Everything Businesses Need to Know About Trade Credit Insurance

Trade credit insurance is a critical financial tool for businesses looking to protect themselves from the risk of non-payment by their buyers. By offering coverage for unpaid invoices, it ensures businesses maintain steady cash flow and financial health, even when unforeseen challenges arise. This comprehensive guide explores trade credit insurance in detail, its benefits, risks it covers, policy types, working mechanism, and more.

What is Trade Credit Insurance?

Trade credit insurance is a specialized policy designed to safeguard businesses against the risk of unpaid commercial debts. In essence, it acts as a safety net, ensuring that a business gets reimbursed (usually between 75%-95% of the invoice value) if a buyer fails to pay within the agreed credit period.

Why Non-Payment Occurs:

Non-payment may arise due to several reasons:

• Buyer-related reasons: Bankruptcy, insolvency, delays, or defaults.
• External factors: Geopolitical events like wars, natural disasters, or currency shortages.
• For businesses, such events can lead to cash flow interruptions, affecting their operations and growth. By adopting trade credit insurance, firms can ensure financial stability and secure their revenue streams.

Also Known As:

Trade credit insurance is often referred to by other names, such as:

• Export Credit Insurance
• Accounts Receivable Insurance
• Debtor Insurance

Global Market Insights:

As of 2021, the global trade credit insurance market was valued at $10.9 billion and is projected to reach $18.1 billion by 2027, growing at a CAGR of 9.12%. In India, the sector recorded a premium income of ₹1,395.25 crore during FY 2020-21.

Types of Risks Covered by Trade Credit Insurance

Commercial Risks:

These arise due to financial issues faced by the buyer. Common scenarios include:

• Bankruptcy: The buyer’s inability to pay due to liquidation.
• Insolvency: A financial state where liabilities exceed assets.
• Protracted Default: Persistent delays in payments beyond the agreed period.

Political Risks:

These risks are caused by external, uncontrollable events, often in international trade. Examples include:

• Geopolitical Issues: Wars, terrorism, riots.
• Government Actions: Import-export bans, license cancellations, or currency shortages.
• Natural Disasters: Events like floods or earthquakes that disrupt trade.

Political risk coverage is particularly valuable for businesses dealing with international buyers.

Types of Trade Credit Insurance Policies

Trade credit insurance policies are tailored to meet the diverse needs of businesses, ensuring flexibility in coverage. Here are the primary types of trade credit insurance policies:

Whole Turnover Policy:

This policy covers the entire portfolio of a company’s buyers, whether domestic, international, or both. It provides blanket coverage for all credit sales, making it ideal for businesses that trade extensively across multiple markets. By insuring all buyers, it reduces administrative effort and provides comprehensive risk protection.

Key Buyers Policy:

Designed for businesses that rely heavily on a few major customers, this policy covers only the most significant buyers. It minimizes exposure to the financial instability of these key clients, ensuring the business can sustain its operations even if a significant buyer defaults.

Single Buyer Policy:

This policy is tailored for businesses dealing with only one customer or undertaking a significant transaction with a particular buyer. It provides focused protection and is often used for large or high-value deals with a single client.

Transactional Policy:

Coverage is provided on a per-transaction basis. This is suitable for businesses that have irregular sales or deal with occasional customers. It allows flexibility by insuring specific deals rather than ongoing credit relationships.

How Does Trade Credit Insurance Work?

Trade credit insurance operates as a safeguard, protecting businesses from the risk of non-payment by buyers. Its structured approach ensures businesses can continue operations smoothly, even in the face of unforeseen payment defaults. Here’s a detailed breakdown of how it works:

Assessment of Buyer Creditworthiness and Risk Profile:

Once a business applies for trade credit insurance, the insurer evaluates the creditworthiness and risk profile of the buyer. This involves analyzing the buyer’s financial stability, transaction history, and market reputation. Data is gathered from sources like financial statements, public records, and even physical inspections. This assessment ensures the insurer has a clear understanding of the buyer’s reliability.

