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Managing Export Credit Risk
Selling overseas on open account terms is often considered high risk. Not surprisingly, most foreign buyers prefer to purchase on open account terms, and many credit departments are expected to find a way to sell without requiring the buyer to provide payment in advance or a Letter of Credit. Being able to sell without a requiring a Letter of Credit can be a significant competitive advantage for an exporter. Why? Letters of Credit are inconvenient to work with, increase complexity and add cost to the sale. One mechanism to sell overseas without requiring a letter of credit involves purchasing export credit insurance.
Export credit insurance is designed to insure a company's foreign trade receivables against various types of credit losses. Export credit insurance policies can cover some or all of the following types of risks:
- A foreign buyer refuses to pay a debt;
- The foreign debtor wants to pay, but cannot purchase the US dollars needed to do so;
- The customer files for bankruptcy protection (or the foreign equivalent of bankruptcy) and defaults on payment;
- The foreign customer /debtor simply disappears leaving the debt unpaid.
Annual premiums for export credit insurance are typically less than 1% of the annual purchases covered by the policy. Premiums are kept relatively low for several reasons including these:
- Most export credit insurance policies do not cover the first dollar of loss. Export credit insurance policies are typically designed to cover catastrophic losses - not small nuisance losses. Therefore, the exporter self-insures until the annual and per loss deductibles are met.
- Certain foreign customers will not qualify for coverage. This may be because the customer is high risk, the destination country is an unacceptable risk, or some combination of both risk factors.
- Export credit insurance polican annual deductible, as well as a per loss deductible or co-payment.
- There is an annual cap on loss payments.
© 2011 by Michael C. Dennis. All Rights Reserved. Mr. Dennis is an author and a consultant. He can be reached by email at mcdennis13@yahoo.com