Managing Trade Risk and Business Credit InsuranceSeminar Date

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Course Objectives

Understand accounts receivable risk and how companies manage their trade credit

Learn how business credit insurance can support your clients’ financial objectives

Examine the resources and channels to purchase both domestic and multi-market credit insurance

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Lesson 1: Understanding Management of Credit Risk (Accounts Receivable)

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Which of your clients’ assets are protected by aninsurance program?

Where does the A/R fall on most companies’balance sheet?

Typically represents from 40% to 70% of a company’s assets

Most vulnerable to unexpected losses Likely to be affected by business cycles

Provides cash flow for the business Only under-leveraged asset with financial lender Few companies can effectively compete without extending credit to their buyers

What amount of loss would seriously impact your client’s annual profit? How many accounts have credit extended over that amount?

Account Receivables Risk

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Risk Management - Business Failures

Bankruptcies are inevitableFailures come from increasingly unpredictable sources

- Management Deficiencies

- Complex Financial Restructuring

- Regulatory Changes

- Legal Maneuvering (Chapter 11)

- Product Liability

- Political Upheaval

- Global Economic Changes

Large Bankruptcies can cause a bankruptcy domino effect with suppliers

- Set off chain reaction that trickles down

- Demands resources to monitor and manage beyond primary debtor

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Consequences of Bad Debt Losses

A healthy credit management program customarily budgets for a certain level of expected uncollectible debt write-offs in the financial management of a business. However, even if an unprotected company is able to withstand an unplanned catastrophic loss or multiple losses to its financials, there are other consequences on earnings and future growth.

If a company’s revolving credit line is secured by its accounts receivable, a write-off of part of those receivables immediately impacts cash flow. The same level of funds is no longer available for the company to run it’s day-to-day operations.

The company may become less comfortable with extending future credit without highly secured forms of repayment, impacting the company’s ability to successfully compete and acquire new customers.

Future growth may suffer if the company lacks the necessary cash to invest in product development, distribution, technology and other areas.

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How Companies Manage Credit Risk

At its most basic level, managing trade credit involves making decisions on whether or not to extend credit, setting terms of a credit arrangement and collecting on receivables.

Most 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

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Catastrophic Loss Prevention and Cash Flow Protection• Prevent disruptive losses to one of company’s largest, unprotected assets • Safeguard revenue stream from bad debt loss due to unforeseen non-payment, slow

payment or insolvencies due to commercial and/or political risks; assuring continuity of business operations.

• Reduce the risk of key account concentration levels• Improve timely collection of receivables, lowers DSO and strengthens cash flow• Cap exposure to bad debt loss and smoothes financial results over the business cycle –

unlike an allowance for doubtful accounts - accomplishes this with tax deductible premium.

Financing – Strengthen Lender Relationship • Improve borrowing power and increase available capital by converting receivables into a

performing asset. • Eliminate lender’s concern over account concentration• Enable eligibility of foreign receivables• Reduce need for personal security requirements

What is Business Credit Insurance?

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Sales Expansion• Increase incremental growth opportunities with existing customers by safely extending more credit • Mitigate the risk of expanding sales into more volatile or new markets, both domestically and

abroad.• Enhance customer relationships – safe profitable cooperation between sales and credit functions.• Increase ability to offer more competitive terms attract export customer base.

o No need for letters of credit and collateral requirements on foreign shipments.o Open terms permit buyers to reserve their own working capital line for other uses.

Improve Financial Monitoring and Operational Efficiency• Strengthen structure and discipline for credit decision making• Improve credit risk intelligence using unparalleled third party evaluations of prospective customers,

industries and countries.• Install on-going and consistent key account analysis, supply chain monitoring and back-up support

for their credit management program• Increase leverage over troubled accounts by utilizing insurer’s expertise and global resources

What is Business Credit Insurance?

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What Business Credit Insurance “Isn’t”

Financial Guarantee

A Substitute for Prudent Credit Management Practices

Routine Bad-Debt Protection.

