When suppliers offer goods or services to customers with payment terms, they often provide trade credit, allowing customers a certain number of days to pay after the delivery. This arrangement helps businesses grow by encouraging more sales, but it also introduces the risk of non-payment. To mitigate this risk, trade credit insurance can be an invaluable solution for suppliers, helping to protect against the potential financial fallout from unpaid invoices.
In this article, we’ll explain what trade credit insurance is, how it works, and why it’s crucial for managing business risks.
1. What Does Trade Credit Insurance Cover?
Trade credit insurance is more than just an insurance policy—it’s a comprehensive solution designed to help businesses manage their accounts receivable. It is built on three main pillars:
- Prevention and Client Information: Insurers provide access to up-to-date commercial information about clients, helping you assess their financial situation and adjust your credit terms accordingly.
- Protection: The insurance covers certain events that may affect a customer’s ability to pay invoices, such as insolvency or protracted defaults.
- Debt Collection: If a customer fails to pay, the insurer will leverage its market knowledge and resources to assist in collecting the debt.
These three components work together to provide an effective risk management tool, safeguarding your business from the negative effects of non-payment.
2. What Events Are Covered by Trade Credit Insurance?
Trade credit insurance typically covers the following events:
- Protracted Default: If a customer fails to pay all or part of an undisputed invoice, the insurer provides coverage after a waiting period, which is typically 90 to 120 days.
- Insolvency or Bankruptcy: If a customer goes bankrupt or insolvent, the policy will cover losses as specified in the insurance terms.
- Political Risk: In some cases, political instability in the customer’s home country could prevent them from meeting financial obligations. This type of coverage is typically included on a case-by-case basis or through a separate policy.
While the first two events are generally covered, political risks may require additional negotiation or coverage.
3. How Does Trade Credit Insurance Work?
Trade credit insurance can cover either a single transaction or the total annual turnover of your business. When covering yearly turnover, the process works as follows:
- Initial Assessment: The insurance company will require details about your client portfolio, including credit limits, account receivables, and any past incidents. They’ll assess the risk profile of your portfolio to determine the coverage terms.
- Setting Limits: The insurer will establish two types of insured limits:
- Discretionary Limit: A small amount (typically between USD 5,000 and USD 10,000) to cover your entire client portfolio.
- Individual Client Limits: Specific credit limits for each client based on their risk profile. Note that these limits can change during the policy period.
The insured period usually extends up to 120 days from the invoice date, and in the case of an unpaid invoice, the insurer generally covers up to 90% of the insured amount.
4. What Does Trade Credit Insurance Cost?
The cost of trade credit insurance depends on several factors, including the industry, annual turnover, maximum payment terms, and any history of losses. While rates can vary, they typically range from 0.1% to 0.5% of the insured amount.
5. Who Are the Key Players in Trade Credit Insurance?
The leading providers of trade credit insurance are Euler Hermes, Atradius, and COFACE. These companies operate in Asia and, while they are becoming more selective in the current uncertain market, they continue to offer new policies.
6. What Are the Key Benefits of Trade Credit Insurance?
There are numerous advantages to purchasing trade credit insurance:
- Protection of Accounts Receivable: It helps safeguard your business from non-payment and protects your revenue stream.
- Increased Sales: With the security of trade credit insurance, you can offer more flexible payment terms to your clients, potentially increasing sales.
- Access to Commercial Information: Insurance providers give you valuable insights into your clients’ financial health, helping you make more informed decisions.
- Debt Collection Support: If a debt goes unpaid, the insurer’s expertise in collections can help recover the money owed.
Overall, the right trade credit insurance policy can significantly reduce the risks and exposures your business faces in global trade.
Conclusion
Trade credit insurance is an essential tool for businesses looking to expand while managing the risks associated with extending credit. By providing protection, access to valuable market data, and support in debt recovery, it helps businesses safeguard their cash flow and grow with confidence.
