|accumulate $15 million in cash reserves,|
|over a five year period,|
|to cover potential receivable losses;|
|with immediate availability of credit insurance protection up to $15 million.|
A Finite Risk Insurance package will provide the company with:
Such an FRI arrangement would only cover losses up to a maximum aggregate amount of $15 million. If the full amount were to be lost on the first day of the arrangement, the insurance element would pay out immediately in full but the fund would have to be reimbursed over five years. The company would not enjoy any further ‘protection’ from that particular arrangement but would have to continue making annual contributions for five years.
Conversely any amount not needed to cover bad debts could be returned to the company at the end of the five-year period.
NOTE:Information about FRI and the example quoted was gleaned from a presentation given by Ranjini PILLAY and Christophe LETONDOT of AIG EUROPE (Paris Office, France) given at the FCIB Workshop held in Amsterdam, the Netherlands, on January 27, 1998.
Telephone: +33 1 49 02 43 09. Fax: +33 1 49 02 44 94.
An internal ‘credit insurance’ solution based on a corporate group could work as follows, for example:
The Group Credit Manager, based in Corporate Headquarters, would operate a voluntary scheme for his business units. He would offer a credit insurance policy to his business unit managers - more simply worded than the usual commercial contract but covering the same ground. He would offer to cover 90% of commercial and country risk on all of the business unit's receivables for which he has approved limits and which are managed within the limits approved. In some cases he would stipulate security which must be obtained before cover would be effective. He would charge a 'premium' based on normal commercial rates. He would simply ask a credit insurance company for a ballpark figure and use that to satisfy tax managers that the arrangement is not a 'transfer of profit' scam. The policies offered would be of the 'turnover' type, which cover the majority of receivables and stipulate a premium based on a percentage of total sales.
In due course the Group Credit Manager would receive claims when debts turned bad, he would pay out 90% (if a claim was valid in terms of the 'policy') so only 10% would go to the bottom line of the business unit, at the time a receivable was written off. He would use premiums received to accumulate a fund to enable him to cover any losses. This is not envisaged as a tax scheme, so the funds would simply accumulate on the corporate balance sheet and would be invested in the usual way by the Group Treasury department.
If the Group Credit Manager had some surplus funds available he could do 'one off' special deals on specific higher risk customers. In these cases he could write a policy to cover one account, on specific conditions and charge a separate premium.
He would have different criteria for credit management in each business unit depending on the individual strengths of each unit. Some may have functioning credit departments with acceptable policies in place. In these cases he would review the credit policies and loss records and set criteria and premiums accordingly. In other cases he himself would set credit limits and conditions for all customers i.e. when only a small number of customers were involved. Accounts, which were not managed within the agreed criteria, would not be covered; he would refuse to cover losses in cases where, for example, limits were exceeded or security was not obtained. In such cases 100% of any loss would go to the business unit bottom line, when the loss occurred.
The key - for the Accountants and Tax Managers - is to develop a scheme which is equivalent to buying external credit insurance. In other words to use normal policy type language in the internal agreements and to charge market rates of premium.
It is recommended that Tax and International Commercial Law advice should be obtained before such a structure is utilised.
© R K WELLS (1998)
PS: Read about Post Loss Funding Credit Insurance.