What is Trade Credit Insurance?
Trade credit insurance (TCI) is a technique of safeguarding a firm against the incapacity of its commercial clients to pay for products or services, whether due to bankruptcy, insolvency, or political unrest in the country where the trade partner operates.
As a result, TCI—also known as accounts receivable insurance, debtor insurance, or export credit insurance—assists firms in protecting their capital and balancing their cash flows. It may also assist them in obtaining better financing conditions from banks that are certain that their clients’ accounts receivable will be paid.
Trade credit insurance provides indemnification for the non-payment of trade receivables. With trade credit insurance in place, companies can generally extend more open credit to customers or enter new sectors or markets. This has the impact of reducing the risk of non-payment, thereby enabling sales growth without a corresponding increase in risk.
Trade credit insurance can also enable a company to secure more favorable financing terms, as insured accounts receivable may be used as collateral, and can support securitizations, receivables purchase and supplier credit/payables programs.
Trade credit insurance can enhance credit risk management by using the credit information, risk monitoring and debt collection services provided by insurers. The use of credit limits, underwritten by insurers, helps an insured monitor its debtor risk.
This helps the company manage its sales policy by enabling it to focus on creditworthy customers, appropriate payment terms and security conditions. Trade credit insurance claims payments improve cash flow uncertainty.
What does trade credit insurance cover?
Trade credit insurance protects businesses from non-payment of commercial debt. It covers your business-to-business accounts receivable. If you do not receive what you are owed due to a buyer’s bankruptcy, insolvency or other issue, or if payment is very late, a trade credit insurance policy will reimburse you for a majority of the outstanding debt.
This helps you protect your capital, maintain your cash flow and secure your earnings while extending your competitive credit terms and helping you access more attractive financing.
With trade credit insurance, you can reliably manage the commercial and political risks of trade that are beyond your control. This type of insurance can help you feel secure in extending more credit to current customers or pursuing new, larger customers that would have otherwise seemed too risky.
Benefits of Trade Credit Insurance
Four key benefits of trade credit insurance for businesses:
- Protects from bad debts and their subsequent effects.
- Enhances and supports working capital requirements.
- Embeds credit management discipline.
- Enables prudent growth.
Reasons to buy trade credit insurance
Protection: Replace money lost through bad debt
Peace of Mind: Feel safe in the knowledge that your outstanding invoices are protected
Competitiveness: It helps you remain competitive by enabling you to offer open credit when your competitors can’t
Funding: We help in securing trade finance which improves banking relationships and access to finance
Profitability: Improve profitability by safely increasing your exposure to more customers
Cash Flow: It complements and enhances existing credit control procedures to improve Days Sales Outstanding’s
Information: You gain access to greater customer intelligence that leads to balanced risk decisions
Growth: It facilitates expansion with security and allows you to deal confidently with new clients and increase credit lines to existing ones.
Types of Trade Credit insurance
Credit insurance providers offer flexible products to meet the needs of individual businesses. Policies are designed to cater for the cover requirements of the policyholder’s business and provide a range of options:
- A business can typically cover their entire portfolio under one comprehensive policy insuring a wide range of risks across both domestic and export transactions.
- Options that provide cover for key buyers only: either on an individual basis or as part of a smaller portfolio of key risks.
- There is an increasing market for supplying businesses that have very specific requirements that trade credit insurers can provide tailored solutions for.
There are many different types of credit insurance policies to suit the needs of all businesses:
Single Risk/Buyer – A policy that covers an isolated single risk. This policy is relevant if the policyholder is exposed to a particular market risk, such as an exceptional transaction in relation to the value of the customer’s overall book of business, or a delivery of capital goods, or when cover is demanded by the bank financing the transaction.
Export – A policy that is specifically designed for exporting companies, and provides additional cover for a range of risks such as new import restrictions, war, inconvertibility of exchange, that may arise as a result of the actions of the buyer or a third party government.
Multinational – A policy that provides multinational group-wide or worldwide cover under the same conditions, irrespective of the location of the business units.
Political Risk – A policy that covers inconvertibility of exchange, contract frustration (for example, by civil war), contract cancellation, import and export restrictions, etc.
Excess of Loss − A policy that covers for exceptional losses over and above the normal level of bad debt by setting an aggregate first loss for the whole policy period. It is sometimes referred to as a “Catastrophe policy” aiming to secure the Policyholder against the failure to pay of major buyers.
Is Trade Credit Insurance Right for My Business?
If, by now, you’re thinking that trade credit insurance is a must-have for your business, there are a few things to note before deciding whether it’s right for you.
For one, most policies won’t allow you to file a claim if the invoice is disputed. In this case, you would have to wait until the dispute is resolved before the account can be declared unpaid. Once that happens, then you can file a claim to collect on nonpayment.
Second, if you do purchase an insurance policy, you shouldn’t let your customers know if their accounts are insured. It’s best to keep that information confidential since it might tempt a customer to default, knowing that their debt is covered.
It can also take leverage out of any collections issues you might have to face down the road. For a very minimal cost – often a fraction of one percent – you not only gain peace of mind, but also the ability to quickly make data-informed decisions about selling to new customers or extending additional credit to existing ones.
Lastly, not all companies qualify for trade credit insurance coverage. Many insurance companies use risk assessment data from companies like Dun & Bradstreet to help them make better informed decisions about who they’ll cover. If your company is just getting started or is not profitable, trade credit insurance might not be a cost-effective option for you.
Overall, trade credit insurance can be a great tool for minimizing credit risk and protecting your accounts receivable (and business) from any significant losses. Most companies provide policies for small, medium, and large companies, and policies can be customized to your specific needs. Either way, if you’re looking for ways to minimize bad debt, it’s definitely worth looking into.
Read also: Casualty Insurance