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Trade Credit Insurance - What You Need to Know | Resolve

Written by Resolve Team | Dec 9, 2021 6:53:00 PM

What is trade credit insurance?

Trade credit insurance (also known as Accounts Receivable/AR insurance, business credit insurance, export credit insurance, or credit insurance) is insurance coverage businesses purchase for risk mitigation against losses from non-payment of invoices. It protects a business’s accounts receivable and is considered a business financial tool.

Some non-payment reasons frequently covered by trade credit insurance include a natural disaster or emergency, bankruptcy, economic collapse, political unrest, bad faith, or even things like ownership changes or currency fluctuations.

Having trade credit insurance may help you mitigate financial risks while being able to win more orders. It’s also viewed favorably by lenders - having trade credit insurance can improve your business’s ability to gain financing.

Most trade credit insurers will cover direct loss costs and indirect costs like interest payments on loans that have been secured by receivables. If you need to proceed through collections on an insured invoice, trade credit insurance will cover excess costs.

Although a business only has a single policy with an insurer, each of their customers will have a set credit limit based on the insurer’s analysis of their creditworthiness. Some insurers allow a discretionary limit where you can set limits based on your knowledge of your customers. You’re always in control of which customers you choose to have trade credit insurance for.

Trade credit insurance can help protect accounts receivable, reduce risk, and improve a business’s ability to extend net terms. It can also provide protection when entering new/emerging markets that may otherwise be too risky to engage with.

Can any business purchase trade credit insurance?

In general, any business that sells goods or services (usually B2B) and offers net terms to their customers can purchase trade credit insurance. It’s important to be aware of what it covers and what its limits are. Trade credit insurance always has a deductible - just like most other insurances.

How much does trade credit insurance cost?

Insurance companies charge a percentage of your company’s sales as a trade credit insurance cost. But they also look at things like the type of coverage you want, where you live, the industry you’re in, any previous losses, the creditworthiness of your customer, and how your business manages credit procedures internally. Typically, trade credit insurance will cost $1.00 to $1.50 per $1,000 of sales.

The most compelling reason companies purchase trade credit insurance is to cover the losses that might occur if an invoice isn’t paid for any reason. On average, businesses that sell products to other businesses have 40% of their assets tied up in unpaid invoices. That’s a lot of risk.

What are the alternatives to trade credit insurance?

There are some options available to businesses that don’t want to use trade credit insurance. The first is in-house credit management. Businesses with solid credit and excellent cash flow may be able to cover the cost of losses with cash on hand, or a line of credit. Of course, this is a very unlikely scenario for most businesses, especially after the economic challenges of the past few years.

Another alternative is factoring invoices. With this process, a business uses a third-party company to finance the invoice by paying out a portion promptly. This third party then pursues payment from the purchasing company. While this option is easier than trade credit insurance, it’s expensive, and can damage your business relationship with your customers.

The third option uses something called net-terms-as-a-service. Resolve is a company offering this alternative. With net-terms-as-a-service, Resolve works in real-time to unobtrusively evaluate a company’s credit and advise a business on the amount and term to offer to their customer.

With the information from Resolve, companies can confidently offer their customers net terms. Resolve then pays out the invoice within 1 day. This solution provides streamlined access to cash flow while helping to protect B2B companies from lengthy delays in payments.

Are there limits to trade credit insurance?

While different insurance companies will have various terms and conditions, every trade credit insurance policy will have coverage limits. Regardless of the amount of the invoice, it’s crucial to see how far the trade credit insurance will take you if you need to make a claim.

For example, if you have an invoice valued at $100,000, the trade credit insurance may only cover $75,000 - and that’s after you pay your deductible. If your deductible is $10,000, then the trade credit insurance will pay out $65,000 if they approve your claim. That means your company is on the hook for a total of $25,000.

