There are two main benefits of credit insurance generally acknowledged to be the main drivers of its popularity with SME’s as well as large international conglomerates. First is related to its role as a form of commercial insurance; that of pure risk mitigation.
In this regard, credit insurance protects the accounts receivable of the insured against loss due to non-payment of invoices (i.e., accounts receivable) as a result of one of the two principal triggers resulting in a Claim. Those triggers are (1) bankruptcy or insolvency and (2) slow pay.
In the case of bankruptcy, your counterparty Buyer is unable to pay the obligation when due. The Buyer is simply out of business with no ability to pay, and a bankruptcy court has taken over the business to liquidate its assets and pay creditors. Unsecured creditors, such as most farmers, will get pennies on the dollar, if anything at all. In the case of some SME bankruptcies, the owners simply lock the door and walk away without an orderly liquidation. In this context, a bankruptcy and its implications are governed by the law of the country in which the bankrupt business is located.
In the case of “slow pay”, a business may still remain in operation, but may be slow to collect revenues, in which case payment in a normal 30 day cycle is slowed to 90 days or more. The business may recover, or it may eventually go bankrupt. The insurer will pay the Claim to you, then may work with the Buyer to establish a payment schedule that will result in the business staying open and the full amount of the credit obligation eventually being paid in full.
The second of the two main benefits is increased borrowing capacity and sometimes, accounts receivable discounting. In the case of increased borrowing capacity, financial institutions will, for good customers, lend at a rate (called “margining”) against “good” (i.e., not delinquent) accounts receivable of between 65% and 75%. With credit insurance in place to mitigate the risk of loss, lenders will generally margin at 90% against those same receivable. As a result of the insurance being in place on these accounts receivable, the accounts receivable are always deemed “good” and will be counted in the margining formula until the Buyer pays or a Claim is filed and paid.
Margining uninsured accounts receivable leaves a farmer open to accounts receivable ageing in which accounts receivable “drop out” of the margining formula. This in turn can cause a bank to call a loan, in whole or in part. Farmers that are more highly leveraged, and who have pledged their farm and farm assets to the bank, can be particularly vulnerable to this trap.
As accounts receivable are a huge component of the farmers Balance Sheet, non-payment of invoices by Buyers always presents the risk of a cascading credit loss, and impairment of farm operations.
Discounting is the process whereby financial institutions purchase accounts receivable at a discount from face value. With credit insurance in place, and 90% guaranteed to indemnified, discounts can be achieved at less than 5% of face value. For farmers who do not wish to wait for payment for longer term obligations (60 day or 90 day terms), discounting may become feasible.
MPA alleviates many of these issues and has the added benefit of increasing working capital with the farmers’ lender.
The MPA Program is available to the following organizations and groups:
- FNA Member farmers
- Non FNA Member farmers
- Commodity brokers (does not take title)
- Commodity dealers (takes title; for own account)
- Processors (takes title; for own account)
- Contract Processors (does not take title)
- Grain companies (takes title; for own account)
- Farmer non-profit organizations
- Agricultural non-profit organizations
- Agricultural related Co-ops
The benefits to farmers of the MPA Program are clear: risk mitigation and increased borrowing capacity. However, other organizations such as commodity brokers, dealers, processors and grain companies can benefit equally from the Program. In the event that either reputation (for those who do not take title) or financial risk (for those who do take title) is at stake, the MPA Program is the clear choice for prudent planning.
Non-profit organizations offering the MPA Program to their membership can do so with complete confidence in the integrity of MPA, and the organizations which back the Program.
In addition to pure risk mitigation and bank margining/discounting, there are many other tangible business benefits that MPA and credit insurance bring to the business of farming.
With significant farmer payment protection changes to the Canadian Wheat Board and the Canadian Grain Commission in what is billed as “Marketing Freedom”, there is also now a significant level of “Marketing Risk”. This marketing risk is now placed squarely on the shoulders of the farmer and it is now the responsibility of the farmer to protect him/herself from Buyer nonpayment.
Both the CWB and the CGC used credit insurance to backstop certain obligations to farmers, and with these credit insurance protects now reduced or eliminated, it is up to the farmer to either sell unprotected, or protect themselves.
MPA is that low cost method of protecting farm sales.
Nowhere is that more important than when a farmer sells to a new Buyer, especially one the farmer is unfamiliar with from a creditworthiness standpoint.
