More and more U.S. companies are generating an increasing share of their revenues from export sales. Over the years, a significant portion of these export sales have shifted towards open account terms with no payment guarantees (such as a traditional letter of credit). As the Ex-Im Bank explains, savvy CFOs should consider leveraging export credit insurance to:
- Mitigate international payment risk
- Offer more attractive sales terms by offering more credit to international buyers
- Utilize it as a credit enhancement to support more borrowing availability on working capital lines of credit
When offering open account terms the exporter ships and delivers product before payment is received. In doing so, the exporter is exposed to the commercial credit risk of its foreign buyer defaulting on its obligation. Since it is considered an unsecured obligation of the buyer, companies tend to reserve open account payment terms for more established customers and trade relationships. However, in today's competitive export markets, foreign buyers often press exporters for open account terms. When exporters hesitate to extend open account credit they risk losing sales opportunities to the competition that is more than willing to offer better payment terms.
The best way for exporters to hedge against the commercial credit default risk associated with open account sales is to use export credit insurance. Accounts receivable insurance for foreign receivables (or export credit insurance) gives the exporter conditional assurance that payments will be made in the event a foreign buyer defaults, depending on terms and conditions outlined in the insurance policy.
Export credit insurance also operates as a credit enhancement for banks that offer working capital financing based on export-related accounts receivable. In many cases, banks will require the addition of political risk insurance to protect losses related to war, nationalization and currency inconvertibility.
The insurance generally covers 90 to 95 percent of the insured amount. The deductible is usually a small percentage of the amount insured and varies based on the premium.
The most common payment terms for export credit insurance are a 30 to 60-day term up to 360 days for longer payment terms. Premiums are determined by individual risk factors. Most policies cost between 25-125 basis points of the value insured. Export credit insurance polices are available in most major currencies such as euro, yen, pound sterling, Canadian dollars and Australian dollars. One of the key elements to keep in mind is that in order for the export credit insurance to be valid, an export event has to happen. Underwriters will not insure advance payments or contingent sale transactions.
In the U.S., there are two camps of export credit insurers — European and American. The fundamental difference between these two types of insurers is that the European insurers, such as Atradius, Coface and Euler, all have their own agents who exclusively sell their own firm's policies. The American insurers, such as FCIA, HCC and Chartis (the credit insurance arm of AIG), generally sell their policies through credit insurance brokers. However, it is important to note that the right insurance brokers will provide significant value-add in managing policies and supporting the process of claims.
All of the aforementioned insurers enjoy single-A or above credit rating and their pricing is generally similar. The key differentiators between them are the past record of claims payment and the ability to cancel the policy. Any policy that gives the insurer the right to unilaterally cancel the policy at any time should be avoided.
Regardless of which insurer, agent or broker to use, getting an export insurance policy usually takes two to four weeks. However, it was not that long ago, during the financial meltdown, that insurance underwriters reduced or eliminated coverage too quickly. The resulting negative criticism and press took its toll on the industry and underwriters have shift back to greater availability on credit as well as a more rational approach to the business.
Most export credit insurance policies sold in the U.S. give the insured the option to pay in arrears. For instance, if a company generated $10 million export sales in December 2009, the company could report these sales to the insurer and pay the premium accordingly in the first few days of January 2010 to have the December 2009 sales insured.
A typical export insurance policy specifies the products/service covered under the policy, the maximum length of sales terms, the country and buyer credit limits and the deadline for filing claims.
It is important to realize that the top two reasons for denial of export credit insurance claims are:
- Late claim filing - In order to be paid in full under the policy, the insured must file the claim on time. The insurer must receive the claim form (proof of loss) within specified time period.
- Non-payment of insurance premium - This does not refer to the insured forgetting to pay the premium, especially when the brokers and lenders track the premium payment. This refers to the insured underreporting their sales figures save on premium expense.
Export credit insurance is a powerful tool in a CFO's arsenal as it reduces or eliminates the buyer credit risk, potentially provides more borrowing capability, and helps expand export sales.
To learn more how export credit insurance can benefit your company, please contact your Silicon Valley Bank relationship manager.
Company A, a California-based software developer, sells to both U.S. domestic customers and overseas customers in East Asia. In 2008, its total revenues were $24 million, with a $14 million domestic sales and $10 million in export-related sales. Historically, Company A's bank only considered domestic-related accounts receivable as eligible collateral for a working capital loan. With the addition of export credit insurance as a credit enhancement, the company not only hedged against its commercial risk related to foreign credit defaults, it also increased its borrowing capacity by 71 percent. Here is why.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or SVB Asset Management, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.