Buy now, pay never?

Bad debts from customers can be crippling for brokers as basic payment practices are essential to the smooth running of any business.

Legislation amended last year aims to improve better payment practices, however. The Late Payment of Commercial Debts (Interest) Act 1998, as amended and supplemented by the Late Payment of Commercial Debts Regulations 2002, is particularly important, according to Dominique Vaughan Williams, the Association of British Insurers' spokeswoman for the Better Payment Practice Group.

This legislation states that a business can charge any other business interest on overdue invoices. In the UK, this interest is 8% above the base rate of interest, meaning that if the base rate is 4%, the interest charged is 12%.

The definition of what is overdue depends on the contract (although the standard approach is 30 days) and the legislation only applies when there are no other payment terms. The legislation also says that companies can charge for outsourcing the debt to a collection company.

"It is a raft of legislation to help companies to get paid. It is not trying to be a threat, but is aimed at focusing the mind on healthy payment practices," explains Vaughan Williams.

Payment problems experienced by brokers often stem from a lack of sufficient written conditions or credit controls but businesses are realising that this must change. Research by the Better Payment Practice Group revealed that in 1997 only 63% of small and medium-sized businesses would check the creditworthiness of a company. This figure rose to 80% by 2002.

There a number of ways to check the creditworthiness of a company. These include, for example, at Companies House looking at a company's reports and accounts, or paying for a report from a credit reference agency such as Experian.

The Better Payment Practice Group research also revealed that the number of small businesses with a written credit policy was 44% in 2002, compared to just 26% in 1996.

A credit policy highlights credit control procedures and could include issues such as how a new debt is approached and what action will be taken after a defined period of time. For example, some businesses opt to call the client 10 days after payment should have been received.

"We advise that you make sure your new client is aware of your payment terms and credit control policy up front so there are no surprises. It shows that you mean business and you will be chasing payment if overdue," says Vaughan Williams.

"Overall, things are getting better, but to change a culture can take many years," she adds.

Smaller brokers may feel the pressure because they do not have the time or resources to chase payments. A third party debt collector may be able to help and, if this route is unsuccessful, legal action can be taken.

However, if brokers have their own payment terms they cannot use legislation, as they already have a contract in place.

"The legal route can be expensive, but people are not deterred by cost alone. It all depends on how important that debt is to your business," explains Vaughan Williams. "You need to make a decision whether to let it go and never deal with the company again, or to pursue the debt and aim to recoup your costs. The main thing is to keep your eye on the ball."

New regulations being introduced by the Financial Services Authority also address the issue of bad debt, although the regulator emphasises protecting customers and their money rather than brokers.

The FSA broaches brokers' approach to clients' money in Policy Statement 174. This states that brokers should segregate client money into different accounts - statutory and non-statutory trusts - to help protect consumers against the risk of their money being lost. As an alternative, brokers can transfer the risk if their insurers will assume responsibility for the funds.

The main difference between the two types of trust is that a non-statutory trust can be used to make advances of credit to pay a client's premium before receiving cleared funds from the client. It also allows claims and premium refunds to be paid out to clients before cleared funds are received from insurers.

Non-statutory trusts put a number of safeguards in place. For example, brokers must maintain systems and controls adequate to ensure they can manage credit risk resulting from making credit advances. The non-statutory trust is also subject to a minimum capital requirement of £50,000, where brokers pay retail client money into the trust account.

Letter exchange

Both types of trust involve an exchange of letters between brokers and their bank, agreeing that all money in the account is held by the firm as trustee. Brokers operating a non-statutory trust must also execute a trust deed.

The FSA advises brokers and insurers to review their practices and agreements to be sure that they fit with the new client money rules. For example, brokers acting with the authority of an insurer to underwrite business will receive and hold premiums as an insurer's agent. But if brokers are only acting for their clients they may need to segregate premiums for onward payment to insurers in a segregated client bank account.

A spokesman for the FSA explains: "What we have done is take the insurance broking account currently on offer and tightened it up. This means that if brokers get into trouble, the customers' money is ring-fenced and cannot be touched."

Grant Ellis, chief executive of The Broker Network, believes the FSA regulations will have an impact on broker's credit control procedures because the majority of brokers will run a statutory trust for their client account. This means they will no longer be able to grant credit to any of their customers.

"Historically, brokers may have said that if customers give them a deposit now, they can pay the rest in a couple of months. This meant brokers could only pay the insurers by using other clients' money,"explains Ellis.

"The new regulations mean brokers will have to get good credit control in place. Some brokers already have superb credit control but others are very laid back. In these cases they end up with more bad debts, and customers who think that having nine months' credit is a normal situation. In the future this is not going to be viable.

He adds: "The new regulations will be good for the industry, as it benefits no one to have relaxed credit control. You would not walk into a supermarket, fill your trolley with goods, then inform checkout staff that you will come back next Thursday and pay. Yet this is what is happening when customers approach brokers, and it is not acceptable."

Ellis points out that some brokers leave an unclear debt forever. "But the correct position is that when the debt is no longer believed to be realistically collectible then it needs to be written off - or at least provision must be made on accounts," he says. "This very much depends on the individual circumstances of each debt. You have to take a view on each one but the important thing is to take a view."

Meanwhile, Ian Mantel, director of Manor Insurance Services, says brokers should not be tempted to let bad debt go. He says: "Do not be afraid. If someone owes you money, sue them via the County Court. This is far less expensive than if word gets around that your credit control is relaxed. Play it sensibly but if the client is no good then why lend them money in the first place? Do not lend to people who clearly cannot afford it."

Mr Mantel says he never writes off bad debts but puts them against the office account. "Moneylenders should be prepared to take the wrap, monitor it and be careful with it. Prevention is better than cure."

He continues: "If the company has a good relationship with an insurer, they will look after one another. However, the moneylenders shouldn't expect the insurer to fall over backwards if it is not doing its bit."

One way of getting rid of the credit risk is to use external premium financiers. Alison Mills, sales and marketing director of Close Premium Finance, says brokers must differentiate between a late payment and a bad debt. A late payment is when the customer has missed the deadline for paying the broker, is on cover, and admits that it is still unable to pay the whole amount.

By contrast, a bad debt is reached when a client has collapsed and cannot pay, and they have an outstanding amount on their statement from the insurer for cover that has been given and has not been paid for.

She says: "If it is a late payment, there is always something we can do. They may require a deal to be structured because circumstances have changed, such as seasonal payments."

"With bad debts, prevention is the better policy. Either the broker should take a deposit or have the premium finance arranged ahead of renewal so that an immediate direct debit collection can take place. It is good practice to take the first instalment, which may be a 20% deposit, by credit card. This means that the client has gone through a credit checking process."

Ms Mills concludes: "It is about being ahead of the game. Process and collection on a daily basis is our business and the technology and processes that we use mean that can move very quickly."

Without adequate payment practices in place, brokers expose themselves to an increased possibility of late payments and bad debts. With new FSA regulations soon to be enforced, brokers are urged to review their procedures so that their business, as well as their customers, are protected.