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Don't Trade Uncertainty for Financial Loss: Cover Trade Receivables

Jeff Abramson, Global Product Head, Trade Receivables, XL Group

Cover Trade Receivables

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One of the benefits of insurance, in virtually any line of business, is that it helps policyholders to sleep soundly in an uncertain world. If something bad happens, coverage can respond.

As the world watches events in Ukraine, with Russia’s annexation of the Crimea region and sanctions imposed by Western nations, it serves as a reminder that political instability and its economic consequences can occur with little warning ... with potentially dramatic consequences for businesses of all types. Instability anywhere can cause financial losses for companies when their payments from customers are cut off – whether by sanctions or other causes that may be both unexpected and outside of a businesses’ ability to control.

For many companies, trade receivables may be their biggest economic asset. If they are unable to collect on these receivables and their income stream is disrupted for an extended period or permanently, the business may not survive. So what to do as a business leader, CFO or risk manager?  Self-insure?  Look for factoring opportunities?  Explore the complex world of Account Receivable Puts with an investment bank? 

Fortunately, there is an alternative, via a straightforward insurance solution that can allow business leaders and risk managers to continue to sleep soundly despite these risks: trade receivable insurance. This form of coverage is part of the world of political risk and trade credit insurance. While political risk coverage may conjure images of – and provide protection against – the impact of dramatic and unusual events, such as coups d’etat, currency devaluations or the expropriation of physical assets, trade receivable insurance does that and more.  Rather than provide protection against narrowly defined, specified risks, this simple and straightforward type of policy offers comprehensive protection against a more fundamental risk – nonpayment by customers on receivables that they owe. There can, of course, be many reasons a customer may become unable to pay what they owe, and many of these, such as access to working capital, inventory turnover, and price trends, may be readily assessed and monitored. Others, such as the unexpected annexation by Russia of its neighbors territory and the resulting sanctions imposed by the US and EU that closes off a customers access to its supply chain, may be more easily overlooked.  But are no less impactful on the customer’s ability to meet its obligations. Trade receivable insurance, with its comprehensive cover and limited exclusions can respond to situations such as this.

Here’s how the coverage typically works: XYZ Company, a U.S.-based trading company, buys a trade receivable insurance policy to protect against nonpayment from its customers. Those customers can be in its domestic market or in developed or emerging export markets, as the coverage is comprehensive and triggered by nonpayment, not a specific country location or underlying event. XYZ agrees, subsequent to negotiation with its insurance partner, to take a $5 million deductible and purchases up to $100 million in coverage above that, with specific (and non-cancellable) credit limits provided on its key accounts – for example $10 million on each of its top ten (10 buyers) buyers – and a “discretionary” limit – perhaps $1 million, also negotiated with the insurer -- allowing it to continue to make its own credit decisions on smaller accounts.  Policy periods are generally for one year. 

Suppose one of XYZ’s key customers and ten of its smaller buyers are based in a country where a government change results in international sanctions, and businesses in the country are no longer able to sell their products to their key customers. As a result, the customers become unable to pay XYZ, with the large customer owing $10 million and the smaller buyers $1 million each, resulting in a loss of $20 million in receivables. Such a loss would trigger the trade receivable insurance which would cover 90% of the loss amount in excess of the deductible.

Besides the obvious economic benefits when a claim occurs, trade receivable insurance offers advantages including:

  1. Flexible and cost-effective credit risk mitigation.
  2. Support for favorable sales terms and financing for key accounts.
  3. Help in penetrating new markets.
  4. Enhancement of counterparty credit monitoring.

So at its best, trade receivable insurance not only provides XYZ potentially enterprise-saving protection in the event of an unexpected loss, but also an insurance partner that is there to help the company confidently grow its business in developing countries, extend favorable credit terms to retain key accounts or attract new customers.

Providing trade receivable insurance at its best requires a partner that can offer analytic rigor, deep technical knowledge and outstanding service.  With a long track record of insuring some of the world’s most complex risks, XL Group provides these capabilities on a global basis with local expertise, financial strength and an appetite for difficult risks. As the world has observed in Crimea, there’s a lot of risk and uncertainty out there.

So if you want to sleep a little easier in a world of constant volatility and ever-changing risk, you may want to explore trade receivable insurance.  It’s a tried and true solution that continues to offer great value.



About the Author...

 Jeff Abramson is senior vice president and global product leader for trade receivable insurance  in XL Group’s Political Risk and Trade Credit division. He has more than 20 years’ experience in the public and private sector and is a Chartered Financial Analyst.

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