A Trade Secret Comes to Light, Again

Globalization and customer consolidation are spurring renewed interest in trade-credit insurance.

Skyworks is one of the few companies to rediscover trade-credit insurance. In the United States, fewer than 5 percent of companies buy it, according to the Credit Research Foundation, a nonprofit research group in Baltimore. In contrast, 40 percent of European companies do. Tradition and culture are key in explaining the disparity. Cross-border trade has been a fact of business life for centuries in Europe, yet many executives there harbor a deep mistrust of foreign receivables. Europeans also tend to have a lower tolerance for risk than Americans, says Neil Leary, CEO of Atradius Trade Credit Insurance Inc., the U.S. unit of Amsterdam-based Atradius NV.

A Second Set of Eyes

In the United States, finance executives historically have used other methods to reduce the risk of receivables. Some companies opt to self-insure against bad debt. Others lower risk by structuring stringent sales agreements. Some customers are required to pay in advance, provide cash on delivery, or supply a letter of credit. But as competition heightens and rivals battle for market share, some companies are reluctant to force customers to tie up their own capital to secure a sale.

So insurers anticipate a growing market for trade-credit insurance in the States. The Credit Research Foundation anticipates double-digit growth in these sorts of policies for the next few years. One reason: bankers are pressing clients to buy policies so that they qualify more readily for larger loans. That’s what happened at Magellan International Trading Corp., a privately held specialty-steel distributor in Northbrook, Illinois.

At his banker’s urging in the early 1990s, CFO Keith Weiss securitized the company’s receivables and bought trade-credit insurance in order to qualify for a line of credit. Magellan’s bankers were concerned that the distributor’s customers — foreign and domestic steel fabricators — might renege on payments. Magellan’s policy offers the company several advantages, Weiss notes. For one, Magellan is permitted up to an 85 percent advance rate on its line of credit. Without the policy, he says, Magellan could be financially hamstrung, limited to a far lower advance rate.

Weiss says his insurer provides another valuable service: the credit limit written into the policy works as a short-term braking system. Magellan’s insurer provides “a second set of eyes to evaluate a buyer’s creditworthiness,” Weiss says, until his staff collects enough payment data on a new customer to make a reasoned decision. If the insurer deems a particular Magellan customer too risky to cover, Magellan may use that rejection to negotiate better terms from that customer.

Looking for Trouble

Still, relying on an insurer for key business decisions does have drawbacks. After all, an insurer does tend to be far more conservative than a growth-oriented CFO. “Atradius pulls the plug faster on a company than we do,” Weiss says of his carrier, although he says that it can be beneficial to use the coverage to “help keep a tight leash on customer payments.”

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