Credit And Risk Assessment Processes Of An Underwriter
by Joe Ketzner

Science and Art- Trade Credit Insurance Buyer Assessment Underwriting is Complex

Trade Credit Insurance has been a commercially viable product since the mid-1800’s. However, the use of the word “insurance” provides little insight into the actual working of the services and products provided by these underwriters. The origins of the three global leaders of trade credit insurance- Atradius, Coface, and Euler Hermes- date back over 120 years. The early franchises built deep platforms of information on the businesses being insured and monitored. Each carrier also invested heavily in debt recovery systems to maximize collections before indemnification as well as after. 

To illustrate and emphasize this point of investment: a short tale about a young man who left the safe confines of a custodian bank in the Spring of 1973 to embark on a career with the largest and oldest trade credit insurer in North America (eventually the world).

April 16, 1973 Day 1

Some background: The young man had previously honed his skills as an accounting clerk in the finance department of one the country’s largest and earliest established railroads in the USA. Performing the usual debit/credit functions that comes from the transport of product between seller and buyer, he learned the importance of rapid DSO. Once university studies had ended, he left the railroad and joined one of the most esteemed trust companies in the nation at that time. He was again deep into the processes of balancing numbers and executing transactional accounting.

On April 16, 1973, everything changed. Having grown tired with the repetitive nature of the accounting routine, he began a career as a “Credit Processor” with the American Credit Indemnity Co. He had applied for a “financial analyst” position found in the local paper’s classified section. There was something about understanding the “why” associated with financial analysis being far more interesting than the “what” as he took on this new challenge.

His first day of orientation quickly provided a glimpse that the actual activity of trade credit insurance was related to financial analysis, risk assessment and account monitoring, and less about insurance. This probably explains why the word indemnity was part of the company name and not insurance. 

Build and buy information

The young man learned that the Credit Processor’s primary responsibility was to build as well as gather, aggregate, and analyze as much financial, credit, banking and background information on each customer (buyer) the trade credit insured (seller) sought to cover. At his disposal was access to more than 30 specialized commercial credit reporting agencies. Beyond Dun & Bradstreet, many sector specific agencies (NCO, Feakes, Smith, Lyons, LCA, Produce Reporter, Blue Book, Red Book, JBT, etc.) existed in which mercantile reports were acquired and evaluated. Industries as diverse as chemicals, lumber, furniture, paper, produce, leather, shoes, jewelry, etc. each providing historical, financial, and current trade payment information on a buyer monitored by one of these mercantile agencies.

Because over 90% of the buyers being analyzed are privately owned, many of these mercantile agencies lacked meaningful financial disclosure. As a result, he would reach out directly to the buyer for current financial information utilizing the leverage the underwriter held through providing cover to multiple suppliers of the buyer. These financials were not typically something any single supplier would possess. When the financials were obtained, the data was analyzed to determine critical ratios such as debt to worth, working capital, cash & A/R to current debt, etc. 

Specific trade references might be researched, but typically the emphasis was directed to information provided by sources other than those advanced by the buyer. In addition, the buyer’s bank would be interviewed or contacted by mail to acquire information associated with the buyer’s balances, loan facilities, and opinion of the principal’s character. This was conducted within the guidelines put forward by the Robert Morris Associates regarding the exchange of information between banks and credit granting organizations.

It became evident to our young analyst that the process of insuring payment from the buyer was a secondary mission to understanding the buyer’s overall financial health, it’s default probability and likelihood of payment for the goods and services acquired. The primary mission of the insurance carrier was to quantify the upside and downside sales opportunity of each buyer as it related to future sales opportunities. The insured credit limit was intended to be a fluid figure.

Complete buyer risk assessment

Ultimately, the complete buyer risk assessment can never be made strictly based on the financial, banking, and credit information acquired. Any full assessment would be analyzed in concert with industry performance and trends, economic cycle, geo-political events and the buyer’s ability to have adequate financial flexibility to weather a storm. 

While many aspects of risk analysis were emphasized during his training, the two most critical focal points were: cash flow from operation (CFO) and external financing flexibility. The importance of understanding debt servicing as a central risk to a company’s solvency was emphasized. All aspects would need to be constantly monitored as external factors could quickly change the company’s ability to access capital or the cost associated with financing the business become overwhelming. 

Each day new data would arrive at the buyer level. In addition, information at the macro level which might impact the company’s risk profile continues to be assessed. In terms of risk of non-payment and sales opportunity, the insured buyer was being constantly monitored. No enquiry was executed in isolation. The young analyst learned that when a specific request to ensure a credit line was being assessed, the aggregate exposure associated with all interested suppliers was being evaluated. If there were seven sellers each requiring a $1m credit limit, the analysis was associated with a $7m exposure and the buyer’s ability to manage this level of trade exposure. 

The depth of the resources available in this risk and financial assessment process extended far beyond the typical capabilities of the seller (insured). This included the monitoring capabilities as the seller tended to manage at the DSO level; the trade credit underwriter maintained surveillance on the buyer’s financial performance, it’s borrowing capacity, the sector’s trend, the geo-political influencers, it’s payment patterns with other suppliers, and the broad economic trends. Cover would be adjusted according to the collective data. The young analyst now understood the “why” behind the numbers. He also became keenly aware that size matters and that the trade credit insurer leverages its depth of knowledge and resources for the benefit of its clients.

Finally, the analyst learned a valuable lesson from the many credit professionals he interacted along the way. Credit management is as much art as it is science. These professionals develop a 6^th sense of the viability of their customers beyond numbers. This experience should never be under weighted, it must be factored into the final analysis. 

Trade credit insurance gets in your blood

Trade credit insurance has evolved over the past 120 years; the partnership of risk management and sales support remains one of the central value propositions to the insured. Sales optimization and asset protection can only be realized through the joint management of a buyer’s credit & risk assessment processes. From that first day, first week, and ensuing months of training; the young analyst learned that he was not in the credit insurance business, he was in the credit management business. He also realized that he became an extension of his clients’ credit and risk management department fully integrated with a common mission to grow sales, improve operational performance and protect their capital, cash flow and earnings. Each client had their respective credit, receivable and risk management departments extended by the global reach associated with thousands of highly trained professionals who specialize in credit, financial and economic assessment. Effectively, their credit management team grew by the aggregate number of financial professionals associated with each of these trade credit insurance teams, leased through part of their annual premium.

As for that young analyst who discovered the answer to “why”, that young man was me. The passion continues to this day, it gets in your blood.