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The Business Owners Guide to Trade Credit Insurance

A remarkable 14.52% of world trade in 2020 was protected by credit insurance, also known as trade credit insurance. This demonstrates the vital role that trade credit insurance plays in facilitating business-to-business sales.

For companies that sell products or services to other businesses, there are different types of business insurance to consider. But trade credit insurance is an essential tool that protects against losses from non-payment by customers who are insolvent or default on their debts.

But what is trade credit insurance? Keep reading for answers on this and more.

What Is Trade Credit Insurance?

Trade credit insurance is a policy that protects companies against losses from non-payment for goods or services by business customers. It covers both domestic sales within a country and export sales to overseas buyers.

Trade credit insurance allows businesses to safely extend credit terms to customers. This helps attract new business and increase sales. It serves as an alternative to letters of credit or prepayment from customers.

With trade credit insurance, the risk of a customer defaulting on payment is transferred to an insurance company. The insurance provider will pay claims on losses from insolvency, protracted default, or other covered causes.

Companies pay a monthly premium to the trade credit insurer based on a percentage of their gross monthly sales. The premium percentage rate can range from 0.05% to 0.6%, with 0.2% being a typical rate. While there is an upfront cost, the increased sales and revenues generated by offering credit terms will generally offset the premiums.

A key service provided is that the insurance underwriter will assess each of the policyholder's customers and set an approved credit limit on each. This represents the maximum amount of coverage for that buyer. The underwriter will monitor and adjust the limits on an ongoing basis as needed.

Some key terms used in trade credit insurance are:

  • Credit limit: The maximum amount that the insurer will pay if the buyer defaults on payment.
  • Premium: The fee that the seller pays to the insurer, usually based on a percentage of their monthly sales.
  • Deductible: The amount that the seller will bear in case of a loss before the insurer pays the rest.
  • Discretionary limit: The amount that the seller can approve for a buyer without consulting the insurer, within certain conditions.
  • Indemnity: The percentage of the loss that the insurer will cover, after deducting the deductible.

Benefits of Trade Credit Insurance for Business Owners

Trade credit insurance is an important tool for managing risk for any business owner. From improving cash flow to protecting against default, below are some key advantages to consider.

Helps Maintain and Improve Cashflow

Trade credit insurance allows businesses to receive up to 90% of the invoice value in case of nonpayment by a buyer. This improves the cash flow and liquidity of the business and reduces the bad debt expense

Extend Credit to Win Sales

With commercial credit insurance, businesses can extend credit to their customers. Providing net 30, net 60, or other payment term options makes the company more attractive to buyers.

This allows a business to win more sales while building customer loyalty. It also provides the ability to negotiate better terms without taking on excessive risk.

Free Up Capital to Invest and Grow

Trade credit insurance reduces the need for maintaining large reserves to cover bad debts or write off unpaid invoices. This frees up working capital that would otherwise be sitting idle.

You can use these funds to invest in new growth opportunities. These include new equipment, expanding facilities, developing new products, hiring more staff, and more.

Mitigate the Risk of Buyer Default

Trade credit insurance is one of the most effective forms of business protection. This is especially true when it comes to avoiding losing money when the buyer defaults. It can happen for several reasons, including political instability, fraud, bankruptcy, and more.

Leverage Expert Risk Analysis

A key benefit of trade credit insurance is that expert underwriters thoroughly assess each of your buyers. They will evaluate the financial health and creditworthiness of every customer. This can help businesses make informed decisions about credit limits and terms to offer customers.

Fuel Growth by Entering New Markets

By protecting against non-payment by buyers, trade credit insurance allows companies to enter new markets. This is because it protects against buyer non-payment. The improved financial security makes it easy to expand into new regions and tap into a diverse customer base.; the result is increased revenue.

Access Credit Intelligence on Global Buyers

Trade credit insurance gives businesses insider credit information and analysis on foreign buyers. This can prove valuable for boosting export sales. It allows for a better assessment of risks and opportunities in overseas markets.

Avoid Slow Payment Hassles

Trade credit insurance eliminates the need for your overseas customers to get letters of credit from their banks. It also means you don't have to require prepayment or cash-in-advance from buyers. As a result, international transactions can flow more smoothly and efficiently.

Avoid Risks of Early Payment Discounts

Early payment discounts to customers often erode profit margins. Businesses can get rid of these discounts altogether and reduce risk by insuring receivables. This also helps retain accounts that would otherwise be lost to competitors with better terms.

Boost Borrowing Capacity

For many companies, receivables are the largest and most liquid asset. Insuring them increases the lenders' confidence in extending credit. This makes it easier to access larger loans with better interest rates and terms.

Refocus on Growth and Not Collections

Insuring receivables means the staff wastes less time on monitoring payments and collecting from delinquent customers. You can refocus those resources on operations that add value. These include any tasks that drive growth and strategic objectives.

