MANAGING TRADING RISKS THROUGH THE ECONOMIC RECOVERY

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1 Trade Credit Practice, UK MANAGING TRADING RISKS THROUGH THE ECONOMIC RECOVERY OCTOBER 2013

2 CONTENTS The trading landscape for UK based companies... 1 Payment default and bad debt... 2 Insurance benefits... 4 In focus credit insight and management...5 In focus using insurance to enable growth... 6 i Managing Trading Risks Through the Economic Recovery

3 THE TRADING LANDSCAPE FOR UK BASED COMPANIES As the UK economy creeps out of recession (see Figure 1), many UK based companies are looking for growth by exporting to new markets. This is backed by the government, which has set the target of helping to double the UK s exports to 1 trillion by (Source: Gov.uk policies, April 2013). Entering new markets oers the potential for ample rewards but is not without risk. Trading in new markets and territories can be the route to expansion, but it can also mean doing business with markets and customers that businesses have no previous experience of. Therefore, it is critical to mitigate the risk of late or nonpayment and the resultant squeeze on cash flow. Marsh s experience shows that, following most recessions, the peak of corporate insolvencies has historically occurred somewhere between 12 and 24 months after Gross Domestic Product (GDP) has stopped contracting. While economic downturns claim victims, many companies experience real diiculties during the recovery when sales are rising. Lenders remain broadly risk averse with a working capital crunch more likely. A considerable percentage of a company s assets can be tied up in commercial debt, in some cases as much as 40% to 50% of the total asset value, so getting the money in, and on time, can be essential to maintain cash flow. Figure 1: GDP and Main Contributors Marsh 1

4 PAYMENT DEFAULT AND BAD DEBT The pattern of trade credit insurance claims provides a good indication of the level of payment default and bad debt in the economy. Statistics from the Berne Union a leading global organisation for the export credit and investment insurance industry give an insight into the territories that are generating the most short-term credit claims, and could therefore be considered the most risky to trade with. Figure 2: Short Term Credit Claims Paid Top Ten Countries 2 Managing Trading Risks Through the Economic Recovery

5 MARSH S INSIGHT Marsh s specialist trade credit claims team saw an upward trend in trade credit claims in This has continued to grow in 2013, particularly in the retail, construction, paper, and engineering industry sectors, and especially for companies involving debtor customers in the emergent economies of Central and Eastern Europe. Figure 3: Marsh Trade Credit Claims Overview Year Total number of claims Percentage change on prior year Marsh claims over 100,000 equivalent Value settled/ agreed ( million) Number settled/ agreed Number rejected = % , % % NOTES Data relates to UK policyholders. Debtors that are the subject of the claims are based in both the UK and overseas territories. Four claims over 100,000 equivalent are still outstanding for Claims over 100,000 equivalent exclude cases where claims have either been collected or withdrawn % % Marsh 3

6 BENEFITS For goods sold on credit terms, a buyer might not pay because: it becomes insolvent, it is unwilling or unable to pay, a political risk prevents payment. Figure 4: The Working Capital Cycle CUSTOMER SEEKS GOODS Credit insurance provides protection by paying a percentage of the debt (usually up to 90%) up to a trade credit limit. It can therefore have a critical, positive impact on the seller s balance sheet. It plays an important part in protecting income and profit, in the same way as other insurances, as outlined in the diagram opposite. Profit or losses made. BUSINESS INTERRUPTION Customers may not pay. TRADE CREDIT Businesses invest and need protection of physical assets. PROPERTY Goods shipped to customers premises. MARINE Goods are made and services provided by sta. EMPLOYERS LIABILITY Goods sold to customer. PRODUCTS LIABILITY But the value of trade credit insurance transcends claims pay-outs, with other key benefits including: Better cash flow and reduced costs: Insurance provides a robust discipline to credit risk assessment and credit management. According to the Credit Management Research Centre, credit insured businesses collection of trade debts averages four days better than non-insured, thus improving cash flow and reducing cost. Increased potential for confident sales growth with new and existing customers: Trade credit insurance provides insight and regular communication about existing and new customers, which enables informed decisions on the granting of credit. Lower borrowing rates and increased funding: Businesses can enhance their capacity for borrowing by converting the sales ledger into a more secure asset. Assigning insured trade receivables to a lender can improve the lending proposition, potentially leading to increased funding and reduced costs. Reduced need for bad debt reserves and provisioning: The customer insight and risk management practices associated with insurance can decrease exposure to unstable companies and provide an early warning of trouble. Ultimately, should a bad debt occur, a claim can be made on the insurance policy. Reduced cost of debt collection services: Insurers oer global debt collection services that can replace the need for third party collection agents and legal support. Risk transfer solution to satisfy capital adequacy requirements: Trade credit insurance may enable bad debt reserves to be removed, improving the capital position of a business. We examine some of these benefits on the subsequent pages of this report. 4 Managing Trading Risks Through the Economic Recovery

