its own internal due diligence. Insurers typically reserve the right to
underwrite the largest customer credit limits or those customers located in the most volatile
markets. Larger annual aggregate deductibles are written to excess-of-loss policies to justify the
significant discretionary credit authority granted.

5. Multi-Insurer Syndication:
Insurers are increasingly willing to participating in syndicated credit insurance structures in cases
where exceptionally large obligor exposures are to be covered. Most insurers require that their
individual premiums be $100,000 or more to consider syndication. These structures have many
benefits, including the diversification of insurer counter-party risk and the access to capacity
necessary to establish large insured lines of credit for obligors. IRC has developed its own

Alliance policy text for syndications that has now been accepted and utilized by all the insurers
in the market. Syndications can be issued on both single and multi-debtor bases.

6. Global Programs:
The traditional market view of a global credit insurance program is one in which a multinational
company packages its global business and negotiates coverage with one carrier. Companies that
take this approach hope to receive high-volume premium discounts and special treatment as a
large premium account. However, individual business units often find that these globally tailored
programs do not meet their local needs and that coverage can sometimes be improved in local
markets. Further, concentrating coverage with one insurer at excessively low premiums can lead
to coverage short-falls and other problems that multinationals should consider carefully.
In response to the inadequacy of this traditional approach, IRC develops global programs
with corporate management, in close coordination with individual business units, to place highly
durable, locally and globally optimized credit insurance coverage. We typically rely on capacity
from multiple insurers to achieve this goal on a global scale. While IRC s aim is to place
coverage at reasonable premium levels, our foremost concern is maximizing coverage for our
clients and building the foundation for strong and mutually beneficial relationships with insurers
that will withstand market downturns and significant claims activity.

7. Captive Insurance:
Captive insurance companies sometimes use trade credit insurers to reinsure the policies they
issue to affiliated businesses. The credit insurer may issue coverage directly to the business unit,
execute a reinsurance agreement with the captive, and then cede a portion of the risk and
premium back to the captive. This structure is attractive if the credit insurer is licensed to write
coverage in a state or country where the captive is not. Alternatively, the captive may issue
coverage to the business unit and then buy credit insurance to cover the captive s exposure above
an attachment point. In both cases, the insurance can be structured in excess layers to help reduce
premium costs and the captive can get the benefit of the credit insurer s policy text and services,
such as credit limit underwriting and claims processing.

8. Domestic Credit Insurance or Whole Turnover Domestic Credit Insurance:

For sales within a business local market, domestic credit insurance covers against bad debt
losses caused by insolvency and/or protracted default for a single buyer or entire portfolio of
receivables (whole turnover). Policies are usually structured with a first loss of 500-1,000 and
many underwriters are now offering fixed premiums inclusive of credit limit charges as well as an
integral collections facility.
9. Export Credit Insurance or Whole Turnover Export Credit Insurance:
For international sales, insurance covers various risks including insolvency, protracted
default and political events in the foreign country. Coverage is available for a single overseas
buyer or for an entire portfolio of foreign receivables (whole turnover).

10. Combined Domestic & Export Credit Insurance:

For businesses trading in the home market as well as exporting abroad. The breadth of cover is
similar to the Whole Turnover Domestic Credit Insurance Policy, but designed to cover a
combination of domestic and export receivables.
11. Pre-Delivery Coverage :
Cover designed for situations where goods are made to order. This type of policy protects against
the insolvency of the buyer and/or political default or political frustration. May be offered as an
independent policy or may be attached to a domestic or export credit insurance policy.

12. Specific Account Credit Insurance is a policy designed to cover receivables for a single
customer:
Often the largest account the business has. Cover is often provided for insolvency only and an
indemnity can be specified on the credit limit granted - typically 80-90%.
13. Key Account Credit Insurance:
This type of Credit Insurance policy offers businesses insolvency and protracted default
protection, but only covers a selection of between 2 and 20 of their largest customers. Key
Account policies will usually carry an excess.
Catastrophe Credit Insurance is designed to protect companies with annual turnover in excess of
10 million and with established and effective credit control procedures in place. Under such
policies, the insurer underwrites these credit control procedures and sets an Annual Aggregate
Deductible, in excess of which, claims are payable. The deductible is usually set at a level of at
least 25,000 and more commonly at 50,000-100,000.

Global Credit Insurance is designed for multinational companies with trading centres in several
countries. A single credit insurance policy is designed to cost-effectively cover all the divisions or
branches of the business on either a Whole Turnover or Catastrophe basis depending on the
individual requirements. Such policies allow businesses to ease the burden of high-risk industry
sectors or trading regions by incorporating cover with better established or safer regions.

BENEFITS OF CREDIT INSURANCE

Credit insurance provides not only peace of mind to you, but also the following key benefits:
1) Catastrophic loss protection:
Your receivables are one of your largest and most at-risk assets. Credit insurance protects against
potential bad debt losses, thus providing a safety net. Click here to see an actual case study from
our client portfolio.
2) Safe sales expansion;
Credit insurance allows you to grow your business without worry. Whether you are trying to
expand credit lines with existing customers, or extend competitive open credit terms to new
accounts, using credit insurance to reduce or eliminate the risk is a great way to safely grow your
business.
3) Increased Borrowing:
Credit insurance can provide cost effective access to working capital that can help you grow and
avoid cash flow crunches. Your credit insurance policy can help you maximize working capital
availability from the receivables you pledge to your lender. Most ineligible receivables (including
concentration of receivables with a few accounts and foreign receivables) can now be included in
your borrowing base with your lender.

