Trade Credit Insurance: A Strategic Tool In Times of Economic Instability & Uncertainty

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1 Trade Credit Insurance: A Strategic Tool In Times of Economic Instability & Uncertainty David Dienesch Euler Hermes Canada Andrew Leonard Marsh Canada Limited

2 ECONOMIC UPDATE

3 Uncertain economic environment

4 Uncertain economic environment

5 Uncertain economic environment Canadian Economy

6 Canada Key Economic Indicators Indicator Q1 Real GDP Growth +1.9% +2.0% +2.4% -0.6% Unemployment Rate 7.3% 7.1% 6,9% 6.7% Inflation 1.5% 0.9% 2.0% 1.1% Balance of Trade $0 -$0.5 $3.11B -$3.5B Bank of Canada (overnight rate) 1.0% 1.0% 1.0%.50% (July 2015) FX Rate vs USA No. of Business Insolvency 3,236 3,187 3,116 3,136 (12 months, -0.6% yoy)

7 RISK MANAGEMENT & LOSS TRANSFER

8 Account Receivables Risk, Protect Your Assets!! A/R is your most volatile asset What amount of loss would seriously impact your annual profit? How many customers have credit extended over that amount?

9 My Customers are Golden Bankruptcies are inevitable, even old well established firms!! Failures come from increasingly unpredictable sources: Surprise economic downturn Unforeseen loss of key customers Management change / succession Complex Financial Restructuring Technology advances Product Liability Political Upheaval Labour strikes/shortages Just one large bankruptcy can lead to the failure of many suppliers. To avoid being caught in the domino effect, the credit strength of the full supply chain must be monitored

10 My Customers are Golden Bankruptcies are inevitable, even old well established firms!! Failures come from increasingly unpredictable sources: Surprise economic downturn Unforeseen loss of key customers Management change / succession Complex Financial Restructuring Technology advances Product Liability Political Upheaval Labour strikes/shortages Just one large bankruptcy can lead to the failure of many suppliers. To avoid being caught in the domino effect, the credit strength of the full supply chain must be monitored

11 Vulnerability Factors=Need for Risk Mitigation Sales Concentration: Sector/Industry/Customer >25% of sales Rapid Sales Growth or New Customer Risk: Sales expansion = greater risk to new customers Export Sales: LOC s can inhibit growth untapped opportunity to leverage foreign receivables with lender. Recent Bad Debt History: reserves > 1% of sales. Special Order Goods: Custom-made orders > 30% of sales

12 Vulnerability Factors=Need for Risk Mitigation Longer Terms of Sale: credit terms > 60 days 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.

13 Vulnerability Factors=Need for Risk Mitigation Middle East: Hostilities and insurrection Latin America: Political alignment with radical left Political corruption in Russia Eastern Europe: Less pro-business & market friendly governments Western Europe: Economic recession Sub-Saharan Africa: armed disputes and instability South Central Asia: Political uncertainty and rising tensions

14 Policy Types of Risks Covered

15 Impact of Bad Debt Losses Bad debts beyond budgeted amounts can impact: Cash Flow: less access to the company s revolving credit line which is secured by its accounts receivable. Future Sales: Due to a lack of credit management flexibility. Investments : less cash to invest in product development, distribution, technology, etc.

16 Mechanics of a Policy

17 Mechanics of a Policy Limits: buyer limits: discretionary credit limit, cancellable or non-cancellable Policy limit or policy face Aggregate limits Country limits Scope of Coverage: export, domestic, key buyer, multi-buyer, single buyer, segmented coverage (e.g. sector, country) Duration: typically one-year covering short term credit extension (e.g. net days). Policies > one year are available (e.g. special projects, political risks) 2 years-20 years Risk Retention: Insured Percentage (co-insurance), Annual Aggregate Deductible, Per Buyer Deductible, Non Qualifying Loss/Minimum Claims Amount

