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Our Subscribers Say...
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Manager of Credit & Collections, ASSA Abloy Americas Division, New Haven, CT
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Fort Worth, Texas
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Thales Navigation, Inc.
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Political Risk vs. Commercial Credit Risk Insurance
Some exporting companies hedge against the possibility of payment default by purchasing a comprehensive credit insurance program or package. What does a comprehensive foreign credit insurance program include? An insurance policy that protects the seller from payment default for commercial or political reasons. Export credit insurance allows and encourages sellers to offer foreign buyers competitive terms.
There are a variety of types of credit insurance policies available to exporters. These policies are sold by private insurance companies, or issued using insurance brokers through the Export-Import Bank of the United States.
There are two separate and distinct types of credit insurance policies: (1) Political Risk Insurance and (2) Commercial Credit Risk Insurance.
Political risks resulting in payment default can be broadly defined as being caused by events beyond the control of the buyer that were caused by the actions of the foreign government. Political risk includes:
- war
- political violence
- government intervention of any type
- cancellation of the seller's import license
- seizure of merchandise in the destination country
- embargoes
- currency non-convertibility (in some policies)
Commercial credit policies protect the seller against payment default involving bankruptcy, insolvency, and other forms of business failure. This is the type of coverage most credit managers are used to discussing when they here or read about domestic credit insurance coverage.
International Credit Management Portal
In an increasingly global world, it's critical to know what steps to take if you receive orders from outside the country. Check out Credit Today's resource center for international credit issues. We help you assess foreign risks, collect foreign debts, benchmark the best sources of international credit reports, and much, much more...
Check out Credit Today's
International Credit Management Portal
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Rapid devaluation of certain foreign currencies such as the Russian ruble and the Brazilian rial in recent years can make it either impossible for foreign customers to purchase the US dollars to pay their US creditors. If the seller elects to denominate its invoice in the buyer's local currency, then the seller may have to absorb significant foreign exchange losses (even if the seller used hedging to protect against volatility in foreign currency exchange rates) because the currency devaluation may be outside of the parameters that hedging is helpful to the exporter.
Devaluation is typically not covered by foreign credit insurance. If the seller can demonstrate that the non-payment was only indirectly responsible for the payment default by the debtor, then the insurance carrier may be liable for the unpaid debt--especially if the exporter has purchased both Commercial and Political risk insurance. The issue of how the insurance carrier will determine if the default was the direct result of currency devaluation is dealt with in detail in the policy terms and conditions.
Export credit insurance does not prevent losses. It is intended to protect exporters against catastrophic losses, but it is not a perfect solution. For example, if a foreign buyer disputes a past due balance under most policies the credit insurance company is not obligated to pay the exporter until the dispute has been resolved. Resolving the dispute might require that suit be filed by the seller in the buyer's country and that the matter be litigated. Assuming the seller/exporter prevails, the credit insurance carrier would then be obligated for the debt. Credit managers must never lose sight of the fact that export credit insurance does not eliminate credit risk.
Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.
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Outlook 2012
This month's survey explores...
- What the top problems are facing credit execs currently, and
- What the top improvement initiatives are.
Click here to participate!
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