October 13, 2021
The funds provided by regular credit lines and other lending are critical for many businesses.
But with the COVID-19 pandemic, banks have contracted their lending to some smaller businesses. This followed a 6 percent drop in small business loan portfolios in the U.S. in little more than a decade. While the U.S. Paycheck Protection Program and similar government initiatives around the world provided hundreds of billions in forgivable loans, what strategic financing decisions can businesses make when state support dries up?
For many businesses, the answer is credit insurance. With this type of insurance, businesses can protect income streams and build resilience. They can also become a more attractive to risk lenders, which expands their access to capital.
Trade credit insurance protects businesses’ receivables against the possibility of their customers failing to pay for products. It’s used by businesses of all sizes to protect both international and domestic trading relationships as they look to build and expand business opportunities. The insured exposure covered by trade credit insurance worldwide stood at 2.4 trillion euros in 2020, according to the International Credit Insurance & Surety Association, with some 6.3 billion euros in global premium.
“As the liquidity provided by government programs dries up and we see the levels of insolvency increase, having an insurance-backed capital stream will become even more important as time goes on,” says Ian Leslie, head of business development for Aon Credit Solutions. “It’s known as credit insurance, but it’s more opportunity protection.”
As businesses begin to rebound from the economic impacts of the pandemic, credit insurance can open the door to new opportunities. “We’re seeing more and more people starting to use credit insurance to enhance a financing opportunity rather than as a risk mitigation tool,” says Leslie.
How Credit Insurance Kept a Manufacturer in Business
For one U.K. manufacturer that relies on a single customer for a large percentage of its revenue, the right credit insurance program allowed it to remain in business.
The manufacturer sold its invoices to a bank, allowing it to be paid more quickly for its products. Concerned that the manufacturer’s large reliance on a single customer represented a concentration of risk, the bank purchased credit insurance on the manufacturer’s receivables.
When the credit insurer pulled its credit limit on the receivables, it threatened the manufacturer’s financing stream and, ultimately, its business.
The solution for the manufacturer was to use a broker to find another credit insurer willing to cover its receivables with the major customer. Aon found an insurer that provided a non-cancellable limits policy, with limits that couldn’t be reduced during the policy period.
The new credit insurance policy provided much-needed security not only to the bank, but to the manufacturer and its customer. The added security allowed the manufacturer to shop for a new bank for its receivables financing program. Ultimately, it found a bank that provided the program at a better rate.
Using Credit Insurance to Help Suppliers
In some cases, businesses take a “reverse credit” approach to credit insurance, essentially insuring themselves to help their suppliers.
Those companies can pass the benefits of the credit insurance through a supply chain finance facility to their suppliers, which improves their working capital base.
A Public Sector Application
Insurance can also help public sector efforts to support business activities, such as those of the Export-Import Bank of the United States (EXIM).
EXIM is an independent federal agency that promotes American jobs by providing competitive and necessary export credit to support the sale of U.S. goods and services internationally.
For example, if an overseas airline seeking to purchase an aircraft from a U.S. manufacturer is having difficulty securing financing because lenders fear repayment risk, EXIM can guarantee the loan and allow the transaction to go forward. In exchange, EXIM can repossess the aircraft if the airline defaults.
In 2018, EXIM launched a reinsurance program where it transferred a significant portion of the risk on its large commercial aircraft financing transactions to private reinsurers. In 2020, EXIM expanded its use of reinsurance. That public/private-sector partnership allowed EXIM to reduce the risk of its financings to U.S. taxpayers, potentially allowing it to expand its financing of U.S. export transactions.
“EXIM still has its underwriting standards, so they’re not going to take risks that they wouldn’t take before,” says Aon’s Public Sector Partnership CEO Joe Monaghan. “It’s the balance between really strong and prudent underwriting, and the fact that frankly people don’t want to default on the U.S. federal government, with the fact that having this private capital might mean they can do more volume. There’s no shortage of opportunities for EXIM.”
Reducing Uncertainty to Create Business Opportunities
As businesses look to grow post-pandemic, they seek to minimize uncertainty and volatility. Bringing security to financings and transactions can play a large role in helping them move forward.
“Credit insurance has always been seen as being about protection, which it is and isn’t,” says Leslie. “But, in many cases, it’s more opportunity protection.”
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