Credit insurance is something of an unmentionable among UK companies, evidenced by the fact that few finance directors want to talk about it – only one of those Financial Director approached was willing to go on the record about it – and fewer admit to needing it. Yet there are some 15,000 companies that hold credit insurance in the UK. After all, the last couple of years have proved boom time for anyone who could provide protection from their business partners not paying up or becoming insolvent.
Looked at objectively, the arguments for credit insurance are hard to argue with: lenders are happier to lend to businesses that can demonstrate adequate risk management, of which default and insolvency remains high on the agenda. And the insurer pays its client what its creditors owe when the insurance is triggered (within a range of limitations), meaning it lives to trade another day.
Where once, credit insurance was a ‘nice to have’ with little perceived payback, it is now the cornerstone of many accounts receivable policies. Insurers have seen a strong rise in demand. Credit insurance provider Atradius says it has underwritten in the region of £300bn in trade in the last year.
But credit insurers can only be as effective as the information they are given. The sector has had doubt cast over the efficacy of its product in the past, based on questions over the quality of the information it gathers, on the exposure its clients hold to debt risk. As demand has risen, holes in that information have been exposed that support the idea companies are embarrassed to admit they hold credit insurance – because they must admit to the state of their finances for cover to be effective.
“In many instances,” Atradius’s UK director Shaun Purrington recently told The Daily Telegraph, “the financials that you see at Companies House are not really worth the paper they are written on.”
Insurers also say they are engaged in a constant battle to convince, cajole and encourage businesses of all sizes to deliver more information, such as management accounts containing more narrative, more frequently. That goes double for companies experiencing financial difficulties.
Richard Rycroft, founder of credit insurance consultant Rycroft Associates, believes that while many business owners and FDs may find it burdensome, presenting much more than just raw numbers has a discernible material effect.
“Always bear the following in mind in the credit area: bad information will spread itself, good information needs to be pushed,” says Rycroft. He cites the example of a business whose turnover dropped because the management decided to clean up the ledger and retain only the better, more profitable accounts. “A drop in turnover could automatically be taken as a bad thing, but only because an analyst is not aware of the full facts,” he says. “FDs should always ‘present’ their accounts, highlighting any changes with clear reasons in order to take guesswork out of the equation.”
Out in the open
Whether this message is getting through is open to debate. In an environment where trust is a priceless commodity, some businesses are far more reluctant to reveal anything but the basics. However, an unwillingness to share information and explain the numbers does not inspire confidence from credit insurers.
“We expect companies in difficulty to meet with us regularly and to share sufficient privileged information that allows us to make an informed view of their ability to pay,” says Marc Henstridge, senior risk underwriter at Atradius. “Now, the protocol that existed for such cases has been extended into a ‘business as usual’ environment, where we can’t rely on long filing periods of historic financial data. Businesses that are able to share their management accounts with us and demonstrate that they are a viable proposition will benefit from that disclosure, making it a win-win.”
To effectively assess credit risk, insurers are looking for more key trading performance indicators, from the demonstration of good cashflow, strong management capability, visibility of order pipeline and solid forecasting, to slightly harder-to-prove concepts including watertight, practical contingencies in place to cover all eventualities – difficult, unless one is confident they know exactly what might happen in the future – to a ‘realistic strategic view’ and a sense of there being no surprises. They more frequently look to get sight of trade contracts.
Peace of mind
So what of the future? If the recovery does begin to gather momentum, will businesses decide credit insurance is an expensive luxury and dispense with it? Rycroft is advising his clients not to relax just yet. “As the economy picks up they could be in a position of not getting the limits again. At the same time, there are still many insolvencies, as companies relax as they are desperate for the orders.”
He also counsels businesses on the intangible benefits of taking on adequate cover. Tackling your credit policies (with insurance as part of that) can improve management discipline and internal control. Both are vital, even if the green shoots are only just making their first appearance.
Case Study: Gary Wilson, FD, Essential Recruitment
I used to self-insure everything but, one year, Essential Recruitment was hit by a large bill. Taking that nasty hit was certainly a learning curve.
Prior to obtaining credit insurance, we would do the normal checks through Companies House and look at the accounts up to the previous year’s data, then take a commercial view.
However, having credit insurance has taken that issue off my desk. It allows for a commercial view to be formed by someone who is almost like a bookie, who will look at it with their professional expertise and say either ‘yay’ or ‘nay’. And when they say ‘nay’ it is usually for a good reason, which we follow to the letter, unless we can do it on a pro forma basis. We never like to turn business away, so we might just say, ‘we cannot give you credit, but if you pay up front we can give you the goods’.
I think the two big benefits of credit insurance are that it lets you spend more time on the business; it allows you to sleep at night, on the basis that if there is a large bill out to a client – in the worst case scenario – you are covered.
Bear in mind that the insurers look at the most up-to-date data on a business and that the picture can change quickly. Look at Jarvis, for example: one year it has a billion pound asset register, the next year… who knows? So if something like that goes bust, you’re covered.
This year I considered self-insuring on the basis that we now have better discipline from having had credit insurance. The theory was that we could put the money we spend on the premium aside to use in the event of default.
But we took the view to carry on with credit insurance this year because we thought that just as many businesses will be facing financial constraints coming out of a recession as did going into it. Cash is still king, after all, so it could well be that there are more insolvencies this year than last. We have ended up taking credit insurance for the forthcoming year as well, which we will then review next January to see what is out in the market.
Overall, it is relatively expensive, as it runs to 0.5 percent of your turnover. And you cannot get that back through pricing – at least, we cannot in this competitive industry. It is a cost, certainly, but one we are very happy to carry for the time being.
See our audiocast about credit insurance, sponsored by Atradius, by clicking here
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