Trade credit insurance protects manufacturers, traders and service providers against losses from non-payment of a commercial trade debt. If a buyer does not pay (often due to bankruptcy or insolvency) or pays very late, the trade credit insurance policy will pay out a percentage of the outstanding debt.
Accounts receivables typically represent more than 40% of a company’s assets, but one in 10 invoices become delinquent. Trade credit insurance can prevent bankruptcies, help companies manage credit, and even present opportunities for business expansion in the increasingly connected global marketplace.
What risks does trade credit insurance cover?
The primary function of trade credit insurance is to protect sellers against buyers that do not or cannot pay. It insures against a buyer that has declared bankruptcy, insolvency or a similar legal status, as well as protecting insureds against buyers who delay payments under a bankruptcy protection arrangement.
The International Credit Insurance & Surety Association explains: “If a buyer does not pay, the trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.
“Trade credit insurance policies are flexible and allow the policyholder to cover the entire portfolio or just the key accounts against corporate insolvency, bankruptcy and bad debts. The most common type of cover is so-called Whole Turnover Cover, which covers all buyers of the policyholder.”
What’s not covered by a trade credit insurance policy?
The risk being transferred has to connect directly to an underlying trade transaction. If no direct trade link exists, outstanding debts cannot be covered by a trade credit insurance policy.
What are the alternatives to trade credit insurance?
The main alternative to trade credit insurance is self-insurance, a practice particularly popular in the US where trade credit insurance take-up is lower than 5%. Businesses that choose to self-insure can put a reserve on their balance sheet to cover any bad debt that may incur over a financial year.
However, according to James Daly, CEO and president of Euler Hermes North America and the Americas, self-insurance is “not the most capital efficient solution.” He said: “Rather than have capital in your balance sheet doing nothing but waiting for bad debt, why not purchase trade credit insurance and then invest that excess capital into growth or new products?”
When should companies purchase trade credit insurance?
Firms tend to turn to trade credit insurance when they have a credit problem or foresee exposure in the near future – but that’s often too late for insurers to take on the risk. QBE North America chief economist Yue Ma commented: “Trade credit insurance can help companies apply longer term risk management strategies. We would advise firms to consider trade credit insurance when business is good, so that when a problem does strike, they don’t find themselves trying to get coverage for an uninsurable risk.”
How is technology impacting the trade credit insurance space?
The shift in the distribution of insurance towards digitalization and technology platforms presents huge opportunities in the trade credit insurance space. Daly explained: “Today, if you want to buy a trade credit insurance policy, we’ll talk to you around all the business you’re doing on open credit, we’ll take a look at the clients you’re supplying to and we will underwrite those buyers. Then, during the year, if any of those buyers go bust or don’t pay, then we will make the payment. We look at the whole turnover of a company and we underwrite the entirety.
“What we’re seeing through digital platforms is that people can go online and can sell a single invoice. In the new fintech world, people are going to be able to go on to a platform and upload their accounting records. The platforms can see the invoices that are outstanding and can make an offer to buy those outstanding invoices. What the customer can then do is take the choice to insure that single invoice. Once that invoice is insured, it’s basically a guarantee that the invoice will be paid.
“At Euler Hermes, we believe there’s going to be a shift in the way trade credit insurance is distributed. We’re at the dawn of a very exciting period.”
Trade credit insurance around the world
The global trade credit insurance market is about $8 billion in written premiums. Of that total, brokerage giant Marsh estimates premium totals of around US$1 billion in the US, US$2 billion in Asia-Pacific, US$4 billion in Europe and US$1billion elsewhere. In 2018, Europe was by far the biggest user of trade credit insurance.