Boom Times For One Group - Bad Debt Experts
Sydney Morning Herald
Tuesday June 27, 1989
Declining business confidence and increasing corporate collapses have created boom conditions for insolvency specialists and corporate doctors -they cannot remember when they have been busier.
Another less well-known sector of the economy which is benefiting from a dismal economic prognosis - the almost universal prognosis that business conditions will deteriorate further before we can expect to see any improvement - are trade credit or bad debt insurers.
According to the two major underwriters of trade credit, Trade Indemnity Australia Limited and MGICA Ltd, premium income from this type of insurance, over the past year, has leapt ahead by large strides. In three years, Trade Indemnity's premium income figures have doubled to $15 million, while MGICA's premium income figures from trade credit insurance this year are expected to reach $10 million, almost 50 per cent higher than 1988's premium revenue.
Mounting bad debts, or the insolvency of a major debtor, are what often brings companies to their knees. Yet few companies and manufacturers are aware that, as with most other risks, they can insure against bad debts for what appears to be a reasonable cost.
Unfortunately, trade credit insurance in this country is still surrounded by clouds of mystery and its principles are not clearly understood by most suppliers.
According to Trade Indemnity's NSW manager, Mr Neil Macdonald, only between 5 and 7 per cent of Australian companies are familiar with the concept of insuring against the insolvency of a major debtor.
However, Mr Macdonald claims, the company's closure rate - that is firms which are offered trade insurance and which decide to take it out - is quite high at present. Once firms are made aware of its availability, half those approached buy it.
Traditionally much of Trade Indemnity's premium income came from insurance brokers who offered it to firms as part of a package of insurance risks but, more recently, it has been coming from the banks who are taking a closer look at the security underpinning their loans.
"The banks have traditionally lent on fixed assets - like plant and machinery - but because of the pressures and deregulation, banks have also been lending against stock and debtors and, if they can get a credit insurance policy which guarantees 80 per cent of the amount owed, then they are probably looking at getting 60c in the dollar back as against 20c (in the event of the insolvency of the debtor)," Mr Macdonald said.
Premium rates are struck according to the assessed risk of default. They vary from 0.1 per cent and 0.6 per cent, that is $6,000 per $1 million of sales, with MGICA charging an average rate of around 0.25 per cent. The insurers pay out in the event of a claim being lodged on the insolvency of a borrower and companies which take out the insurance write off the amount as a normal business expense.
Trade Indemnity covers only trade credit. MGICA insures both trade credit and mortgages, although the figures quoted above relate only to trade credit insurance. Neither company insures consumer credit. Both companies pay out following debtors being placed into receivership, liquidation, setting up a scheme of arrangement or following the personal bankruptcy of directors who have guaranteed credit lines.
Usually claims are paid within 30 days of confirmation that the debt has been admitted to rank for distribution in the insolvent debtor's estate, whereas other secured and unsecured creditors may have to wait for up to a year or two for payout from the liquidator.
Cover is also provided for protracted default which involves situations where a debt is not disputed and all reasonable steps have been taken by the insured but formal insolvency has not occurred, for example when a director guaranteeing credit may have skipped the country. After an agreed period -normally 180 days from the due date - claims are paid without insolvency having occurred.
According to Mr Macdonald there are only two Australian companies operating in this specialised field due to the large amounts of money required to back potential claims and the sophisticated computer database required. MGICA is backed by the AMP, Australia's largest insurer, and Trade Indemnity's shareholders include the GRE, Prudential Assurance, Royal Insurance, Commercial Union, Swiss Reinsurance and C.E. Heath.
In Trade Indemnity's case, risk assessment and debtor control is based on a comprehensive computer database relating to some 350,000 debtors with input from mercantile agencies such as Dun and Bradstreet, the Credit Reference Association of Australia and Australian Ratings.
This information is supplemented by information from stock exchange reports, corporate affairs commissions, bank reports and trade references. As a third tier to the database, TI officers interview debtor companies and analyse internal financial data which is kept confidential to TI to assist in arriving at an assessment.
The information obtained is then evaluated and used to advise clients of good and bad risks in the form of a credit limit. A supplier, for example, might decide that of the $4 million of the debtors on the books, he or she can carry $50,000, but needs insurance for the balance. Usually claim payouts are restricted to between 75 and 80 per cent of the debt.
Often, says Mr Macdonald, firms are unaware that they have a problem. They may have been dealing with the same people for five or six years, extending credit and then the corporate entity changes and they are unaware of those changes. Trade Indemnity picks up this type of information from its data sources and can point it out to the client.
Once a decision has been given, regular reviews are carried out and the information updated so that if a situation deteriorates, policy-holders can be advised.
While bad debts are beginning to do damage to the market place, Mr Macdonald says the company's claims record remains satisfactory, although he expects the claims rate to worsen around September when the effect of higher interest rates begin to wreak havoc on corporate cash flow statements.
"Last year we paid out over $1 million (in claims) per month," Mr Macdonald observed. "This year I think claims will probably be of a similar magnitude. It is relatively quiet at the moment and I guess it will pick up towards the end of the year.
"We believe there will be a downturn. We're close to a number of insolvency practitioners and the (1987) stockmarket collapse is coming to the forefront now. This is probably the first wave of insolvencies."
Mr Peter Bradford, MGICA's managing director, says claims are very well spread, with a preponderance of small firms among the claimants. However, claims are rising now and probably are running at double the level for 1988. While this has not yet pushed premiums up, they could rise by 10 per cent over the next 12 months if the current trend continues.
© 1989 Sydney Morning Herald