Establishing a Credit Limit:

Based on the evaluation, the insurer sets a credit limit for each buyer under the policy. This limit represents the maximum amount the insurer will reimburse in case of non-payment. Businesses are advised to extend credit only within this limit, as any amount beyond it won’t be covered.

Adjustments to Credit Limits:

During the policy term, businesses may request adjustments to credit limits for existing buyers or add new customers to the policy. The insurer re-evaluates the associated risks and decides whether to approve or deny the request based on their analysis.

Filing Claims for Non-Payment:

In case of buyer default, the policyholder informs the insurer and submits necessary documents. The insurer investigates the claim, verifying its validity. If approved, the insured receives compensation, typically 75%-95% of the outstanding amount.

Trade credit insurance ensures businesses maintain steady cash flow and remain resilient, even in challenging economic or geopolitical scenarios. It serves as a vital tool to promote confidence in expanding trade relationships.

Claims Procedure Explained

Documents Required:

• Completed claim form.
• Identity proof.
• FIR report (if applicable).
• Financial books for inspection.
• Bank account details.

Timeline:

• Typically, claims are settled within 30 days. However, disputes or legal complications can extend this period.

Exclusions:

Claims are denied if:

• Filed after the maximum reporting period.
• Essential information is omitted.
• Non-payment results from trade disputes or excluded risks.

Eligibility Criteria for Trade Credit Insurance

Trade credit insurance is suitable for:

• Businesses selling goods or services on credit.
• Small, medium, and large enterprises.
• Domestic and international suppliers.

Note: It does not cover banks, financial institutions, or long-term receivables exceeding 12 months.

Pricing and Premium Calculation

Premiums are calculated as a percentage of the company’s turnover (typically below 0.5%). Factors influencing the premium include:

• Turnover size.
• Risk profile of buyers.
• Industry type.
• Credit terms.
• Additional coverage and buyer locations.

Benefits of Trade Credit Insurance

Trade credit insurance offers a wide array of benefits that help businesses mitigate risks, maintain cash flow, and explore growth opportunities. Here’s a detailed look at its advantages:

Protection Against Bad Debts:

One of the primary benefits is safeguarding businesses from bad debts caused by buyer defaults. If a buyer fails to pay due to insolvency, bankruptcy, or prolonged delays, trade credit insurance compensates a significant portion (typically 75%-95%) of the outstanding amount, reducing financial losses.

Ensures Business Continuity:

With trade credit insurance, businesses can maintain a steady cash flow even when buyers fail to pay. This stability allows businesses to meet their operational expenses, pay employees, and invest in growth without disruptions.

Supports Sales Growth:

The coverage provides businesses the confidence to offer more credit to buyers and expand their customer base without fear of non-payment. Reports suggest that businesses with trade credit insurance can increase sales by up to 20%.

Facilitates Market Expansion:

The policy helps businesses enter new and riskier markets, including international ones, by providing protection against political and commercial risks.

Improves Access to Funding:

Insured accounts receivable are more reliable assets for lenders, enabling businesses to secure loans or credit at better terms. Banks often lend up to 80% more on insured receivables, enhancing financial flexibility.

Drawbacks of Trade Credit Insurance

• Cost of Premiums: The additional cost can strain businesses, especially smaller firms.
• Limited Coverage: It doesn’t cover all risks, such as trade disputes or product quality issues.
• Partial Reimbursement: Only 75%-85% of the receivable amount is covered, leaving businesses to bear part of the loss.

The Role of Trade Credit Insurance During COVID-19

The COVID-19 pandemic disrupted global trade, leading to increased demand for trade credit insurance. Many businesses relied on it to mitigate risks and secure cash flow when supply chains were disrupted, and bankruptcy rates soared. In India, the demand for trade credit insurance grew by 30% in 2021.

Frequently Asked Questions (FAQs)

Conclusion

Trade credit insurance is a vital tool for businesses seeking financial stability and growth. It protects against non-payment risks, improves access to funding, and supports expansion into new markets. By understanding its features, benefits, and limitations, businesses can make informed decisions and strengthen their financial resilience.

Also Read: Credit insurance: Why does it matter in International Trade and where can you get it?