Samsung is an “ultra-conservative” company when it comes to protecting itself against the costs of bad debt, says Joseph McNamara. That was true before the Asian financial crisis of 1997, and the many corporate bankruptcies in South Korea at the time only stiffened the company’s resolve to not be burned by its accounts-receivable portfolio.
For at least 20 years, the parent company has been buying trade-credit insurance, and at its Samsung Electronics America unit, the policy covers “all receivables,” said McNamara, who, as SEA’s director of financial services and business operations, directs the credit department. “Our preferred method [of managing A/R risk] “is hedging via trade insurance.”
Such sweeping insurance protection is indeed a conservative approach, considering that SEA has a wide variety of risk-management approaches available to it. They include bank-issued letters of credit (which cover the buyer of the LOC against non-payment for a specific period of time and dollar amount); financing statements, which are legal notices filed at the state level that give a creditor the right to take possession of and sell a debtor’s assets; put contracts; and factoring arrangements.
But the electronics maker prefers the insurance route because, for example, it protects both long-term liquidity and immediate cash flow when a key customer is lost, McNamara said at a session on credit insurance at last week’s Risk and Insurance Management Society Conference in Los Angeles. Another reason is that it gives SEA confidence to grow, even though the “lion’s share” of its risk is concentrated in a mere 250 big clients — each of which represents a big loss if it becomes unable or unwilling to pay.
Until recently, SEA was unusual among U.S.-based businesses in being a long-time buyer of trade-credit coverage, which was more frequently seen in Europe. But deeper economic troubles and the growing threat of non-payment of debt by businesses because of bankruptcies in Europe have led trade-credit insurers to boost premiums. At the same time, insurers hope that the lower prices they are charging U.S. companies and their increasing conservatism in the wake of the 2008 financial crisis will cause them to buy more credit insurance.
If U.S. companies do bite, there will certainly be a market of insurers hungry to take on their risks. In 2010 and 2011, as the financial crisis waned in North America, a bevy of underwriters entered the market, according to Michael Kornblau, the U.S. trade-credit practice leader at Marsh, the insurance broker.
The increased supply of coverage, coupled with a rise in reinsurance support for insurers, led to price decreases in the United States of 5 percent to 10 percent through 2012, Kornblau told CFO. He predicted that corporations looking to buy coverage in 2013 will see declines in premiums of another 5 percent.
Samsung’s McNamara said he likes to lock in coverage for a long period of time with a single carrier, rather than buying coverage that stretches over short periods. Doing so results in cheaper prices and more flexibility in terms of the coverage provided.
It also provides the company with added clout in disputes with the insurer. During the financial crisis, McNamara learned that his credit insurer was in the midst of a big cutback in the coverage it was supplying for the same price. “We said, ‘Knock it off. A wholesale sale [is] unacceptable to us. We don’t expect you to do it to us or to our clients,’” he recalled. The insurer complied with SEA’s request.
Jackie Hair, the executive director of risk management for Ingram Micro, a wholesale electronics distributor and one of SEA’s customers, has a more near-term approach to suit its decentralized operations. The company has customers in about 160 countries and operates in 37 of them. Using the company’s own software “decision tool,” regional CFOs answer questions that yield a score. On the basis of that score, those finance chiefs buy the smallest amount of credit insurance that their operations need, the risk manager said.
Besides covering the risks of non-payment, Ingram Micro’s carrier provides “an extension of [our] credit department,” Hair said at the RIMS session. Through the insurer, she has access to a much broader selection of credit data. “My ability to grant credit is [thus] a much broader and better decision.”
The choice of trade-credit insurers has broadened since 2010 and 2011. In just that period, at least five carriers joined the trade-credit-insurance market: Equinox Global, Ironshore, Latin American Underwriters, Markel International and XL Insurance.
Those players joined the existing big three of trade-credit insurance: Euler Hermes, Atradius and Coface. Speaking at the RIMS session, David Santos, regional sales and marketing director for Euler Hermes in North America, contended that for many companies, A/R, which he said typically represents 40 percent of a company’s assets, is “the only major asset left uninsured.”
While A/R provides cash flow for the company, it tends to be an under-leveraged asset “most vulnerable to unexpected losses’ and “highly likely to be affected by business cycles,” the underwriter asserted. Not unexpectedly, he touted the value of the coverage in obtaining leverage, contending that “if receivables are insured, banks will give better terms on loans.”