Credit Insurance – a False Sense of Security?

In the same way, your business takes out insurance on plant and machinery, it can also be insured against the cost of bad debt. Just as a voluntarily excess reduces a car insurance premium, a percentage deduction on claims can reduce the premium – for example, you could insure 70% of each debt. Likewise, the setting of a minimum annual write off threshold before a claim can be made. The cost of a trade credit insurance (TCI) policy is not for everyone and is normally based on a percentage of sales or outstanding receivables. Premiums are also affected by the risk profile of a ledger or debtor. Strict credit limits are imposed to manage the risk. TCI is provided by large financial institutions with global reach such as Allianz, Atradius, Coface, and Euler Hermes.

The Advantages of Credit Insurance

We’re not going to be singing the virtues of TCI for some sneaky affiliate marketing commission, so the advantages presented here are not tainted. TCI gives a business protection because it replaces money that would otherwise be lost. It also provides comfort that your invoices will be paid by either the debtor or insurer. Credit limits can make or break new tenders, so being able to offer a limit higher than other bidders will give your business a competitive advantage without overreaching. Extending credit to existing customers will help organic growth. TCI can also make it easier to obtain funding because banks see lower risk which means more favourable lending terms. DSO (average time invoices are outstanding) is improved because bad debts are cleared rather than left ageing on the ledger until a suitable write off time comes. With a TCI policy comes access to commercially sensitive information and insights that would otherwise be unavailable. Because insurance providers are constantly reviewing the local, national and international risks you can get early warning on debtors and sectors. When setting a lower credit limit than the debtor would like, the backing of an insurer adds credibility and strength to your argument. The carrot and stick of credit insurance can improve the effectiveness of a company’s own debt collection processes.

Heating Up Trade Credit

According to a recent survey by Atradius 8% of all UK invoiced debt was written off in the last 12 months. In December 2021 Atradius published a Payment Practices Barometer which gave an interesting insight on bad debts and trading terms. Just under half of business-to-business debts were listed as overdue in 2021. The outlook for 2022 indicates 39% of businesses expect DSO to increase year on year. With that comes additional time and resources spent on chasing debtors. At Advocate we can commence action when a debt is overdue on terms of 30 days or more, and we are increasingly seeing cases where the invoices are only a few days overdue. This is because clients are wanting to focus efforts on obtaining new customers and nurturing accounts who are paying on time. According to the Barometer, 78% of UK businesses apply 30-day payment terms. Payment terms can be specific to a particular industry or customer’s credit risk. Some 3% of businesses have standard payment terms of 90 days or more. The Barometer showed an increased awareness of credit risk and that businesses are being more proactive in view of recent national, European and global events. It also found a 16-point increase in the number of firms expecting to use TCI in 2022, with 61% of businesses now incentivising early payment through discounting. The economic hibernation of 2020 saw the UK economy contracted by 9.8%. Growth since then places the UK economy within 1.5% of pre-pandemic levels. TCI claims and industry fallout has not been as dramatic as initially feared. There was no deluge of insolvencies. The Barometer suggests UK insolvencies could increase sharply (up to 33%) in 2022 resulting in many businesses being reliant on TCI to protect their bottom line. Debt collection agencies can be used to complement a TCI policy, or as a tool to recover payments ahead of other creditors.

False Dawn V Resplendent Sunrise

Historically recessions are caused by high-interest rates, reduction in consumer confidence, and deflation. On the eve of the pandemic, the UK economy was not suffering from any of those ailments. Some have gone so far as to describe it as a placebo or ectopic recession. In cartoons, gravity only applies when you look down, or the Roadrunner got his legs up to speed before starting the pursuit. At the risk of outlining a conspiracy, the rate of economic growth once the UK economy reopened suggested it was ready to move before gravity or ground was made up. The government has plied billions into coronavirus financial support for UK businesses with a raft of initiatives, loans and grants. This is not ‘normal’ inside your average recession or recovery. The credit insurance industry and their underwriters try to prepare for as many boom-and-bust scenarios as humanly possible, but predicting the pandemic playbook is something only God themself could have foreseen. The presence of exceptional circumstances gives fewer precedents and historical trends as reference points. This lends the current response to credit risk being more easily swayed by opinion than the history books. As inflation continues to rise and consumer confidence teeters towards the cliff of hesitation, what if the real recession is yet to come? There is always a risk of overthinking, overanalysing and drawing conclusions that history will see as nothing short of speculative lunacy. Looking too much at the worst-case scenario presents the danger of it becoming a self-fulfilling prophecy, especially when the UK economy is still growing by > 1%.

The American Wave

In 2019 the credit insurance industry was preparing for a downturn. Not because it saw the pandemic coming, but because it saw signs of global economic slowdown. Generally speaking, once a company has bought TCI they don’t leave the market. When enshrined in a company’s credit policy, the motion to surrender TCI is a prickly one for boards and the shareholders they represent. The pandemic saw an increase in first-time policies for UK firms. Much like our American counterparts, the number and value of claims are still below pre-pandemic levels. In a trend likely to waft upon British shores, Atradius has seen companies start to self-insure and leave the American TCI market. With low numbers of insolvencies and lower write-offs than three years ago, increasing numbers of US firms are questioning whether the policies they are paying thousands of dollars are worth it.

The German Contrast

When the pandemic hit, German firms were in a stronger starting position than for the previous 2002 and 2009 recessions. Like the UK, state support was put in place to assist affected companies and a furlough scheme helped preserve jobs. As a result, Germany also saw notably fewer insolvencies during 2021. Unlike the UK it has not resulted in lower losses. Germany saw more than €45.5 billion of insolvency liabilities in the first 9 months of 2021. That is higher than at any point in the last decade, according to the Federal Statistical Office. It’s worth noting a large variation between sectors with transport seeing an 84% reduction in insolvencies compared with a 383% increase in hospitality businesses failing. In stark contrast as the UK energy market got hit by some 20+ suppliers going bust in 2021, there were 97% fewer insolvencies in the German energy sector.

On Balance

TCI clearly has advantages otherwise firms would not invest thousands of pounds a year to protect their bottom line. Not making a claim does not mean the policy was unnecessary. Outside of Brexit (Brexit-Covid), self-insuring rather than taking out a TCI policy is tempting when losses for the year are minimal. But you can’t get retrospective insurance. Applying for cover on a particular debtor is no guarantee of obtaining it. When an economic downturn looms or recession strikes, insurers acknowledge the higher risk in their policy conditions, costings and in some cases refusal to provide cover. If a business can afford to get TCI the next question is can they afford to do without it? Most SMEs trade successfully without TCI. Some will only get insurance for their largest account; others will cover the risk through stricter payment terms. Brexit has brought credit terms and risk into the minds of not only the board and senior management, but the average employee who is eager to safeguard their job. If you’re of the viewpoint that to be worth it a policy must pay out more than it costs, then TCI is a false economy. If you’re of the viewpoint having a safety net proportionate to the risk is value for money, then TCI could make financial sense. We say ‘could’ because TCI is not guaranteed to fit every single business. At Advocate the majority of clients don’t have TCI, but for those who do our debt recovery process is just as effective. Whether you’ve got invoices outstanding from the pre or post-Brexit times, get in touch with us to see how we can help your business get paid.