With MPA and credit insurance in place, the farmer can sell to new Buyers with the assurance that, if the Buyer fails to pay you, the MPA will – at the 90% indemnity level. Sell to new Buyers anywhere in the world at your best price and on flexible terms that meet the needs of your customers.
Don’t sell unprotected and blind – for about ½ of 1% you can protect your sales, your farm and your livelihood.
Selling to new Buyers in new markets can be a daunting task. After all, if you sell your farm commodities to Buyers in the United States, or anywhere else in the world, you are at a distinct disadvantage – your Buyer is in a foreign country governed by laws that may not protect your financial interests well.
And the cost? Can you really afford the cost of travel to a foreign country to pursue legal remedies that may or may not recover the full value of your sale? Legal fees? Even if you do sue, can you recover compensation?
MPA solves this problem for you, and does so at a cost of about ½ of 1%. You will be paid an indemnity of 90% of your invoice value, and the insurer will then seek to recover from the Buyer – not you.
One of the common issues that may arise is what happens when you are offered a premium price for your farm commodity? Should you take the offer? What do you know about the Buyer?
All of these issues are easily resolved by using MPA.
With MPA you can sell at that premium price, or determine that it is too risky to proceed. If the insurer approves the Buyer, you can sell with confidence, knowing you are backed by credit insurance.
With MPA, farmers have more flexibility than ever before to meet the needs of its Buyer when it comes to available, flexible and safe terms of sale. With MPA you may offer terms as long as 90 days for the same price as 30 days. Longer terms for large sales can also be arranged if needed.
Providing flexibility and longer terms can mean the difference between making a great sale at a premium price, or just getting the usual low offer from the same grain companies.
With longer terms comes better prices in a competitive environment.
Protect yourself and get in the game!
Very often, a farmer will make a small sale just to find out if payment arrives on time. Then another small sale, possibly at a lower price. This scenario is repeated often in Canadian farming as an informal mechanism to build confidence in the Buyer over a longer period of time. While it may be prudent, it is also inefficient.
First, payment for small shipments is no guarantee of creditworthiness in the future, particularly for a large shipment.
Second, this mechanism provides absolutely no insight into the financial condition of your Buyer.
With MPA, the farmer can either ship commodities with confidence or avoid a potentially disastrous or catastrophic loss.
Harvest can be a busy time for a farmer eager to make sales and pay off farm debt. In some cases you may need to pay off farm obligations to avoid payment of penalties and higher interest rates. Historically the answer was “selling from the combine” to large grain companies at a bargain price – just to access the cash flow. It is a vicious cycle, and one all too familiar to farmers in Canada.
So when many offers and opportunities come in, how can you evaluate the good offers from the bad, strong offers from the weak?
The answer? MPA. Sell with confidence for the best price knowing you cash flow will be there when you need it.
It is not uncommon for farmers to borrow working capital from a lender against domestic accounts receivable in order to pay other farm obligations. This is simple “margining” with an advance rate between 65% and 75% from your lender.
With MPA, your advance rate can be up to 90% of an insured receivable, thus maximizing the amount of leverage you need from your receivables.
The case for new export accounts receivable is significantly different than for domestic accounts receivable. In the case of export sales, Canadian financial institutions will generally not margin any accounts receivable unless they are credit insured against non-payment.
If you need to margin export sales, MPA is the low cost solution to your needs. And, like domestic receivables, you can borrow up to 90% of the value of your exports.
Margining accounts receivable with your financial institution can be a tricky endeavor. The formulas involved for “advancing” or lending against receivables can be problematic for a farmer.
Advances are made against a pool of “good” accounts receivable; that is accounts receivable that are likely to be collected. Accounts receivable that have aged beyond a certain number of days (say, 60 days past due) may be considered bad collateral. In this event, amounts borrowed against those receivables when they were still considered “good” may have to be repaid immediately. This can create another fire sale situation for the farmer to meet this obligation.
With MPA and credit insured accounts receivable, this situation will never occur. Credit insured accounts receivable are always considered “good” up to 90% of the receivable value. Insured receivables do not drop out of the margining formula.
In some cases, it is possible to have a financial institution buy your insured accounts receivable at a discount. Factors provide the same service, but at a high cost or discount. When banks “factor”, this is usually called “discounting”, and it is somewhat less costly to arrange.
Your accountant will normally make an allowance for uncollectible accounts receivable, anywhere from 1% to 5% depending upon payment or bad debt history.
With full credit insurance protection, this reserve can be reduced or eliminated.