One of the main reasons for a company to enter the world of factoring is the chance to cover the risk of insolvency of their debtors with the backing of a third party: the factor. And the question is: what does a factor do to cover a risk which its clients are, in a way, already warning it about?

It is obvious that companies don’t usually have the risk units we find in the structure of organisations dealing in factoring, but even so, even having these specialist risk departments is often not enough to evaluate and establish the right risk rating and limits for each of their clients’ debtors.In these cases, the usual method is to under-limit or refuse the inclusion of coverage clauses for debtor companies which do not comply with the factor’s risk policies, with the consequent loss of contracts and revenue this would involve.

This is where a new player comes in: the reinsurer.

Insurance and reinsurance companies have the tools and information they need to study and classify practically all the companies in a country or region, whether at the individual level or based on their own groupings, industries, NACE classification, etc. This means they can establish risk limits according to their solvency, providing factors with additional risk coverage which can meet the coverage needs of their clients.

This relationship is established contractually between the factor and the reinsurer company or companies through the payment of a premium which in most cases is annual, based on the overall volume of sales or loans declared by the factoring company to the reinsurer for a given period (e.g. the premium for 2015 would be based on the sales declared over the last 2 or 3 years), although it can be adjusted depending on those sales.

If there is an incident caused by a debtor’s failure to pay all or part of its debts, the factor will inform the reinsurer, which after executing its own recovery processes, will pay compensation corresponding to the insured percentage of the nominal values of the declared sales within the period set in the policy terms (usually 90 days after the default is declared).

An additional benefit for the factor (in the case of banks) of reinsuring assigned debtors with risk of insolvency is the possibility of adding guarantees corresponding to the insurance company; this reduces the consumption of equity, overall risk statement, etc. This is possible because the reinsurer’s guarantee means the rating applied to the debtors is that of the insurance company and not the debtor company.

The downside to this type of reinsured factoring is the need for product information systems that support the type of operation and processes needed for management and control: maintenance of insurers and policies, a communication model with the reinsurance (request to reclassify debtors, responses, cancellations, etc).