Fraud or Trade Dispute Insurance

Accounts Receivable Factoring

Valuable Papers or Accounts Receivable Records Property Insurance

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Vulnerability Factors – Greater Need for Risk Mitigation Vehicles

Sales Concentration – vulnerable to devastating losses when a single industry sector or few customers represent more than 25% of total sales

Rapid Sales Growth or New Customer Risk – increased need to safeguard bottom-line results from sales expansion, which is frequently accompanied by write-offs of new customer receivables

Export Sales – relying upon LOC’s or other trade mechanisms can inhibit ability to attract customers and achieve sales growth. There may also be a untapped opportunity to leverage foreign receivables with lender.

Recent Bad Debt History - reserves for write-offs in excess of 1% of sales may indicate company that has experienced impact of unusual receivable write-offs on their past earnings and cash-flow.

Key Indicators of Exposure

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Vulnerability Factors – Need for Credit Risk Mitigation Vehicles

Special Order Goods – If custom-made orders are greater than 30% of company’s total sales, the business is at greater financial risk because inventory can not easily be sold to second party without loss or heavy discounts.

Longer Terms of Sale – open credit terms of more than 60 days increase amount and duration of credit risk (uncertainty of getting paid)

Financing Receivables

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.

Key Indicators of Exposure

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Options to Manage Short-Term Credit RiskSelf-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.

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)

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Options to Manage Short-Term Credit RiskCredit 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.

Put Option – the right to sell a named trade receivable at a set price within a defined period of time if an insolvency or other specified event occurs.

Loss occurring with limited trigger for recovery, i.e. insolvency (shipment and loss event must occur within “put period”.

Typically available for public high-risk buyers (or buyers with public debt) that traditional credit insurance market will not cover

Backer is an investor – untested market in terms of claims settlement in event of catastrophic occurrence

Extremely expensive compared to other forms of credit protection.

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Options to Manage Short-Term Credit Risk

Factoring – Unless it is a non-recourse agreement, factoring is usually a financing tool rather than a risk transfer mechanism. This option is typically used by companies with temporary cash-flow problems or unusual cash demands that do not have access to traditional financing sources. A factor usually purchases a company’s accounts receivable at a reduced amount of the face of the invoice.

Immediate access to cash in exchange for a % of the receivables value plus a fee

Many factors offer invoicing, collections and other bookkeeping services for companies looking to outsource their entire accounts receivable function.

Not all factors assume the risk of non-payment for invoice they purchase

Considerable margin erosion

Loss of control over customer relationships

Asset is removed from balance sheet restricting line availability

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Lesson 2: Overview of a Business Credit Insurance Policy

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How Does A Policy Work?

Unlike other types of business insurance, once a company purchases credit insurance, the policy does not get filed away until next year’s renewal, but rather relationship becomes dynamic.

Policy can change often over the course of the policy period and the company’s credit manager plays an active role.

Requests for additional coverage on a specific buyer

Request for coverage on a new buyer

Many established credit insurers are “limits underwriters”, meaning the company’s more significant buyers are analyzed individually and assigned a credit limit for coverage.

A company’s less significant buyers may be insured under a blanket type of cover, known as a “discretionary credit limit” or DCL.

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How Does A Policy Work?

The ultimate goal of credit insurance program is not to simply pay legitimate claims as they arise, but rather to help a business to avoid forseeable bad debt loss altogether.

It is credit insurer’s responsibility to proactively monitor the company’s buyers throughout the policy period to ensure their continued credit-worthiness

Gather financial information about private and public companies from variety of sources, including visits to the buyer, financial statements, data supplied by other policyholders that sell to the same buyer, public records, bank references etc.

When data signals that a company’s financial position is deteriorating, the insurer notifies its policyholders that sell to that buyer of the increased risk, and establishes an action plan to mitigate and avoid loss.

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How Does A Policy Work?

The ultimate goal of credit insurance program is not to simply pay legitimate claims as they arise, but rather to help a business to avoid forseeable bad debt loss altogether.

It is credit insurer’s responsibility to proactively monitor the company’s buyers throughout the policy period to ensure their continued credit-worthiness

Gather financial information about private and public companies from variety of sources, including visits to the buyer, financial statements, data supplied by other policyholders that sell to the same buyer, public records, bank references etc.

When data signals that a company’s financial position is deteriorating, the insurer notifies its policyholders that sell to that buyer of the increased risk, and establishes an action plan to mitigate and avoid loss.

