The first half of 2020 revealed a looming risk: claims for trade credit insurers covering unpaid trade receivables - outstanding invoices on sales that are shown as a major asset on the company balance sheet - were growing. Insurers' claims for unpaid receivables in North America were up 53% over last year, and few companies were immune.
Government injections of liquidity and more flexible banking terms may have only created a near term protective bubble of sorts. According to PwC, most of these early insolvencies were already pending. Businesses that were already highly stressed have been propped up. Supports will be withdrawn.
Euler Hermes', the largest trade receivables insurer, states that its global insolvency index is likely to hit a record high for bankruptcies. According to their data, North America will reach a critical level (+57% by the end of 2022 compared to 2019).
Unpaid trade receivables as an issue, will likely continue to increase as pandemic effect losses mount and companies feel more financial pressures. Without board directors and officers properly addressing the risks, trade receivables losses could negatively impact cash flow, balance sheets, and even your own corporate reputation.
Receivables risk - your directors and officers liability insurer is watching
Uncollected receivables and bad debt can have a ripple effect on your company. This impacts your cash-flow and available working capital, and hurts your P&L and balance sheet. Your bank may reduce available credit and seek repayment of some the debt under the borrowing formula. You may be unable, particularly amid an ongoing pandemic, to grow sales fast enough to replace the loss of working capital and profit.
One in ten companies that file for insolvency does so due to the impact of a large bad debt.
Insolvency and financial distress concerns are part of the reason for heavily increased rates for directors and officers liability coverage. In 2021-23 many more companies are going to face up to a likely Chapter 11 and Chapter 7 insolvency (CCAA, BIA, Canada). That, compounded by the increase in class action activities in the US, Canada and other countries that are ramping up after an initial pandemic relief-related pause, punctuates the need for boards to address trade receivables and their related credit risks more thoroughly.
NFP's Directors and Officers liability broking specialists are seeing insurers test for the survivability of the to-be-insured company, and assess the accounts receivables risk profile and potential impact on the important cash-flow forecast and liquidation scenarios. Bad debt expense statements are also being reviewed carefully.
Insurance policies are beginning to exclude risks based on failure to maintain proper insurance. Any losses viewed as risks that were not considered and acted upon appropriately could, and likely will, go unpaid.
Therefore, the responsibility of the corporate board and senior management to surround trade receivables risk and maintain a protective financial moat and excellent governance is imperative. Boards need to be carefully examining their receivables risks and seeking appropriate mitigation and other treatment.
New challenges for corporate credit and an opportunity to compete more effectively
Yet that in itself is not an easy undertaking. There is increasing consolidation of your customer base as mergers and acquisitions continue, often with private equity debt complicating the picture. Fast-growing disruptors in the supply chain are also a new challenge for proper risk rating and control.
Nonpayment drains cash flow, decreases profit and hurts the sales forecast. New sales have to be found, financed and paid for at substantial additional cost to stay on target.
Fortunately, much of this exposure to risk can be turned to your advantage. Mastering these risks may make your company more competitive, add certainty, help grow the top line and protect the bottom line. It may lower your risk profile to stakeholders - your lenders and D&O insurer amongst them.
Get your risk profile in good shape and trade smartly
NFP's large specialist trade credit practice has deep expertise. We work with boards and financial officers to properly benchmark and mitigate credit risks and build best practices. We appraise vulnerabilities, offer peer group insight and present strategies that can work with your corporate priorities. Customers that already insure with us see us challenge renewal terms and negotiate better ones, push for higher credit limits, support compliance, and secure optimal claim payment.
Insuring trade receivables is not an uncommon practice. The market covers over $1.6 trillion in short term trade receivables exposure. Insurance options are only a part of an overall strategy we can assist you with whether you currently purchase the cover or are uninsured.
As trade activity picks up in the second half of the year, nonpayment risks and insolvencies are set to increase significantly. Making better informed choices while managing your organization's exposure is critical to its long-term health. It behooves directors and officers to place trade receivables risks high on its list of priorities. Understanding credit risk is part of a good governance strategy. It may lead to profitable opportunities and more predictable results and avoid additional external scrutiny from stakeholders.
For more information, please contact Russell Parker.
Sources
- Berne Union, Berne Union Yearbook 2020, Pg. 21, 2020
- PwC, Turnaround and restructuring 2021, PwC.com, 2021
- Ryan Smith. Directors and officers facing heightened risks in 2021 - AGCS, Insurance Business Magazine, 2021
- Berne Union, 2020 AGM - Insurers prepare for claims increases in 2021, Archive of Press Releases, Berneunion.org, 2020