Types of Trade Credit Insurance

There are several types of trade credit insurance policies to suit different needs. Understanding them can help businesses make informed decisions to safeguard their financial stability. The most common options include:

Whole Turnover Policy

This covers all buyers that meet the underwriter's criteria with a blanket limit up to the policy maximum. It provides flexibility and eases administration. This is the most comprehensive and convenient policy option.

This policy can apply to domestic and/or international sales, depending on the needs of the business. It's especially useful for businesses that engage in wholesale or international trade. If any of their customers default or pay late, the business could face serious financial difficulties.

A whole turnover policy can provide a percentage of coverage for the entire balance sheet, up to a certain credit limit set by the policy. The credit limit and the percentage of coverage are based on various factors. These include the size, track record, and location of the customers, as well as political events and risks.

The premium for a whole turnover policy is also influenced by these factors, as well as by the amount and frequency of invoices. The higher the percentage of accounts receivables, the higher the premium will be.

Partial Turnover Policy

As the name suggests, this policy covers only a portion of the insured's sales turnover. It's suitable for businesses that have a diversified customer base and want to protect themselves from the risk of non-payment by some of their buyers.

The policy allows the insured to select which buyers to cover based on various criteria. These include their creditworthiness, payment history, and more. The policy also provides flexibility in terms of coverage percentage, deductible, and premium rate.

The partial turnover policy offers several benefits, the main one being lower premium costs. It also reduces the administrative burden and enhances the management of cash flow.

Single-Buyer Coverage

Single-buyer coverage protects against losses from one identified high-risk or essential buyer. This policy insures an individual customer who poses a concern. It allows you to cover customers who represent a large revenue share.

This type of policy is commonly used when dealing with a new buyer. It's also ideal for a customer who has uncertain finances or past payment issues. It reduces the risk of a problematic account requiring special attention.

The key benefit of single-buyer policies is reducing default risk. It also helps manage bad debt, improve terms of supply, streamline collections, and increase access to capital.

Top-Up Policy

This policy provides additional coverage above what is included in a standard trade credit insurance policy. They fill gaps where a business needs more protection. For example, a company may use this cover to increase limits on certain buyers beyond what the main insurer approves.

Top-up policies can also extend terms, allowing coverage on longer repayment terms over 360 days. They are often issued by specialized insurers, such as a surety association and credit re-insurer.

The premiums, coverage ratios, and claims processes align between the top-up and primary insurer. The policy allows companies to tailor protection to their unique needs and risks. It gives you peace of mind that sufficient limits or terms are in place.

If still unsure, we recommend a consultation with a trade credit broker near you

When to Consider Trade Credit Insurance

Trade credit insurance can be a useful risk management tool for companies that sell products or services on credit terms. Here are some key situations when securing it may be advisable.

Managing Accounts Receivable Risk

Businesses with many receivables and a few major customers can benefit from trade credit insurance. It covers a percentage of unpaid invoices. This can go a long way toward protecting against loss if those customers default.

Entering New Markets

Expanding to a new market? An international credit insurance cover may be just what you need to protect your business. It covers you as you build relationships and establish credibility in new markets.

Experiencing Business Growth

Rapid growth can strain a business's finances and increase risks. Trade credit insurance allows you to take on new customers without taking on full risk. It enables growth while mitigating risk.

Dealing With Increased Expenses

During times of inflation or higher input costs, trade credit insurance helps ensure you get paid for sales you have already made and cover increased expenses. It protects your bottom line.

Handling Economic Volatility

Trade credit insurance is worth considering if facing uncertain economic times. It can protect you if customers default or declare bankruptcy. Moreover, it provides stability, making it easier to weather bad times.

The Costs of Trade Credit Insurance

There are several costs associated with this type of business insurance. Companies must weigh them against the value of covering credit losses. 
Some of the common costs to consider include:

Insurance Premiums

Premiums are a key cost that comes with trade credit insurance policies. They are based on the insured company's risk profile. This is influenced by factors like the company's industry, number of customers, past losses, desired coverage limit, and more.

Generally, companies that are deemed a higher risk by the insurer will pay more in premiums for the same coverage. On the other hand, companies with lower risk will pay less for their policies. Overall, premiums represent a significant cost of maintaining trade credit insurance.

Retained Risk from Deductibles and Policy Limits

Deductibles require that the insured company pay a set amount out-of-pocket for each claim upfront. Lower policy limits mean the insurer will cover a smaller percentage of losses beyond a certain dollar amount.

Both deductibles and lower policy limits leave the insured company with retained risk. They also result in greater costs in the event of a significant credit loss.

Administrative Costs

Filing claims and providing information to the insurer creates administrative work for the finance staff. More claims lead to higher administrative costs. In addition, staff time is needed to properly manage the policy.

The burden of this work can be significant, driving up the cost of maintaining the policy.

Protect Your Business With Trade Credit Insurance

This post answers the question "What is trade credit insurance?" by covering its benefits, costs, and when to use it. If you want to learn more about what trade credit insurance entails, the expert brokers at Ari Global can help.

We'll also provide competitive quotes to find you the right custom policy for your business needs and budget. Reach out today to connect with our brokers and protect your business