34 (129) 2018
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Finance & Financial Services

Credit risk management – challenges and responses old and new from the Polish insurance market

by Marek Brandt, business unit director, CEE Trade Credit Practice Group Leader, Aon and Artur Szast, broker, business development director, Aon Credit Solution, Aon
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How do you make cash from your sales? This old dilemma is the cornerstone of credit risk management.

Today, however, credit managers are facing new problems. Where do these new problems come from, and which issues are particularly important in Poland nowadays?

Let’s start with something seemingly unrelated. When you read about new business risks today, you may notice plentiful coverage given to cyber risks. New threats emerge as new technologies implemented – mobile access, data storage, big-data analysis or even further to blockchain, artificial intelligence, use of cryptocurrencies. Aon’s risk management study has also shown that cyber risks are emerging rapidly and require much more attention in the perception of managers worldwide.

However, the reality is that even more risk comes from the transition from traditional old trade models to e-commerce or, even more, to m-commerce. Habits of customers are changing rapidly, jeopardising conventional supply chains model.  The bankruptcy of ToysЯUs, a giant $11 billion-revenue toy retailer which become insolvent in late-2017 is only one of the biggest examples of traditional retailers losing the battlefield to new internet players. But it's just the tip of the iceberg where even small regional shop chains are losing the battle in the new economy. This means that even if your company has a stable portfolio of business customers they might be very prone to disruptors in their sectors.

Now, Lets come down to Poland. From the macroeconomic perspective, we are enjoying low inflation, stable GDP growth and historically low unemployment. So why are we facing a downturn in payments and double-digit growth in business insolvencies? Also, as we will see in Aon's report, most Polish companies indicate risks related to the economy, trade receivables and competition very high on the list when compared to their international peers.

A factor specific to Poland, resulting in skyrocketing claims in 2016 and 2017, is VAT investigations and the resulting charges imposed. News of penalties imposed cause a cascade of cancelled financing, often forcing the company’s management to declare insolvency. Stories of Action, AGD Market, and MGM Computers are just some examples with most media coverage, but others also occurred. This makes job of credit manager a bit like clearing landmines.

The construction sector, despite the ongoing boom caused by EU-funded infrastructure investment, is seriously pressured by the introduction of reverse VAT. The VAT split-payment initiative will make cash liquidity management even tighter. Moreover trade-free Sundays take away a few percentage points of revenues of retailers. Finally we have the implementation of GDPR ('RODO'), which creates the risk of high potential penalties for non-compliance and changes to the social security scheme which will increase labour costs.
All these factors are very high on the agenda of financial institutions as to their impact on payment behaviours of Polish companies.

OK, but we do have a mature credit-insurance market in Poland with all the top international players active here for 20 years, along with strong Polish insurers. Don’t they have robust solutions to cover these risks? Not necessarily. Changes in the global trade model mean that new credit risk assessment techniques and risk monitoring are playing an ever more important role. Already today artificial Intelligence and machine learning – terms once reserved for technology geeks – play an important role in credit-limit decisions. Insurers' decisions about credit limits are constantly calculating not only the risk of buyer’s default but also costs of keeping credit limits in place and revenues that stem from them.

Credit insurers in Poland have been struggling in a price wars for years. Today, they need to look more at the risks they are taking and they need to finance the claims they are paying. A new regulatory framework requires them to manage their capital more prudently. This comes down to a very conservative credit limit appetite.

This means today we do not have off-the-shelf credit insurance solutions available to address this challenges. What does it mean to CFOs, sales managers and credit managers?

Firstly, we need to focus on credit-risk management as an overall process. This covers risk assessment, mitigation, transfer and risk avoidance. We need to use the right data to identify our clients; we need a comprehensive solution to measure the non-payment risk of a given client and to monitor this risk regularly. We need to deal promptly with disputes, proactively address invoice due dates. The dunning [the process of communicating with clients to ensure the collection] and collection processes are crucial from the cash-flow perspective; they also build the image of prudent supplier who takes care of cash and risk. Many large companies still don't have such a process in place nor have they clearly defined responsibility for this.

Then there are several emerging solutions from the credit insurance market to consider.

Traditional credit insurance – a transfer of risk –  is an important part of the credit risk management process. If you are a supplier who exercises strong control about how you credit your customers – you may benefit from better pricing and higher credit risk acceptance from your credit insurer. This is true even if you are in a high-risk sector like construction or consumer electronics. When you have a policy and enter a possible client bankruptcy scenario, having a lot of coverage details start to play important role. It's not only the basics like the indemnification deductible. The key impact on indemnity received is often attributed to the rules of allocation, grace periods of credit-limit decisions or conditions of discretionary limit. It is a complex scheme where the role of experienced advisor is indisputable.

Credit-limit escalation. Credit-risk underwriters are usually experts when it comes to assessing buyers' risk in the sector they are watching. Their decisions are, however, not irrevocable. There are several ways to negotiate credit-limit decisions, starting with simple commercial pressure, moving on to joint negotiations with buyers or working on additional collaterals. Often a multi-level pressure on the insurer is required by supporting broker.

Combined trade credit programs. Even medium-sized companies can benefit from having policies spread across two or three insurers. When well structured, benefits of such policies are clearly visible, particularly when credit-limit problems arise, but also in terms of information benchmarking.

Top-up limits. Some credit insurers provide the possibility to buy additional credit limit capacity for additional costs. While this is one solution, check if a second independent insurer may provide more credit exposure. The market already has developed several top-up products for sales-oriented companies which can double available limits.

Single-risk or single-transaction coverage. These are increasingly possible for medium-sized deals in the Polish market. When the values of limit exceed 10 million zlotys, it starts to be possible to check foreign markets, including Lloyd’s, the world centre of insurance.

Factoring. It delivers not only working capital finance enhancement but may often include risk transfer. Good structure of factoring along with credit insurance supports safe trade growth.

Credit insurance is a complex, interdisciplinary area where finance, insurance, sales and trade law interact with each other. This is why the professional advisor's role here is indisputable.

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