Guide to Trade Credit Insurer & Insurance: Definition, Benefits & How It Works

Trade credit insurance coverage protects businesses from overdue payment and 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 debtor insurance can be a smart investment for many companies, it may not be the best choice 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 can be a major competitive advantage.

Additionally, trade credit insurance is a pivotal tool for credit risk mitigation. As businesses navigate the complexities of global trade, ensuring that their interests are safeguarded against possible defaults is paramount. Through trade credit insurance, companies fortify their defense against unexpected insolvencies, offering an extra layer of security in their commercial engagements.

It is also important to know what trade credit insurance is not. Trade credit insurance is not a substitute for prudent, thoughtful credit management. Sound credit management practices should be the foundation of any trade credit insurance policy and partnership. Trade 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

While trade credit is a powerful commercial tool for conquering new markets and building customer loyalty, it is also a double-edged sword that can weigh on your working capital and cash flow. As part of your cash flow management strategy, trade credit insurance can help you control this credit risk.

One of the paramount benefits of trade credit insurance is the business liquidity assurance it provides. In scenarios where debt repayment gets delayed or defaults occur, maintaining operational fluidity can become challenging for businesses. However, with trade credit insurance, businesses have the assurance that their liquidity won't be severely impacted, thereby enabling smoother operations and facilitating consistent growth trajectories.

With trade credit insurance, you can ensure that you are compensated quickly in the event of a bad debt. Consequently, your working capital ratio improves and uncertainty regarding your cash inflows falls off dramatically.

Trade credit insurance also:

• Allows you to substantially improve your DSO (Day Sales Outstanding), which is the average number of days it takes to recover a payment after a sale is made. 
• Guarantees your ability to manage your operations and investments efficiently in the short and medium term and to secure your growth. 
• Offers peace of mind to your finance partners, reassuring your bankers or shareholders about the financial stability of your company and giving them a greater inclination to guarantee your financing. 
• Protects and accelerates your commercial development while controlling the risks that trade credit poses to your cash flow, giving you the advantage of an efficient and resilient trade credit strategy.

Companies invest in trade credit insurance (accounts receivable insurance) for a variety of reasons, including:

• Sales expansion – If receivables are insured by credit insurer, 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 – This insurance protects against unique and delivers market knowledge to help you make more informed 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, trade 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 will require trade credit insurance to qualify for an asset-based loan.

Trade credit insurance protects businesses from non-payment of commercial debt. It covers your business-to-business accounts receivable. If you do not receive what you are owed due to a buyer’s bankruptcy, insolvency or other issue, or if payment is very late, a trade credit insurance policy will pay out a percentage of the outstanding debt. This helps you protect your capital, maintain your cash flow and secure your earnings while extending your competitive credit terms and helping you access more attractive financing.

With trade credit insurance, you can reliably manage the commercial and political risks of trade that are beyond your control. Trade credit insurance can help you feel secure in extending more credit to current customers or pursuing new, larger customers that would have otherwise seemed too risky.

There are four types of trade credit insurance, as described below. The cost of your policy will vary depending on the type of coverage you choose, your industry, your annual revenue that needs to be insured, your history of bad debts, your current internal credit procedures and your customers’ creditworthiness, among other factors.

• Whole Turnover – This type of trade credit insurance protects against non-payment of commercial debt from all customers. You can choose if this coverage applies to all domestic sales, international sales or both. 
• Key Accounts – With this type of insurance, you choose to insure your largest customers whose non-payment would pose the greatest risk to your business. 
• Single Buyer – If most of your transactions are with one customer, you can choose a trade credit insurance policy that insures against potential default from just that customer. 
• Transactional – This form of trade credit insurance protects against non-payment on a transaction-by-transaction basis and is best for companies with few sales or only one customer.
  
  Trade credit insurance goes beyond merely covering transactions; it offers robust accounts receivable protection. This means that, in the unpredictable world of business, where various factors might affect a client's ability to pay, companies can confidently operate knowing their accounts receivable – a significant asset on their balance sheet – is shielded against unforeseen adversities.

A strong trade credit insurance remains the most reliable way to deal with trade credit risk and avoid cash flow issues. It protects and accelerates your commercial development while controlling the risks that trade credit poses to your cash flow.

With trade credit insurance, you ensure that you are compensated quickly in the event of a bad debt, so your working capital ratio improves, uncertainty regarding your cash inflows is greatly reduced, and your bankers or shareholders can be reassured about the financial stability of your company.

Getting Started with a Trade Credit Insurance Policy Onset

At the onset of the trade 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.

While you trade with your existing customers, the credit risk is covered up to the limit. Thanks to its internal resources and experts, the credit insurer can inform you about the solvency of your customers to help you identify potential bad payers and makes adjustments to credit limits when economic conditions change.

Comparing Trade Credit Insurance to Alternatives

Self-insurance, an alternative to trade credit insurance, means a business puts a reserve on its balance sheet that covers any potential bad debt for the fiscal year. It is typically not the most effective solution, because instead of investing excess capital into growth opportunities, a business must put it on hold in case of bad debt.

A letter of credit is another alternative, but it only provides debt protection for one customer and only covers international trade.

Another option, factoring insurance for receivables, is an agreement with a third-party company to purchase accounts receivables at a reduced amount of the face value of the invoices. The factor provides a cash advance ranging from 70% to 90% of the invoice’s value. When the invoice is collected, the factor returns the balance of the invoice minus their fee. These costs may range from 1% to 10%, based upon a variety of components.

Some factoring services will assume the risk of non-payment of the invoices they purchase, while others do not. AR factoring can be a good idea if your company is having cash flow problems and needs to collect on receivables quickly. However, while receivables factoring can be beneficial in the short-term, you will have to pay fees ranging from 1% to 5% for the service, even if the receivable is paid in full within 60-90 days. The longer the receivable remains unpaid, the higher the fees. Payment guarantees aren’t always available, and if they are, they can double factoring fees to as high as 10%.

When you need funding but want non-payment security, you may work with your bank or factor and use credit insurance as well. The bank or factor will provide the funding and the credit insurance policy will protect the invoices. In this case, when a funded invoice goes unpaid, the claim payment will go to the funder.

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’ (you) buyers (your customers) 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 credit insurer will investigate the risk of increasing the coverage and will either approve the additional coverage, or maintain current coverage with a detailed explanation. Similarly, policyholders may request coverage on a new buyer with which they’d like to do business.

When signs indicate a company is experiencing financial difficulty, the credit 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 credit insurer would pay the policyholder the claim benefit, typically within 60 days from the date of loss on domestic claims.

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 credit insurer and the trade 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 also to provide businesses with the support and knowledge they need to avoid foreseeable losses from the start.

Having the right information to make informed credit decisions means you can avoid or minimize losses. Allianz Trade careful analysis of this information allows companies to determine how much credit they can safely and reasonably extend to their customers. More importantly, it enables companies to avoid losses and profitably grow their business through the close monitoring of their customers.

Navigating the complexities of trade credit risks? Let Allianz Trade guide you. With our tailored trade credit insurance solutions, ensure your business's liquidity, protect your accounts receivable, and grow confidently.