Bill Vitucci, vice president and CFO of Vitco Steel Supply Corp., recalls the unexpected and shocking failure of a long-time and loyal customer, which led to his company’s investment in trade credit insurance six years ago. “It was an awakening,” Vitucci says “You can talk about partnerships and win-win situations, but in reality there is no such thing. People are out to protect themselves and their employees before they will worry about their suppliers. When they hit times of trouble, the last people they will take care of is their unsecured creditors.”
Vitco, based in Posen, Ill., insures its receivables with Euler Hermes, which claims to be the world’s leading trade credit insurance company. Other major insurers of accounts receivable include the Atradius Group, headquartered in Hunt Valley, Md., and Coface North America Inc., East Windsor, N.J.
“All we do is insure companies against abnormal or catastrophic bad debt losses,” says Jim Furio, regional vice president for Euler Hermes, which has an office in Lisle, Ill.
Credit insurance can provide metals distributors with four key benefits, he explains: greater peace of mind, operational efficiencies, improved bank financing and sales expansion.
Perhaps the most direct benefit for a small-business owner is the emotional effect of knowing that if a large account goes out of business or otherwise fails to pay its bills, the result will not be devastating. “One service center client told me, ‘this will be the first good night’s sleep I’ve had since I started the company seven years ago’” recalls Lee Fahrenz, a senior agent with Euler Hermes.
Euler Hermes becomes an extension of its clients’ credit departments, Furio says. The insurer maintains a giant database on companies’ payment histories and has automated tools that rate buyers on a 1-10 scale of risk, so service center salespeople can make quick decisions about how much credit to extend to new accounts. “A user can go on line to look up a buyer’s risk rating and get immediate approval for customers under $25,000,” Furio says.
Bankers have a favorable view of credit insurance. If they know a service center’s accounts receivable are insured, they will be more willing to lend that company money. More access to capital means more opportunity to grow. “If you insure your receivables, you are in a stronger position to negotiate with the bank for better credit terms. The bank sees this as a risk mitigation tool, while the service center sees it as an opportunity to leverage the banking relationship,” Fahrenz says.
Which leads to the ultimate benefit of credit insurance, say Furio and Fahrenz: sales expansion. Credit insurance can more than pay for itself by giving a service center both added buying power and added selling power, they maintain.
For example, a bank typically may loan a metal distributor up to 75 percent of the value of its receivables on an asset-based line of credit. But knowing those receivables are backed by an insurance policy, the bank may up the loan to 85 percent. In the case of a small company with $4 million in outstanding accounts receivable, that 10 percent difference amounts to an additional $400,000 in liquidity that could be used to expand sales. “Most banks won’t even consider foreign trade receivables as collateral, but they will if they are insured,” Furio notes.
Like bankers, most service center executives are averse to risk. But with the backing of a credit insurer, it’s easier for them to extend additional credit to existing customers and to be more aggressive in selling new accounts, Fahrenz says. “At most companies, sales has one foot on the accelerator and credit has one foot on the brake. If you don’t have an account’s financials, you may hold them to a $50,000 credit limit to be safe, even though you know they would buy more if they could. If Euler Hermes says a customer is good for $100,000, why not sell them $100,000?”
In such a case, if that translates into an extra $50,000 in sales to an account that turns over six times per year, the service center could boost its revenues by $300,000. At a 20 percent gross margin, that amounts to an extra $60,000 in gross profit for the year.
Thus credit insurance is not just for service centers that have had bad-debt issues. “If they have not had bad debt write-offs for years and years, that tells us they are probably running a pretty conservative credit shop. If they can use this as a tool to take on more risk safely, they can ultimately put more profit to the bottom line,” Furio says.
Vitucci agrees that having credit insurance can actually help a service center expand its business. “I might be comfortable selling all my accounts on a $30,000 or $40,000 credit limit, but if I can get credit insurance for $100,000 or $150,000, I go for the coverage. That allows me to build a rapport with that customer and maybe become one of their main suppliers.”
Vitucci is also a member of the National Association of Credit Managers, which also maintains a database on industrial companies and their credit histories. NACM provides information to members that can alert them to high-risk customers before they supply them with material. “Some people view that as double coverage, but I find it incredibly beneficial to have both,” he says.
Service centers cannot simply insure their questionable customers. The credit insurer generally bases its premium on the client’s total annual sales volume. Like health or auto insurance, where the buyer may opt to pay a large deductible to keep the premiums low, a credit insurance buyer may only choose to get coverage on large accounts, say those with over $100,000 in exposure.
The cost of each policy varies from company to company, depending on its size and risk profile, but a credit insurer typically charges from one-tenth of a percent to one-third of a percent of a client’s annual sales. Therefore, a $10 million company charged 25-30 basis points would pay $25,000 to $30,000 annually. A $100 million company might pay 12-15 basis points or $120,000 to $150,000 a year. The more risk the client is willing to shoulder, the lower the premium. A 10 percent co-insurance is common, where the insurer carries a 90 percent indemnity. The insured can usually file a claim on accounts that are over 60 days past due.
One common misperception is that a trade credit insurer will force a client to change the way it operates. Most owners do not want some insurance company poking its nose in their business. In fact, owners are free to continue making both business and credit decisions, say Furio and Fahrenz. Euler Hermes just insures the credit ones. “If a policy holder asks for $200,000 coverage on a particular buyer, and we only approve a $100,000 credit limit, they can still ship whatever they want. They can make the business decision to take on the risk for the other $100,000. We don’t tell our clients who they can or can’t ship to, or how much. We just help them make a more educated choice on their business decision,” Furio says.
Vitucci is convinced his investment in credit insurance has paid dividends, even though Vitco has never filed a claim. He takes it on faith that his company has avoided potential losses because Euler Hermes’ underwriters have steered Vitco away from risky customers. “I believe I have saved money by not selling to certain companies. I might get three trade references from a customer, but they will only give me the good ones. I won’t know about the 12 other people they owe excessive money. But the credit insurance company will.”
Perhaps the best dividend of credit insurance is psychological payoff, he says. “You are buying comfort and security, being able to sleep at night knowing that if you do experience a loss, it is not going to be the one that puts you on the other side of the aisle in bankruptcy court.”