Trade credit insurance is also known as accounts receivable insurance or export credit insurance. It is a type of insurance that protects businesses against losses due to non-payment or late payments from their customers. It is designed to help businesses manage the risk of offering their goods and services on credit to their customers, and to protect their cash flow.
Trade credit insurance works by providing coverage for accounts receivable, which is the amount of money owed to a business by its customers. Therefore if a customer fails to pay an invoice or becomes insolvent, the business can file a claim and the trade credit insurance policy will pay a percentage of the amount owed to the business, typically between 75% and 90% depending on the policy limit.
Key benefits of trade credit insurance
- Protection against bad debts: Trade credit insurance helps protect businesses against the risk of late payment or non-payment of customers due to customer insolvency.
- Enhanced cash flow: By protecting against non-payment, trade credit insurance can help improve a business’s cash flow, allowing it to reinvest in its operations or expand its business.
- Improved credit management: Trade credit insurance providers often provide credit management tools and advice to help businesses mitigate risks and avoid non-payment by providing assistance with credit checks, credit monitoring, and other risk management services
- Increased confidence in the marketplace: Having trade credit insurance can help businesses demonstrate their financial stability and creditworthiness to customers and suppliers.
- Improved access to financing: Some lenders may require trade credit insurance as a condition of financing, as it can help reduce the risk of non-payment and improve the lender’s collateral position.
Potential disadvantages of trade credit insurance
- Cost: Trade credit insurance can be expensive, particularly for businesses with a high risk of non-payment. It could be unaffordable for small businesses and or start-ups.
- Policy limitations: Trade credit insurance policies may often have limitations/restrictions on certain types of customers or products, which mean the policy, will not cover some losses and this could affect the company. These restrictions would however be contained in the policy document.
- Claims process: Filing a claim with a trade credit insurer can be a complex and time-consuming process, the insurer could also dispute the claim in some cases, which can cause delays in receiving payment and adversely affect the business.
- False sense of security: Having trade credit insurance may occasionally cause some businesses to become relaxed/complacent about credit management and risk assessment, which can lead to increased exposure to bad debts. Some businesses may also be more likely to extend credit to high-risk customers if they feel they are protected by insurance, which can increase the overall risk to the business.
- Reputation risk: Some businesses may be concerned that purchasing trade credit insurance could harm their reputation, as it may be seen as an indication that they are concerned about their ability to collect payments from customers.
Types of trade credit insurance policies
Some of the most common types of trade credit insurance include:
- Whole turnover policy: This type of policy covers all of a business’s sales on credit terms for a specific period of time, such as a year, providing protection against the risk of non-payment or late payment by customers. It provides comprehensive coverage typically ranging from 70% to 90% of the amount owed.
- Key account policy: This policy is designed to protect a business’s most important customers against the risk of non-payment or late payment. It provides coverage against the risk of non-payment by these key customers, which can help protect the business’s cash flow.
- Single buyer policy: This policy provides coverage for a specific customer or buyer, providing protection against the risk of non-payment or late payment by that customer. It covers a specific transaction or series of transactions with a single customer.
- Top-up policy: This policy is designed to provide additional coverage above the existing credit limits set by a business’s credit insurers, helping to protect against the risk of non-payment or late payment by customers. It is designed to provide additional coverage for high-risk customers or to cover specific transactions that are not covered by the main policy.
- Excess of loss policy: This policy provides coverage for losses that exceed a certain threshold, helping to protect businesses against the risk of catastrophic losses due to non-payment or late payment by customers. Excess of Loss Policy: The policy typically covers a percentage of the business’s annual turnover.
- Export credit insurance: This type of policy is designed to protect businesses that export goods or services against the risk of non-payment or late payment by foreign customers.
Criteria for trade credit insurance application
The following factors could be considered by different insurers before accepting a customer for trade credit insurance:
- Creditworthiness of customers: Insurers will always evaluate the creditworthiness of a business’s customers based on existing data before issuing a policy. This includes reviewing the customer’s payment history, financial stability, and other relevant factors.
- Industry sector: The industry sector in which a business operates can also be a factor in determining eligibility for trade credit insurance. Some business sectors are often considered to be of higher risk than others, which could impact the availability and cost of coverage.
- Financial stability of the insured business: Insurers may also evaluate the financial stability of the business applying for coverage, including factors such as its credit history, cash flow, and financial performance
- Sales volume: The volume of sales made by a business can also be a factor in determining eligibility for trade credit insurance. Insurers will consider the number of customers the business has, the size of individual transactions, and the overall volume of sales made by the business over a period of time.
- Trade terms: The terms and conditions under which a business sells its goods or services on credit can also be a factor in determining eligibility for trade credit insurance. Insurers may consider factors such as the length of the credit period, the payment terms, and the collateral requirements.
- Coverage requirements: Businesses may have specific requirements for the coverage they need, such as a particular policy type or coverage limit. Insurers will evaluate these requirements and determine whether they are feasible and cost-effective.
Cost of trade credit insurance
The average cost of trade credit insurance is usually a percentage of the insured amount, typically ranging from 0.1% or 0.25% to 1% or more of the total insured amount. The cost can vary widely depending on a number of factors, including the following:
- Size and nature of the business: Businesses operating in high-risk industries may be subject to higher premiums than those operating in lower-risk sectors.
- Customer base: The creditworthiness of a business’s customers is a major factor in determining the cost of trade credit insurance. If a business has a high percentage of high-risk customers, it may be subject to higher premiums.
- Policy type: The cost of different types of trade credit insurance policies can vary depending on the level of coverage provided. For example, a whole turnover policy that covers all sales may be more expensive than a policy that covers only specific customers or transactions.
- Coverage limits: The coverage limit of a trade credit insurance policy can also impact the cost. The higher the coverage limit, the more expensive the policy is likely to be.
- Deductibles: Some trade credit insurance policies require the insured business to pay a deductible before coverage kicks in. The size of the deductible can impact the cost of the policy.