7 IN FOCUS: CREDIT INSIGHT AND MANAGEMENT Marsh is seeing an increase in the number of businesses purchasing trade credit insurance, with many doing so for the credit management discipline and customer insight it provides as much as for the insurance protection. This discipline and insight can be especially important when moving into unfamiliar markets or territories, or when seeking to increase trade with key customers. When a new trade credit insurance policy is negotiated, the underwriter will investigate the insured s top customers. These may be selected based on a proportion of the value of the total ledger, or by number. An immediate benefit of insurance cover is therefore knowledge of the underwriter s analysis of customers, based upon their latest report and accounts, general industry and market/sector information, information from banks and third parties, and the reports/payment performance from other insured companies who may be dealing with that customer. CASE STUDY 1: EMBEDDING RISK MANAGEMENT DISCIPLINE A major pharmaceutical client, with operations in many dierent territories, continues to purchase trade credit insurance despite never having made a claim. The customer information provided by insurers, and the credit risk management actions required under the terms of the policy, give it a consistent approach for evaluating and managing trade credit risk across its worldwide operations. The company s operations in each territory are advised of the credit management requirements of the policy and understand that any loss that occurs where the requirements have not been followed will have to be carried on the local balance sheet. This encourages good risk management practices and a coherent framework in which to operate. While some of this information is not available to the public and therefore cannot be fully disclosed, underwriters generally try to give as much detail as possible. Marsh 5

8 IN FOCUS: USING TO ENABLE GROWTH CASE STUDY 2: DEALING WITH A BUYER DOWNGRADE Due to a ratings downgrade on its largest buyer, a client found that the draw down facility on its invoice discounting facility was severely restricted and credit funding costs became prohibitive. Marsh worked with the client to secure a solution to alleviate the situation, approaching selective insurers for 10 million single risk cover, non-cancellable for a 12-month period, with a loss payee assignment to the bank. This allowed the client to increase its exposure with its buyer, with the comfort of default protection, in addition to reducing the cost of funding and increasing the availability of finance through its invoice discounting facility. CASE STUDY 3: FILLING THE FUNDING GAP For over 30 years, our client had a factoring facility with its bank. It operated in the construction sector and found that coverage levels were being greatly reduced. As a result, the client s funding was restricted and it was forced to make credit decisions on a daily basis and trade uninsured. This was damaging the growth potential for the business and was placing a strain on cash flow. Through discussions with Marsh, it was decided that a new company would be formed, with an invoice discounting facility rather than the factoring facility in place, supported by a selective name buyer insurance policy. As a result, the client now has increased levels of cover across the two companies, meaning it can channel sales through either company and still be protected. 6 Managing Trading Risks Through the Economic Recovery

9 For further information on the benefits, structure and costs of trade credit insurance, please contact your local Marsh trade credit representative or: TIM FISHER Trade Credit Leader, UK and Ireland +44 (0) COLIN CUNNINGHAM Trade Credit Practice +44 (0) The information contained herein is based on sources we believe reliable and should be understood to be general risk management and insurance information only. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. These case studies are for illustration purposes only and should not be relied upon as governing your specific facts and circumstances. Actual circumstances are governed by your specific policy terms, limits and exclusions. Marsh Ltd is authorised and regulated by the Financial Conduct Authority for insurance mediation activities only. Copyright 2013 Marsh Ltd. All rights reserved. Ref: 80257BE9002B221D exp: Feb 2015

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