A Guide to Trade Credit Insurance
Credit insurance coverage protects businesses from non-payment of commercial debt. It makes sure invoices will be paid and allows companies to reliably manage the commercial and political risks of trade that are beyond their control. It ensures that:
- Capital is protected
- Cash flows are maintained
- Loan servicing and repayments are enhanced
- Earnings are secure
While commercial credit insurance can be a smart investment for many companies, it may not be applicable to companies that sell exclusively to governments or retailers since trade credit insurance only covers business-to-business accounts receivable.
A trade credit insurance policy allows companies to feel secure in extending more credit to current customers, or to pursue new, larger customers that would have otherwise seemed too risky. The protection it provides allows a company to increase sales to grow their business with existing customers. Insured companies can sell on open account terms where they may have previously been restrictive or only sold on a secured basis. For exporters, this especially can be a major competitive advantage.
As important as it is to know what trade credit insurance is, it is equally important to know what it is not. Credit insurance is not a substitute for prudent, thoughtful credit management. Sound credit management practices should be the foundation of any credit insurance policy and partnership. Credit insurance goes beyond indemnification and does not replace a company’s credit practices, but rather supplements and enhances the job of a credit professional.
Benefits of Trade Credit Insurance Coverage
Companies invest in trade credit insurance for a variety of reasons, including:
Sales expansion – If receivables are insured, a company can safely sell more to existing customers, or go after new customers that may have been perceived as too risky.
Expansion into new international markets – Protection against unique export risks and market knowledge to make accurate growth decisions.
Better financing terms – Banks will typically lend more capital against insured receivables and may also reduce the cost of funds.
Reduction in bad-debt reserves – Insuring receivables frees up capital for the company. Also, credit insurance premiums are tax deductible, but bad debt reserves are not.
Actionable economic knowledge – The trade credit insurer’s information database and technology platform help reduce operational and informational cost.
Protection against non-payment and catastrophic loss – Should an unforeseeable event catch a company and its insurance carrier without warning, the bill gets paid via the claims process.
Increase in sales and profits – A credit insurance policy can typically offset its own cost many times over, even if the policyholder never makes a claim, by increasing a company’s sales and profits without additional risk.
Improved lender relationship – Trade credit insurance can improve a company’s relationship with their lender. In many cases the bank actually requires trade credit insurance to qualify for an asset-based loan.
How Does Trade Credit Insurance Work?
Trade Credit Insurance Policy Onset
At the onset of the credit insurance policy, the carrier will analyze the creditworthiness and financial stability of the policyholder’s insurable customers and assign them a specific credit limit, which is the amount they will indemnify if that insured customer fails to pay.
Unlike other types of business insurance, once a company purchases trade credit insurance coverage, the policy does not get filed away until next year’s renewal − the relationship becomes dynamic.
Trade Credit Insurance Policy Coverage
A trade credit insurance policy is constantly updated and cross referenced over the course of the policy period.
It is the credit insurer’s responsibility to proactively monitor its customers’ buyers throughout the year to ensure their continued creditworthiness. They do this by gathering information about buyers from a variety of sources, including:
- Visits to the buyer
- Public records
- Information supplied by other policyholders that sell to the same buyer
- Receipt of financial statements
Throughout the life of the policy, the policyholder may request additional coverage on a specific buyer should that need arise. The insurer will investigate the risk of increasing the coverage and will either approve the additional coverage, or maintain with a detailed explanation. Similarly, policyholders may request coverage on a new buyer with which they’d like to do business.
Trade Credit Insurance Policy Claims
When signs indicate a company is experiencing financial difficulty, the insurer notifies all policyholders that sell to that buyer of the increased risk and establishes an action plan to mitigate and avoid loss.
If an unforeseeable loss should occur, policyholders would file a claim with supporting documentation, and the insurer would pay the policyholder the claim benefit, typically within 60 days from the date of loss on domestic claims.
The Goal of Trade Credit Insurance
Ultimately, should an unexpected loss occur, the trade credit insurance policy provides indemnification, thus protecting the policyholder’s revenue and bottom line. By maintaining a strong relationship between the insurer and the credit management department, trade credit insurance may be the wisest investment a company can make to ensure its profits, cash flow, and capital are protected.
The ultimate goal of credit insurance is not simply to indemnify losses incurred from a default, but provide businesses with the support and knowledge they need to avoid foreseeable losses from the start.
Investing in Trade Credit Insurance with Euler Hermes
The key is having the right information to make informed credit decisions and therefore avoid or minimize losses. Euler Hermes’ careful analysis of this information allows companies to make more informed decisions about how much credit to extend to their customers. More importantly, it enables companies to avoid losses and profitably grow their business through the close monitoring of their customers.