4) Credit Decision support and information on your customers:

When you implement a credit insurance program with Global Commercial Credit, you are
not just buying coverage on your receivables, you are getting a partner in credit risk management
whose goal is to help you avoid credit losses before they happen and back you up when they do.
Credit insurance can also provide you with valuable market intelligence on the financial viability
of your customers (buyers), and, in the case of buyers in foreign countries, on any trading risks
peculiar to those countries.

5) Allows companies to lower their bad debt reserve;

Credit insurance will allow you to lower your bad debt reserve significantly and manage writeoffs with greater certainty. By reducing the bad debt reserve on this scale, you will be able to take
excess bad debt reserves back into income (by provisioning significantly less) thus improving
earnings, shareholder equity and financial ratios etc. Credit Insurance premiums are tax
deductible (whereas your bad debt reserve is not).
6) Helps avoid an unexpected significant impact on your company:
For example, you would have to generate a significant amount of future sales at $0 profit (beyond
your normal sales) to make up for a credit loss.

DETERMINING WHY TO BUY CREDIT RISK INSURANCE

Before actually going to the market for quotes, you would be best served by clearly identifying
what your interest in credit insurance is and how you think it will benefit your company. As a
custom tailored financial tool, there are many practical benefits to having this type of coverage in
place. That said, there are also some common misconceptions about what this type of coverage
can be used for.
At the most basic level, credit risk insurance is designed to protect you from unexpected losses
due to the insolvency or past due default on the part of your insured customers. The limited
number of underwriters who specialize in this unique coverage will in most cases, conduct credit
evaluations on the accounts you wish to insure and approve them for specific credit limits based
on your requests and the results of their research. Given this active credit evaluation on the part of
the insurer, credit insurance should not be approached as a tool you can use to grant credit to
companies that don't merit it. Likewise, it should not be sought when you have an imminent loss
that you are looking to shelter.
Credit risk insurance is a proactive management tool that best helps you in the following
specific areas:-

1. Catastrophic loss protection:

Across most industries and companies of all sizes, it is generally true that the top 20% of
accounts represent about 80% of the company's revenue. In some cases, the concentration of
credit exposure among a few or even one key customer is even greater. Just one sudden,
unexpected loss could have a devastating impact on the business. If you consider that your
receivables are a concentration of all of your cost and your profit, and that, in many cases, you
create them based on nothing more than a customer's promise to pay; you can see that there is a
tremendous amount of risk facing your business. Even with customers you believe are "good as
gold", the risk of unexpected default persists. Credit insurance is a great tool to remove this
catastrophic risk from your balance sheet and cap your company's exposure.

2. Safe sales expansion:

It is not uncommon for customers to request more credit than you are comfortable giving them, or
to have new customers you aren't familiar with seek meaningful amounts of credit from you.
While you may invest in a professional credit practice to review these requests and manage the
exposures, if you are limiting sales as a result of concern over the risk, credit insurance is an ideal
answer. Many companies use credit insurance to be able to expand on existing credit limits
without having to put them at additional risk. It is also helpful in covering open credit sales to
new accounts where you might have limited information and sales history. It is worth pointing out
that using your credit insurance policy to support additional sales you would not have made
otherwise will not only allow you to recapture the premium, it will help you drop additional profit
to your bottom line.
3. Credit decision support:
As mentioned earlier, in just about every case, the underwriters on your credit insurance policy
are going to actively research, approve and monitor the accounts you wish to insure. Having an
industry specific financial analyst doing this work for you as part of your credit risk insurance
program adds a lot of expertise to your credit practice, or provides you, to a certain degree, with
an outsourced credit department. This allows you to focus your internal resources more on cash
flow management and collections work. If you consider the cost of amassing the information
resources, many by costly subscription only, and hiring the additional expert financial analysts,
this decision support alone is worth the typical annual premium. Most companies operate on the
general rule that as long as the customer is paying timely credit management efforts can be
focused elsewhere. Unfortunately, payment history is not a valid predictor of default. Many
companies are current on their bills at the time they file for bankruptcy protection or are forced
into default. Having the carrier watching your covered accounts and helping you evaluate credit
limits on new risks is a great advantage to the program.

4. Borrowing enhancement:
If the company borrows against its receivables, credit risk insurance can provide additional
protection to the lender so they may be able to enhance the borrowing arrangements. They do this
by increasing the percentage they will advance against insured accounts, and/or roping more
accounts into the borrowing base- large concentrations, slow payers, export customers, etc. This
allows you to maximize the amount of working capital available from the same pool of
receivables. If you're in a high growth mode and find yourself in need of more working capital,
credit insurance is a great way to resolve the problem.
5. Exporting on open credit:

With more companies sourcing customers outside their own borders, the risk of granting credit
terms has to be balanced against maintaining competitive terms against other sellers. Export
credit risk insurance is one tool you can use to offer competitive open credit terms without the
additional risk.
6. Before you talk to a specialist in this field, you should take a look at your business:
The customer base, credit practices, risk appetites, etc. and think about how you want the policy
to go to work for you and where it can bring value. With this accomplished, you'll be better
prepared to have a productive dialog with a specialist who can help you find the ideal solution.

7. Put option:
A Put Option is an effective tool to help you continue to sell to a buyer(s) representing significant
credit risk concerns or deal with a concentration issue with an investment grade customer. With
the risk removed from your balance sheet, you are able to continue with the relationship until the
credit risk improves or it no longer represents a concentration issue allowing you to realize your
original revenue projections and / or increase market-share. It can also help you maximize
borrowing availability under your existing bank line.
This program involves a non-cancellable contract whereby the option seller agrees to buy
qualifying accounts receivable at a pre-determined amount if your protected customer(s) goes
Insolvent during the contract period. The protection would be provided by a financially strong
counterparty.