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Policy – Purchasing a Policy

Submit a completed and signed application

Business Description Terms of Sale Sales History and Bad Debt Experience Sales Volume Current Past Dues Names and Addresses of Key Buyers Export – Breakdown of Sales Distribution by Country with Terms of Sale Brief Summary of Company’s Credit Procedures

Provide a copy of the company’s current Accounts Receivable Aging Report.

Once policy is active, ongoing administration may include reporting to the insurer past due exposures/invoices for buyers at the end of each calendar month in order to keep coverage active.

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Lesson 3: Methods and Channels to Acquire Credit Insurance

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Types of Insurance Providers

Private Insurers

Privately owned, but may also act on government’s behalf for foreign receivables

Provides pure cover, insurance to business or a lending institution

•Public Export Credit Agencies (ECA’s)

Country created, state owned export credit agency acting on behalf of governments in the countries where they are located.

In some countries, export credit agencies also provide financing support Cost is frequently more expensive than private insurers. Often avenue used

to obtain coverage for high-risk buyers that is not available in private market. Examples: EX-IM Bank or Export-Import Bank of the U.S., JEXIM or the

Export-Import Bank of Japan, and EDC (Canada).

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Examples of Private Global Insurers

Euler Hermes

Chartis/AIG

Foreign Credit Insurance Agency (FCIA)

Atradius

Compagnie Francaise d’Assurance pour le Commerce Exterieur (COFACE)

QBE Specialty Insurance

ACE

HCC Insurance Holdings Inc.

Zurich

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Public Export Credit Agency: EX-IM Bank

Established in 1934, EX-IM Bank is an independent government agency of the United Sates headquartered in Washington D.C. with sales offices in NYC, Miami, Chicago, Houston, Los Angeles and D.C.Mission – support U.S. exports in order to create and sustain U.S. jobs with reasonable assurance of repayment.

Non-competition with private sector Products must have at least 51% U.S. content, including labor but excluding mark-up

Mandated Initiative Small business (85% of transactions) Africa Environment Minority Business

Available Products Working Capital Guarantee Short and Medium Term Insurance (Single buyer and multi-buyer policies available) Medium and Long-term Loans

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Benefit Summary – Credit Management Solutions

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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

Manufacturers, wholesalers, distributors, and service providers with annual domestic or export sales of $3 million or more.

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

Who Can Benefit from Credit Insurance?

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1. Strengthen the balance sheet and safeguard sales and gross margin. “The lower the gross margin percentage , the more sales and production required to replace a bad debt.”

ASK – What amount of loss would seriously hurt your company’s financial stability or yearly profit? How many accounts are over this amount?

ASK – What percentage of total or current assets does your customer’s accounts receivable represent?

2. Secure the company cash flow and avoid the domino effect – a large portion of business failures are directly attributed to uncollectible accounts

3. Reduce bad debt reserves and free up working capital to be invested more productively

Reduce Credit Risk and Improve Financial Planning

Benefit Summary – Credit Management Solutions

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1. Improve accounts receivable margining.

ASK – Does your company rely on financing, collateralized by your receivables, to fund working capital needs?

ASK – Do you export products? Would you be interested in a way to include foreign receivables in your lending base?

2. Reduce cost of borrowing

ASK – Are you happy with the rate you pay with your current lender? Is your operating line substantially used at this time?

3. Reduce bank security requirements

ASK – Do you provide a personal guarantee to your bank? Do you feel significantly over-secured at your bank?

Enhance Financing

Benefit Summary – Credit Management Solutions

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1. Expand sales to new, unknown or higher-risk customers and new markets to which sales are currently restricted. Credit insurance is a tool to increase incremental sales. The higher the gross margin percentage, the greater the contribution from incremental sales

ASK – Are there any new or higher-risk customers to which you are restricting sales?

2. Improve export sales by selling on less restricted payment terms (no need to require Letters of Credit)

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?

Expand Sales

Benefit Summary – Credit Management Solutions

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1. Partnership with Credit Management

2. Access to Risk Management System, Analysts and Evaluation Intelligence

ASK – Does your company currently utilize external resources in your credit process? Which sources?

ASK – How well do you know your customer’s customers? Do you evaluate potential exposure to failures in the supply chain that may adversely impact your customer’s ability to pay (domino effect)?

Complement Credit Management Function

Benefit Summary – Credit Management Solutions

Thank you for your attention.

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