Trade Credit Insurance protects a company from the non-payment risk of extending credit to their clients. The insurance is also referred to as Accounts Receivable Insurance or just Credit Insurance. Trade credit insurance helps companies reduce bad debts, increase sales, trade internationally and make better credit decisions.
A company purchases trade credit from a broker or insurance carrier. The insurance carrier underwrites the company’s customer and their creditworthiness. The insurance carrier will then assign a credit limit for each of the company’s customers. Should a customer not be able to pay the amounts owed to the company, the insurance company will cover the losses, subject to the terms of the policy.
Unlike other types of insurance, many credit insurance companies are active in reducing the company’s loss exposure. When the insurance company finds that a customer’s credit risk increases, they immediately notify the company and take proactive measures to reduce losses.
Trade Credit Insurance can be written to accommodate a company’s needs and is very flexible in most cases. Common type of Trade Credit are below. Click on the tabs to learn more.
Another important distinction between trade credit insurance policies is cancellability. Most trade credit insurance policies run for a term of 1 year or 2 years.
Cancellable policies involve the insurance company taking a more active role in the company’s credit department. These policies may be referred to as “Limits Policies.” The insurance carrier sets an insurable credit limit for each of the company’s customers. The insurance carrier will help the company constantly monitor a customer’s credit worthiness. While the entire policy cannot typically be canceled during a policy period, credit limits can be changed or withdrawn for certain customers if their financial status changes. While some policies can reduce or cancel limits to a customer immediately, many give a certain amount of notice. Most Comprehensive Credit Insurance Policies are cancellable policies with active management of customer financial conditions.
Non-cancellable policies are generally written for Excess of Loss or Catastrophic policies. These policies are not actively managed by the insurance company. The insurance company writes a policy for set limits during each policy period. The insurance company bears the risk of a bad debt if the covered customer’s financial situation deteriorates, subject to the self insured discretionary limits.
The cost of trade credit is determined by the type of coverage purchased and by the risk of the company’s customer accounts. Comprehensive coverage on all of a company’s accounts may cost as little as 0.1% of sales for that company. Transactional or Key Accounts coverage may cost as much as 0.5% of sales to those customers. In either case, trade credit is affordable coverage and much cheaper than other financing options such as factoring in most cases.
Often a company may have a higher rate for international transactions as they carry more risk. For example, a country may have a rate of 0.2% of domestic sales and 0.4% for international sales.
Many factors affect what a company will ultimately pay for Credit Insurance. These include:
The benefits of trade credit insurance cannot be overstated. According to the U.S. Court System, business bankruptcies were up 16% in 2023. It's not just small companies at risk either. In the first 6 months of 2023, 72 companies with over $100 million in assets filed for bankruptcy. Companies should not assume that their customers will be able to make payments just because they are large. However, there are many other benefits of trade credit as well. They can be seen by clicking on the tabs below:
The first step to obtaining trade credit insurance is to complete an application. While each carrier has different requirements a prospective buyer will need to provide the following:
While many brokers may advertise trade credit insurance, there are currently limited insurance carriers offering the product.
There are generally three alternatives to trade credit insurance. These include:
Self-insurance has historically been the way companies handle credit risk. Companies create a “bad debt reserve” on their balance sheet and fund it with cash. This can be problematic as that cash cannot be used for other purposes. If a company is using $1,000,000 for bad debt reserves and their gross profit margin is 20%, that’s an additional $200,000 in additional gross profit the company may be able to recognize using credit insurance.
Another reason why credit insurance may be preferable to self-insurance is the taxability. A company cannot typically deduct self-insurance losses until they occur. Trade credit insurance premiums are usually tax deductible.
Letters of Credit are a popular way to secure trade receivables in the international market. As discussed earlier, a letter of credit has many downsides to the buyer. It can take time to obtain, is costly and can reduce their borrowing ability. Many international buyers would prefer to pay extra for the seller to cover them under credit insurance.
Factoring involves a third-party purchasing account receivables from a company at a discount. In return, the company may or may not assume the risk of non-payment. The major downside of factoring is expense. Companies generally charge anywhere from 1% - 5% of the receivables and may be as high as 10%. This can eliminate or significantly reduce a company’s profits.
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