Trade Credit Insurance

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What is Trade Credit Insurance?

Trade credit insurance (TCI) is the type of insurance provided to trading companies, or their financiers, who wish to protect their receivables from credit risks. Trade Credit insurance can be a risk management tool to safeguard against non-payment of invoices arising from the sale of goods or services. 

It is often termed credit insurance and can be differentiated from other forms of credit products. Credit insurance plays a large role in international trade. These types of trades can be larger, more complex, or involve more unknowns, increasing the associated risk of non-payment.

The financing of both domestic and international trade comes under the umbrella term trade finance. Trade credit insurance is complementary to this sector and can help to protect and mitigate risk from credit loss. 

Credit insurance also protects companies from non-payment across many other types of goods and services. While trade credit insurance is often used to protect foreign or export accounts receivable, it is routinely used for domestic use cases. Trade credit insurance is a B2B class, meaning that both seller and buyer are companies. 

Trade credit insurance can also improve access to financing for businesses. A financial institution may take out a credit insurance policy for invoices acquired, increasing their capacity to lend. Alternatively, a credit insurance policy may also be ceded by a trading company to a bank or factoring company as general collateral as part of financing arrangements.

How can credit insurance work with trade finance?

If your profit margins are 5% and a customer defaults on a debt worth $200,000, then you would have to create $4,000,000 in sales to make up for this loss. This can put any company out of business quite rapidly. Trade credit insurance can help to mitigate these losses, so the company can continue its operations. 

It is important not only to get the losses covered, but to work with an efficient provider who can get losses covered quickly. Access to liquidity is imperative for the smooth functioning of any company.

When dealing with trade, trade credit insurance becomes very important. Companies go out of business all the time for a myriad of different reasons. And they never advertise the fact that they are having financial difficulties. 

For this reason, taking out a policy with an insurance company that monitors the creditworthiness of buyers can enhance business resilience greatly. Trading on credit, backed by trade credit insurance, enables businesses to focus on what they do best. 

Without this protection, credit risk is borne by the seller and they may have to rely on cash deals, limiting the ability of partners to work with them or more expensive instruments such as letters of credit.

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There are a number of advantages to trade credit insurance. The main is that companies are indemnified in the event of unpaid debts, which can occur to many businesses both large and small. Generally, the larger and more frequent the trade occurs, the more important it is to have some type of safety net or buffer. Some 25% of bankruptcies are attributed to unpaid invoices

If a customer does not pay the invoice, then it will have a negative impact on vital cash flow which is necessary for general day-to-day operations. Lack of finance will also result in opportunity costs, where companies are unable to capitalise on opportunities as they arise. 

Companies can also gain access to credit experts through the purchase of trade credit insurance, for instance: gaining access to the detailed credit assessment and debt collection experience of the credit insurer. The financial services provider supplying the insurance will often collect the debt for the policyholder. Costs incurred to reclaim the debts are also frequently covered.

There are few disadvantages associated with trade credit insurance, aside from the cost of purchasing a particular policy. However, there are often a number of restrictions on making a claim, including a maximum limit on claims. Credit insurance providers will not pay out on the policy if the balance is in dispute by the debtor, which can occur. 

Periodic reports are often necessary from the company purchasing the policy. This may be automated and technological innovations are making this process easier and more intuitive for companies involved. It should be noted that the policyholder is required to bear some of the loss in the form of an aggregate loss or a percentage deductible. 

This ensures that the seller retains an interest (i.e. skin in the game) and ensures they remain aligned with the insurer. 

How to get trade credit insurance

Obtaining credit insurance first involves contact with a trade credit insurance broker or provider. They will ask for certain information about the company to be insured, the trade, and customers (the end debtors). Once all the information has been provided, a quote for the policy is issued, and upon consent, the policy will become active.

Providers of credit insurance

Three groups now account for nearly 85% of the world’s credit insurance market, based mainly in Western Europe. The world’s largest credit trade finance company is Allianz Trade. Other large providers include AIG, Coface, Atradius and FCIA. Different credit providers will have distinct features, although the core features of the protection will remain similar.

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About the Author

Richard Wulff is the Executive Director of International Credit Insurance & Surety Association (ICISA).

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