18 Mechanics of a Policy Premium pricing components: Industry or trade sector Nature of goods or services Buyer financial strength Spread of risk, i.e. total amount of sales insured Country Risk Terms of Payment Bad Debt history Quality of Aged-trial balance Credit Management structure/procedures. Premium Rates: Typically < 0.50% of sales Average 0.20%-0.30% cases of <0.05% of sales

19 Mechanics of a Policy Claims: Proof of loss/debt Claim Form Accurate records of shipments including credit files

20 Mechanics of a Policy Top reasons claims can be denied: Late filing Disputes Wrong Buyer No Proof of Debt Shipment after coverage period Wrong Country

21 SALES EXPANSION

22 EXPANDING & SALES GROWTH Credit insurance is a tool to increase incremental sales. Expand sales to new, unknown or higher-risk customers and new markets to which sales are currently restricted while protecting bottom line. The higher the gross margin percentage, the greater the contribution from incremental sales. Improve export sales by selling on less restricted payment terms (no need to require Letters of Credit). Increasing competitiveness in foreign markets. Analysis and review of your portfolio of buyers and sellers by a third party insurer ASK Are there any new or higher-risk customers to which you are restricting sales? 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?

23 EXAMPLE MANUFACTURING Manufacturing Situation A manufacturer of consumer goods was interested in growing sales into new markets. It understood that selling into international markets increase its exposure to risk, but it also understood there were tools available that would help it to mitigate risks. By utilizing Trade Credit Insurance and protecting itself from buyer payment default the company has grown in new markets such as Brazil, Mexico, France and Italy. Solution August 2015 Trade Credit Insurance gave the company an opportunity to get to know the new market and is not only selling to these new markets, but it has also set up subsidiary manufacturing companies in these locations.

24 Sales Expansion Operating Facts Company: $40 Million in Sales Average A/R: $4 Million Gross Margin: 10% Account Turns Per Year: 8 Objective Company has a few large/new accounts that offer additional selling opportunities but reached their comfort exposure level. Interested in a credit risk protection program that would allow to safely increase sales. One Account Can Make A Difference "Comfort" Exposure $500,000 Approved Coverage $750,000 Additional Sales Opportunity $250,000 Gross Profit 10.00% A/R Turns 8 Increased Revenue $2,000,000 Increased Gross Profit $200,000

25 Return on Investment (ROI)

26 CASH FLOW CONSIDERATION

27 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.

28 Options to Manage Short-Term Credit Risk Collateral transfer credit risk from balance sheet by using pre-payment, cash on delivery, letters of credit or other assets (i.e. liens) Mechanism for quick recovery, depending on liquidity of the collateral LC s are obligations and require performance of specific conditions Can make a business very unattractive to potential customers in competitive marketplace. May damage relationship with a client if the company has to move against the asset Requires administration to maintain security position (for example, filing UCC statements, monitoring escrow accounts, and/or execution of LC documents)

29 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.

30 Managing Costs Administrative costs associated with credit risk 1. Collecting and managing security deposits Get help in identifying where the real risk lies Remove the liability from your Balance Sheet Improve your leverage Less processing/managing 2. Third Party collection/legal fees Assistance with collections - fees are lower than market rates Once the debt is passed on to the insurer, i.e. after the claim is paid, the insurer handles legal costs associated with the loss.

31 Managing Costs Administrative costs associated with credit risk 3. Third Party reporting fees (e.g. D&B) Need for third party reporting is reduced as the insurer monitors your customers The insurer will provides recommendations with actual dollar amounts 4. Internal credit management/information systems Monitoring services Reporting services

32 EXAMPLE COLLECTION PROCESS PROTRACTED DEFAULT Invoice Due Date Cease Shipment/ Coverage Notification to Insurer Insurance Claim Indemnification 0 Days Past Due 60 Days Past Due 90 Days Past Due 120 Days Past Due 150 Days Past Due Insured Involvement Insurer Involvement/Collection Assistance