Another thing to remember is that insurance claims and payouts always take time. There’s the actual completion and submission of the claim (your job), then any discussions with the insurance company where they may ask for more information. If the claim is approved, there may still be a delay before payment is issued. Of course, getting some money eventually is much better than being out the entire amount of the invoice. But it’s important to understand the limits of the coverage.

The six stages of trade credit insurance

The trade credit insurance process can be broken down into six steps:

1. Customer analysis: First, the insurance company will evaluate your customer to determine their creditworthiness.

2. Determine credit limit: Next, the insurer will set a credit limit for the customer. This credit limit applies to the total of all outstanding invoices, and businesses cannot exceed this amount when selling to the customer.

3. Proceed with sales: Now the business is ready to close sales with their customer.

4. Credit limit updates: The insurer may choose to increase or decrease the credit limit of an insured customer at any time. This is determined through further creditworthiness checks and evaluation of current economic conditions

5. Add new customers: The business can add new customers to their insurance policy by requesting a customer analysis from the insurer.

6. Pursuing a claim: If a customer doesn’t pay their invoice, the business will formally request payment on the policy from the insurer.

When should I use trade credit insurance?

There are some specific situations where trade credit insurance is recommended. The first is when you’re dealing with international sales. While Resolve is an optimal solution when you’re doing business with US companies, international sales are an entirely different ball game.

Every country may have different banking rules, different credit expectations, and different legal requirements than what we’re used to when dealing with American companies. In these situations, trade credit insurance is a valuable resource. Since a big part of their business model is due diligence, they’ll have the best information on an international customer’s creditworthiness. Often, trade credit insurance companies partner with local insurers, which adds additional protection to you.

One of the best-known trade credit insurance companies is Euler Hermes (they refer to the coverage as trade credit insurance). Euler Hermes was formed when two credit insurance companies from Allianz Group merged. Their coverage includes (with limitations) both commercial risks and political risks.

Other companies offering AR/trade credit insurance are Coface (owned by Natixis) and Atradius—another company created from a merger (between NCM and Gerling Kreditversicherung).

As countries change regulations—or experience sudden changes in the political climate that can impact imports/exports—it’s easy to see how the unexpected can suddenly become a challenge. Having the right coverage for these types of events is prudent.

While having trade credit insurance for domestic transactions is less common than international contracts, it is still offered in the US. Your business may choose domestic trade credit insurance when you have a substantial single contract with a customer or whenever you’re facing a larger risk if a customer doesn’t pay their invoice.

Important Note: Trade credit insurers can—and do—withdraw insurance coverage. This happened in 2020 when there was a ‘wave’ of coverage denials because of invoice payment concerns due to the coronavirus pandemic.

What’s the best way to mitigate the risks involved with offering net terms?

Although in-house financing and invoice factoring remain alternatives to trade credit insurance, net-terms-as-a-service is your best option—and for far more than just risk mitigation.

To start, net-terms-as-a-service gives you reliable information about the amount of credit you should extend to each client. This is determined using unobtrusive evaluations of your customer’s creditworthiness and payment history. With this information, you already have a level of protection, since you know what your customer can pay.

Once you’ve closed a sale and issued the invoice, net-terms-as-a-service steps in to cover the invoice with payment within one day. This means your business is never acting as a bank and floating the amount of the invoice for 30, 60, or 90 days. The cost for this service is a percentage of the invoice, and it’s much less than the cost of factoring or trade credit insurance.

However, there’s more to net-terms-as-a-service than the credit advisory and invoice payment services. Resolve also includes enhanced payment processing capabilities that allow your customers to pay invoices on a platform with your information using all payment options. They also offer payment reminders, auto bookkeeping, and collaborative collections support.

When it comes to protecting and growing your B2B business, having all the information about different options will help you make the best choices for your business. Feel free to contact Resolve if you have any questions. We’re here to help you reduce the risk of offering net terms, improve your cash flow, and grow your business.

This post is to be used for informational purposes only and does not constitute formal legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Resolve assumes no liability for actions taken in reliance upon the information contained herein.