Trade credit insurance and accounts receivable
Trade credit insurance is coverage that protects businesses against the threat of non-payment when customers are unable to pay due to insolvency or deferred payment.
Rather than taking on the burden of non-payment itself, a business can submit a claim with its insurance company for a quick payment on a portion of the total owed amount. This injection of cash keeps working capital in the business and decreases exposure to bad debt. Businesses can submit requests for payment as long as the agreed upon time frames have passed, and the transaction in question was a business-to-business deal.
If a customer can’t pay their accounts receivable invoices, a business that doesn’t have trade credit insurance will be liable for that loss of income. In this case, they may need to use a debt collection service (like accounts receivable factoring) or forfeit the payment and bear the responsibility for any losses. Trade credit insurance is a means of mitigating credit risk for new customers that protects businesses from the risk of unpaid invoices from clients. This method ensures more consistency and predictability in cash flow, even when your customer’s financial situation changes.
International trade credit insurance also covers foreign transactions and customers that may have additional risk factors such as damage to goods in transit.This is a common policy plan for businesses that export goods across international borders but need to protect their cash flow from a customer’s potential risk of non-payment. The elimination of risk in business-to-business transactions makes it easier to trade and conduct business with foreign partners.
Benefits of trade credit insurance
Guaranteed invoice payments. The biggest benefits of trade credit insurance is a promise to the business policyholder of compensation if a customer doesn’t pay their invoice—a strategic decision when it comes to risk management and credit management. With guaranteed cash payment, a company can rely on more predictable cash flow leading to smarter business decisions.
Less risk. As businesses grow, it is a challenge to identify which customers are well-positioned to fulfill payments. Factors to consider include creditworthiness and industry risks to economic and political events. Coverage from trade credit insurance creates less risk when taking on a new customers—or even a new market.
Sales growth. Trade credit insurance helps a business expand its reach and grow its client base as the company can take on more risks knowing they will be compensated for their shipments. With guaranteed cash flow, businesses can expand into new foreign markets, grow product lines, and streamline operations.
Access to capital. Financial institutions and lenders are much more likely to offer financing to a business with this type of policy as they are less likely to associate businesses that have trade insurance with insolvency risk.
How much does trade credit insurance cost?
A common detractor of using trade credit insurance is the higher cost. Because the insurance company takes on the risk of guaranteeing a customer’s payments, the fees are generally higher than generic business insurance. Typically, policy premiums begin at $3,500 but are subject to change depending on the nature of the business. For most businesses, trade credit insurance costs less than 1% of the sales volume—but the deductible must be considered.
How trade credit insurance works
There isn’t a cookie-cutter approach to finding a policy that best fits any business. The level of protection and cost is entirely dependent on the size of the business and the perceived risk of non-payment from that business’ customers.
To measure the risk of non-payment, the insurance company will consider the profile of the customers, their creditworthiness, and of course, the size of the business and number and amount of sales transactions. Most insurance providers will provide a free quote.
The most common types of coverage are for companies that conduct a large amount of international trade or businesses with a large volume of domestic and foreign sales. Coverage that protects accounts against non-payment risk (to the extent that the policy covers) is known as whole turnover coverage.
With key accounts and single buyer insurance, businesses can insure higher-risk customers or a single customer. Single customer insurance, also known as transactional coverage, serves smaller businesses that have fewer accounts and need to ensure that accounts receivables are fully covered.
There are also trade credit insurance options that scales in coverage if businesses don’t need to insure every single accounts receivable yet. This is ideal for smaller businesses that are beginning to grow but require high working capital demands or have specific higher-risk customers of non-payment.
The two most common alternatives to trade credit insurance are AR factoring and B2B BNPL software solutions that offer net terms as a service. When companies choose to protect their accounts through a B2B payments provider (like Resolve), they access additional benefits.
In addition to cash-advances, Resolve provides businesses with fast and quiet credit checks on customers that reveal what credit limit and credit terms are best to offer. This is essential in establishing many b2b sales contracts. And the payment protection is still there: Resolve pays up to 90% of every invoice for approved customers within one day. This improves the company’s cash flow predictability and provides the relevant information needed to close bigger sales contracts and attract more customers.
Non-payment and insolvency
A business is considered insolvent when they’re unable to repay what they owe. An insolvent business often cannot repay its debts in full, leaving businesses that don’t have trade credit insurance on the hook for non-payment. Yikes. Insolvency is the leading cause of non-payment and thankfully, most trade credit insurance policies pay out a percentage of this outstanding debt.
It’s important to carefully read the terms of a trade credit insurance policy. If a clause isn’t clear, seek clarification. Accessing and reading third party reviews from the Better Business Bureau (BBB) and online reviews are tactical ways to conduct due diligence of the insurance company you are considering working with.
Assess whether the policy covers all types of non-payment including customers who become bankrupt, insolvent, or default on payment because of political unrest.
Pre-existing or outstanding debts are the only invoice transactions that aren’t covered by these policies. There is one exception to this rule: continual and direct trade between the two businesses at the time of the insurance claim. In other words, if an outstanding debt exists from a few months ago, but two businesses have continued to sell and buy since, pre-existing accounts receivable invoices may be considered for insurance coverage within the policy period. If those businesses no longer work together, outstanding invoices would not be eligible for coverage.
Political risks and political risk insurance
Unsurprisingly, there are more payment challenges when dealing with multinational transactions. Under the umbrella of trade credit insurance and export credit insurance, there’s a subcategory of coverage called political risk insurance. This form of insurance covers businesses that do most of their sales internationally and run the risk of non-payment due to political issues that affect their ability to secure payment from international customers. Considering how the world and international trade have been impacted by recent events from the pandemic to countries at war, this coverage may be more prudent in current times as it gives policyholders more peace of mind.
If political unrest, violence, or currency inconvertibility creates a roadblock between businesses, political risk insurance protects companies from taking the full brunt of losses. For example, if a business has an ongoing sales transaction with a foreign business in a potentially unstable country that poses a political or economic risk, the trade credit insurance policy will guarantee a portion of unpaid invoices be paid.
Just like trade credit insurance, political risk insurance protects against non-payment from customers due to political events of any sort, whether payment is simply delayed, or the business becomes insolvent because of political unrest. Political risk insurance and trade credit insurance are both insurance products that protect B2B transactions domestically and with cross-border trades.
If a business is deciding which policy to purchase for their business consider this: for businesses that primarily export goods internationally and have minimal domestic trade, political risk insurance may be a better fit. Trade credit insurance has broader coverage that gives increased financial security in their dealings, without limiting them to a customer base who are domestic and fit a strict criterion for credit requirements.
Trade credit insurance protects you from the high costs of bad debt and gives you the confidence and peace of mind to do business with foreign companies or those whose financial health is in question. Do the appropriate research and find a solution that works best for your needs as there are also new alternatives that now exist.