What is Trade Credit Insurance?
Trade Credit Insurance, also known as Accounts Receivable Insurance, provides coverage for a Seller’s financial loss arising from its Buyer’s:
- Default or Slow Pay
For Exports, Trade Credit Insurance policies add a layer of Political Risk coverage which includes:Commercial Risk – Buyer’s Bankruptcy, Insolvency, Default or Slow Payment.
Political Risk – inability to pay because of:
- War, Political Violence, Strike, Riot, Revolution
- Currency exchange transfer blockage
- Sanction or Embargo by Buyer or Seller’s Government
- Cancellation of an import or export license or other trade restriction
- Acts by the Buyer’s Government which prevent payment or other contractual obligations
What types of transactions can be covered?
A common misconception is that the seller must insure all of its receivables in a credit insurance program. While that was the case many years ago, the market has evolved to accommodate the following types of programs:
- Sales to a Single Buyer – repeat sales under a credit limit or a one-off sale
- Sales to Key Buyers, usually the top 10 to 25 buyers
- Sales to Multiple Buyers, such as:
- A foreign dealer network
- All export sales
- All sales from a specific division, product line, market segment
- Whole turnover programs
Generally, these programs cover receivables with due dates from 1 to 360 days. Trade Credit Insurance is also widely available for medium-term receivables such as loans, promissory notes and leases. Trade Credit Insurance for medium term transactions is available for domestic and export, transactions.
Why do firms purchase Trade Credit Insurance?
Increased Sales – Selling on a cash-in-advance basis sends a clear message to the buyer: You are not trusted. Selling with a Letter of Credit or other documentary collections is expensive and time consuming for both buyer and seller. Selling on insured, open account terms provides a balance between aggressive sales needs and responsible credit practice. The ability to lengthen sales terms and increase credit limits are often the key to increased business.
Selling in New Markets – Whether it’s an unfamiliar customer set because of a new product or acquisition or sales in a new country, Trade Credit Insurance helps you sell to those buyers safely.
Export Risk Mitigation – A bad debt loss in the Seller’s home country is often handled easily. A loss to an export buyer brings a host of new challenges: What rights and standing do creditors have in a foreign court? How efficiently are insolvency claims handled? Is the legal system corrupt? The questions and expense can be daunting. With Trade Credit Insurance, the Seller is promptly paid after a claim, and the insurer – who is accustomed to handling international debt recoveries – is subrogated the rights to the debt.
Financing – Without Trade Credit Insurance, banks are often unwilling to lend against the full value domestic and export receivables in a firm’s borrowing base, resulting in reduced borrowing availability. Banks will often exclude foreign receivables entirely and will limit the value allowed for key accounts. Trade Credit Insurance assures banks and other financial institutions that accounts receivable are protected by an investment-grade insurer. This allows them to lend against insured receivables at substantially higher values. The result
is increased borrowing availability – often at lower cost – for the seller.
Catastrophic Loss Protection – The bankruptcy or insolvency of a key buyer will likely cause severe financial distress to the seller. Production interruptions, financial covenant violations and loss of market confidence can result. In the worst case, the buyer’s bankruptcy causes the seller’s bankruptcy in a catastrophic chain reaction.
Outsourcing – Sellers without a formal credit department or whose department lacks the expertise to analyze the transactional risks to an export sale often use trade credit insurers to help set appropriate credit limits.
Efficiency – Many trade credit insurers have vast databases of public and proprietary buyer information which enables very rapid credit limit request decisions. In many cases, the underwriting of credit limits requests on export buyers are done in that country. This results in faster decisions by an underwriter familiar with the local business climate and regulations.
Effective Budgeting – Many firms use Trade Credit Insurance as a tool to quantify a worst case bad debt loss. As a business expense, Trade Credit Insurance premiums are typically tax deductible, while reserves require differing accounting treatment.