Let's start with the adverse event mentioned above in the introduction. Within credit insurance, this is the failure (or inability) to pay supplier receivables due to a (probable) bankruptcy, usually within a 12-month period. This probability of bankruptcy (the so-called 'probability of default') an insurer calculates using a large number of variables. These variables, largely based on past experience, have the most predictive value for future liquidity squeeze and thus possible bankruptcy.
The four variables to calculate limits
Insurers have adjusted the calculation models they use over time to reflect new insights. Consider, for example, the entry of big data in recent years. Moreover, each insurer sometimes gives just a different weighting or nuance. Despite these factors, we can group the most important basic variables into four groups: country risk, sector risk, business information and payment behaviour. We explain these four categories in more detail below.
1. Country risk
Country risk includes the overall (macro)political and economic climate in the country where you want to do business. Large and/or frequent changes in this climate can disrupt trade to such an extent that even healthy companies can run into liquidity difficulties. This is therefore an important part of risk assessment. Within this category, political (in)stability, laws and regulations and the quality of the financial infrastructure, among others, play a role.
Based on these indicators, insurers assign a certain risk category to the country, which factors into the company's overall risk assessment. In doing so, insurers use local analysts with knowledge of laws, regulations and customs in a particular country (the so-called 'proximity to the risk'). This gives them the tools to make the best possible assessment of what is going on at the economic and political level in these countries.
2. Sector risk
The next (meso) level that insurers look at is the economic sector in which the company you want to do business with operates. Each sector has specific risks. Construction often involves long-term projects that are delivered in instalments, while a clothing shop has seasonal shop stocks that need to be sold and renewed in a timely manner. Insurers also assess sector-specific indicators such as buying and selling price indices, profitability, financeability and bankruptcy statistics. It also leverages the existing ongoing contacts that insurers' risk analysts and underwriters maintain with companies in this sector. For example, to proactively request figures or comment on filings or press articles.
3. Company information
After this, the company's individual (micro) data are scrutinised. Whereas country and sector risk are only reviewed periodically, company information is continuously monitored. So not only with each insurance application, but also with ongoing monitoring of existing coverage. Here, the insurer takes into account some basic (administrative) data. For instance, how long the company exists, whether it belongs to a certain business group, who the shareholders are and (as a further deepening of sector risk) what activities are carried out. More information is usually available on companies with a long history and belonging to a strong group than on a stand-alone company that was recently established.
Another important component is financial information. Usually, this can be found in the form of financial statements, especially for companies with a publication requirement, such as BVs in the Netherlands. Insurers test the probability of bankruptcy based on liquidity, profitability and (visible in the figures) solvency - in this order. After all, a solvent company may have its affairs in order in the long term, but still face acute liquidity shortages in the short term. At least as important as the single financial statement is the trend over several years. After all, a company with structural losses is more likely to be unable to pay its bills at some point than a company with a single loss-making year (if well-founded).
A trend change is therefore one of the main 'triggers' for the insurer to request additional information directly from a company. Besides the aforementioned differences in the risk model, this additional information is often one of the main causes of differences in risk policies between insurers. After all, not every insurer has the same (need for) information.
4. Payment behaviour
Strictly speaking, payment behaviour is part of the individual assessment, but it is important enough to place in a separate category. This is because (negative) payment behaviour has a major impact on the assessment. All previous categories were mainly about the predictive value of (historical) information. Changes in payment behaviour are in many cases an acute deviation (or confirmation) of a previous assessment. After all, the annual figures can be as good as ever; in the case of a large collection, it is then 'too late'. Good payment amount may just be the deciding factor for a positive(er) assessment.
So-called payment morale can also be a predictive indicator; a company that makes an occasional late payment (if properly substantiated) will be judged less harshly than companies on which overdue claims are reported structurally. Again, the available information may vary by insurer. In fact, it is rare if ever that all insurers have exactly the same payment experiences with a particular company. Incidentally, this applies to both bad and good experiences.
From rating to credit limit
The risk assessment initially results in a rating, let's say, the 'rating' of a company. The scale and meaning of this figure vary from one insurer to another, but in all cases, it serves as an indicator of the aforementioned probability of bankruptcy. The worse the rating, the higher that chance.
Based partly on this rating (and the aforementioned components of this rating), the insurer determines the amount of outstanding receivables that can be insured on a company at any time. This is the credit limit. This limit is determined according to insurance needs (the limit request), also taking into account the conditions in the policy, such as the maximum claim amount and the payment condition used. As these conditions differ for each insured, the credit limit may also differ for each insured, even with the same insurer.
Open communication is essential
The fact that insurance levels are determined based on statistics has a major advantage: the resulting assessment is rarely set in stone. With new information (from both the side of the rated company and the insured itself) and proper consultation, a reassessment can take place in many cases. The more information the insurer has, the more accurately credit risk can be assessed. In addition, a transparent attitude and open communication build the bond of trust not only between insurer and policyholder, but also between insurer and the rated company. Without trust, there is no basis for insurance. And so this too is an essential part of the assessment.
What can you do yourself?
By providing transparent information, and thereby creating trust, you can to some extent influence insurers' risk assessment. It is not only the assessment of your buyers that can be discussed; if you use supplier credit, it may also be well worth having the assessment of yourself reviewed.
Xolv can help you find the right path to insurers in this regard by discussing the existing assessment with the insurer or taking on some of the information provision. Want to know more? Contact your regular contact person or via our contact form.