33 Example of Total Cost of Risk Analysis Current Program Option 1 Option 2 Option 3 Covered Portfolio Select Buyer Select Buyer - Expiring Select Buyer - Add Vol. Whole Turnover 1) 5 Year Avg. Losses ( ) Cost of Losses without Insurance $ $ $ $ Premium $ $ $ $ Deductible / Retention $ $ $ $ % Uninsured/Co-Insurance $ $ $ $ Retained Uninsured Portfolio $ - $ - $ - $ - Cost of Losses with Insurance $ $ $ $ Savings / (Costs) VS No Insurance $ ( ) $ ( ) $ $ (65 473) 2) Worst Year Losses Cost of Losses without Insurance $ $ $ $ Premium $ $ $ $ Deductible / Retention $ $ $ $ % Uninsured/Co-Insurance $ $ $ $ Retained Uninsured Portfolio $ - $ - $ - $ - Cost of Losses with Insurance $ $ $ $ Savings 33 / (Costs) VS No Insurance August 2015 $ $ $ $

34 FINANCIAL IMPACT

35 Borrowing Ability Enhanced Improve Working Capital Access Improve Relationship with Lenders Monetize Receivables now! Reduce Debt Servicing Costs

36 Improve Working Capital

37 Improve Relationship with Lenders Through its trade credit insurance policy, H&W has secured its receivables, therefore making itself very attractive to business partners, such as banks and agents. H&W Trucking a family owned and operated company in Newark, OH

38 Monetize Receivables/Reduce Debt Borrowing Costs If you answer yes to one of these questions you may be able to lower your cost of debt with better debt management via supply chain financing. 1. Do you, or have you considered using 60% or more of your line of credit for much of the year? 2. Are any of your larger customers paying you in 45 days or longer from sale? 3. Could you sell more to these or other larger customers if you agreed to extend longer payment terms to them? 4. Do you have growth plans coming up that will require additional financing? 5. Would you be interested financing your business today and its future growth at lower interest rates? (particularly if 1-4 apply)

39 Monetize Receivables/Reduce Debt Borrowing Costs Reverse Factoring BANK (Standard) Factoring Suppliers Accounts Payable Client Accounts Receivable Buyers Unsecured note insured by Insurer Ease of traditional financing Credit limits unsecured for the clients and their buyers 39 August 31, 2015

40 Monetize Receivables/Reduce Debt Borrowing Costs Helps Manage Risk Removes Debt Liabilities Reduces Interest Costs Improves Leverage

41 CREDIT INFORMATION & ENHANCEMENT

42 Credit Information & Enhancement Businesses use a variety of tools to determine credit-worthy customers and to minimize bad debt losses: Third Party Information such as merchantile 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

43 Credit Information & Enhancement

44 Credit Information & Enhancement

45 Credit Information & Enhancement

46 Credit Information & Enhancement

47 Credit Information & Enhancement

48 USERS & SAMPLE TRANSACTIONS

49 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 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

50 Companies most inclined to purchase Credit Insurance Companies in very competitive industries Offer better credit terms to increase sales Companies that want more information about their customers: because Credit Insurance companies have huge data bases of information about millions of companies Companies with thin profit margins takes more sales to pay for a loss commodity producers and distributors Companies in financial difficulty Taking extra risk to push product out the door Companies needing/seeking financing Receivables are used as security for a loan. Credit insurance enhances the value of the receivables. Companies that export Reduces risk of the unknown Help increase sales Companies expanding quickly and/or trading in high-risk geographies Concentration of risk to one or two customers or geographies

51 CONCLUSION

52 Main Advantages of Credit Insurance Benefit corporate financial planning Protect the balance sheet and P&L Limits an area of budget variance and risk concentration Profit from additional sales via insurance through capability of sales people to extend pre-approved credit limits Enhanced credit management decision-making via access to insurers credit database Improve working capital finance Expand your eligible receivables base for financing Savings from reduced interest costs Reduce costs associated with letters of credit Strengthen relationship with your financial institution by lowering your overall risk profile August 2015

53 Main Advantages of Credit Insurance Accounting and Tax Benefits Lower bad debt reserves for one-time income gain Tax efficiencies of insurance vs. bad debt reserve Usage of captive solutions Improve your company s financial profile August 2015

54 QUESTIONS

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