Trade Credit Insurance | Insurance for Trade Finance
Trade Credit Insurance – What is it?
Trade Credit Insurance is the type of insurance provided to trading companies who wish to protect their receivables from credit risks. Trade Credit insurance can be a risk management tool to safeguard against non-payment of goods, invoices or other debts. 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, as these types of trades are usually larger and have more risk associated.
The financing of both domestic and international trade comes under umbrella term trade finance. Trade credit insurance is a subset of this, and can help protect and mitigate risk for exporters from credit loss. Credit insurance also protects companies from non-payment across many other types of good and services. While trade credit insurance is most often used to protect foreign or export accounts receivable, it can also be used for domestic use cases. Trade credit insurance is not available to individuals.
How Credit Insurance Works
Trade credit insurance protects companies against the failure of clients to pay debts, so if the client or customer becomes insolvent and fails to pay the company, then the trade credit insurance policy will cover the associated loss. A credit insurance policy can be written to cover an entire client base, or a subset of clients. Financial services providers are unlikely to provide coverage for high risk clients. The insurance provider will track the activity of the client and provide updates on credit worthiness and potential risks.
To provide the initial policy, the insurance company will first analyse the credit worthiness of the customer base, and there will be a premium rate based on the aggregate risk of the pool of customers. After this, the policy holder pays the quote and can continue business as usual with customers. Upon the event of a credit event, then the policy holder submits a claim to the insurance provider who will investigate the claim. If the criteria have been satisfied, then the policy holder will be indemnified.
Advantages and Disadvantages of Credit Insurance
There are a number of advantages to trade credit insurance. The main is that companies are indemnified in the event of unpaid debts, which occurs 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 cost, 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, and the financial services provider supplying the insurance will in many instances collect the debt for the policy holder. 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 frequently occur. Periodic reports are often necessary from the company purchasing the policy which can be an administrative burden. Additionally, policies often come with annual deductibles, so trade credit insurance is not a dollar first policy.
How to Get Credit Insurance
Obtaining credit insurance first involves contact with a trade credit insurance broker or provider. They will ask for certain information about your company, the trade, and your customer (the end debtor). After all the information has been provided, you would be issued with a quote for the policy and once the payment is made, the policy will become active.
The documentation you need to provide for credit insurance can be extensive, and you will need to supply accounting figures as well as other information. There are many trade insurance providers that can easily be found and contacted online.
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 Euler Hermes. Other large providers include AIG, Coface, Atradius and FCIA. Different credit providers will have distinct features.
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 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 large international trades, 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 their creditworthiness is something of a necessity.
Bonds, Guarantees and Letters of Credit
Structured Terms of Payment
Currency Exposure and Risk Management
Shariah Compliant Finance
Benefits of Credit Insurance
- Could protect your company against bad debts
- Worry less about your customers’ solvency
- Avoid large losses and help your business grow profitability
- Work with larger and more risky customers