Driving down the cost of borrowing and increasing financing.
Trade credit insurance has historically been used by businesses looking to hedge risk on what is usually their biggest asset, their accounts receivable. But as we look toward continued economic volatility, companies are using trade credit insurance to reduce the cost of financing.
When securing debt to finance deals becomes more challenging and expensive, it constrains the amount of capital buyers can collect to reach vendors’ expectations on valuations. That causes companies to turn to trade credit insurance to bridge the financing gap by credit enhancing their accounts receivable, lowering their overall cost to finance deals - putting trade credit insurance to work. Not long ago, dealmakers had sufficient funds to forego this route, as the cost to finance through banks was significantly lower. Now, firms are using trade credit insurance to insure their pool of receivables, transferring their risk to a AA/A+ rated insurance company. A bank that offers receivables finance that is backed by this form of unfunded credit protection for a portfolio company’s account receivables pool can not only lower their cost to finance due to the preferred risk weighted assets treatment, but also help bridge the gap to vendor price tags.
Lenders use trade credit insurance as well, insuring receivables finance portfolios (often on a silent basis) and facilitating off-balance sheet structures. Structured credit insurance is also used by lenders to insure loans, such as those for acquisition finance, increase facility sizes and improve capital. Insurance capital will continue to help bridge funding gaps and increase credit accessibility.
Reducing post-deal volatility.
There are a few significant ways that trade credit insurance can reduce post-deal volatility. Trading issues commonly identified within the scope of the Financial Due Diligence include difficulties in collecting debts or identifying high historical levels of bad debts. It is imperative to include warranties in the Share Purchase Agreement to give certainty to the purchaser that no assets are paid for which do not carry any economic value. The identification of issues in the target’s customer base will support the strategic risk mitigation decisions required by the purchaser post-completion. Trade credit insurance therefore helps to bridge the negotiation gap between seller and buyer and adding clarity to the economic value of a business’s receivables.
Secondly, when carving-out an entity, new sources of financing will be required. In those cases, buyers will often have to provide new credit lines. Trade credit insurance can help firms enhance collateral and secure additional financing from banks.
In addition, in the wake of a transaction, buyers can use the access to trade credit insurers’ data platforms to model expected credit losses, implementing the model required according to IFRS 9. Once identified, this may be used as a price negotiation tool for the purchaser.
Finally, political risk insurance (PRI) is a useful tool for buyers. As a risk mitigation tool, PRI helps to provide a more solid environment for investments into developing countries, and to unlock better access to finance. Some examples of events covered by PRI include war, terrorism, government expropriation that can directly affect an investment's operation and violate its ability to perform critical functions.