In today’s business climate, organizations are expected to extend credit to their customers, as it enhances purchasing power and creates opportunities that may not have been available otherwise. However, offering credit is a balancing act for most businesses, as just one late payment or customer insolvency can put stress on an organization’s cash flow and profitability.
Thankfully businesses can protect themselves using trade credit insurance. Trade credit insurance—also known as credit insurance or export credit insurance—is a form of insurance that transfers risk for businesses seeking to protect their accounts receivable against nonpayment.
To better understand the coverage and its uses, it’s important to review some frequently asked questions (FAQs) regarding trade credit insurance.
What is insured?
Trade credit insurance is designed to protect businesses against the risk of nonpayment of goods or services by their buyers—whether it be for a domestic or international sale. In essence, policies protect against nonpayment as a result of insolvency of the buyer or nonpayment after an agreed number of months after the due date.
The following risks can be insured under trade credit insurance:
- Nonpayment or late payment
- Customer bankruptcy, insolvency or similar legal status
- Nonpayment following an event outside the control of the buyer or seller
It should be noted that insured risks must have a direct link with the delivery of goods or services, otherwise they are not insurable.
What is the goal of trade credit insurance?
For insurers, the goal of a trade credit insurance policy is not only to indemnify losses as they arise, but also help businesses prevent foreseeable losses from occurring in the first place. To meet this goal, insurers provide businesses with services to help strengthen their credit management practices.
Most trade credit insurers offer their policyholders some or all of the following services:
- Proactive monitoring of a business’s customers to ensure their continued creditworthiness
- Up-to-date country reports that detail the potential risks for conducting business in foreign markets
- Manage outstanding receivables using complex financial solutions.
- Proactive debt collection procedures
Can I insure a buyer based in my own country?
Yes. A domestic credit insurance policy will address any payment risks created by local buyers. Such policies typically have low premium rates and a relatively simple structure.
What is political risk?
Political risk often refers to things like war, terrorism, riots or actions by local governments (e.g., changing import or export regulations suddenly). In relation to trade credit insurance, political risk is an event or situation that is outside you or your buyer’s control and obstructs the payment or delivery of goods.
Typically, trade credit insurers that protect against export risks will also offer political risk cover.
Can a business choose the accounts it insures under a trade credit insurance policy?
Yes. A business can choose from several types of trade credit policies. Trade credit insurance policies can be structured to cover specific losses without having to include every receivable the company has. Alternatively, organizations can opt for policies with high thresholds or retentions if they are only concerned about large losses.
The following are three types of trade credit insurance policies:
- Whole turnover policy: A whole turnover trade credit insurance policy includes all buyers and insures against nonpayment. Typically the only decision a business has to make is whether to insure all domestic sales, all export sales or both.
- Key account policy: This type of trade credit insurance is designed for businesses that want to insure key accounts, but not their entire book of business.
- Single buyer policy: Provides a business insurance coverage for accounts receivable related to one of its clients. This type of policy is typically reserved for businesses that have a disproportionate amount of exposure through one large client.
You may also be able to seek coverage on a transaction by transaction basis, depending on the complexity of your contracts. This type of cover is particularly useful for companies that deal with only one buyer or have very few transactions.
Are trade credit insurance policies standard or tailor-made?
Trade credit insurance policies are drafted to suit specific needs. Standard policies do exist and can be particularly useful for small and medium-sized enterprises.
How do credit limits work and what is their value?
During the underwriting process, insurers analyze the financial stability of a business’s customers. Each of these customers are then assigned a credit limit, which is the amount the insurance company will indemnify if the customer fails to pay.
Unlike other forms of insurance, these coverage limits can change during the policy period. The insurance company has the right to reduce or cancel a granted limit at any time, usually as a result of negative information. In other instances, a business can request additional coverage of specific buyers should the need arise.
How much does a trade credit insurance policy cost?
The cost of trade credit insurance can vary by insurer and the risks being covered. Customers can either choose between insuring a single transaction or every sale. Both of these options can have a vastly different impact on premium rates.
Typically, trade credit insurance is priced on standard actuarial techniques. It is sold mostly on a whole turnover basis, and premium rates are generally given as a percentage of the company’s turnover.
For many businesses, trade credit insurance is a vital piece of their insurance portfolio. Contact the Axis Insurance Group today and one of our experienced insurance professionals will work with your business to find the right trade credit coverage.