Trade credit insurance is a product that can help your business control cash flow, protect your capital, lower the risk of bad debts, and even grow your business. Sounds good, right?
If you are a B2B business, you will probably have to deal with outstanding accounts receivable at some point. Up to 40% of a company’s assets tend to include accounts receivable, so this is a substantial portion of every business that could be exposed to risk. Research from 2021 indicates that about 15% of all business receivables for B2B businesses are overdue. Of that amount, a certain percent will never get paid, leaving many businesses (especially SMEs) in very challenging financial positions.
Some people may refer to trade credit insurance as accounts receivable insurance or A/R insurance.
Trade credit insurance is protection against accounts receivables that don’t get paid. It covers non-payment because of a customer’s bankruptcy, insolvency, and other reasons. Although it will not cover the entire amount of an outstanding debt, it will cover most of it.
Having financial protection against non-payment of invoices can lead to some valuable business benefits. Companies who have trade credit insurance policies are better situated to increase the credit they provide to customers, and can improve their balance sheets in addition to feeling some peace of mind when they consider the possibility of bad debt.
Financial institutions and lenders view trade credit insurance as a benefit for their customers and may give better financing terms. This makes sense, as the insurance means that the company is protected from bad debt due to non-payment.
Trade credit insurance can also offer protection from non-payment of invoices for international customers. Having this protection allows businesses to expand to new markets with confidence, even when they are unable to run the type of credit checks that are typically done on commercial customers before offering credit terms.
Depending on the insurance provider you work with, you may be able to take out a customizable policy that only covers certain accounts. This may be a good option if you have a few high-risk key accounts or the occasional high-value sale that would pose a substantial risk to your working capital if it wasn’t paid.
When a business looks at its whole turnover, there are always risks associated with extending credit to customers. Paying insurance premiums to cover this risk may be a small price to pay for the reduced exposure to bad debt.
According to Euler Hermes (another company is Atradius), trade credit insurance cost is calculated with consideration of a number of factors. These include some evaluations of your business including overall revenue, how many past bad debts your business has had to deal with, what types of credit policies are in place for your business, and checks of your current customers’ creditworthiness.
Different businesses present different risks when it comes to the likelihood that a customer will fail to pay an invoice for any reason. If you have customers in multiple industries or countries, trade credit insurance companies will rate your risk of bad debt as higher, and the cost of a policy will be higher.
You can generally expect to pay about ¼ of a cent on every dollar of your total sales for trade credit insurance coverage. So, that means that if your annual sales are $2 million, your trade credit insurance policy might cost $5,000. This may be a cost-effective insurance product that allows you to seek out new customers, have peace of mind, and lower your risk of non-payment.
Another way some insurers calculate cost is by charging premiums based on anywhere from 1/10 of 1% of sales to 4/10 of 1% of sales. Insurance companies state that their customers who purchase trade credit insurance see a positive ROI, even if they never need to make a claim. That’s because they tend to offer customers higher credit limits and take on more customers who only do business with companies that offer net terms.
This is an important factor to consider. Getting a trade credit insurance payout for bad debt—just like any other insurance—is not a quick process. First, the entire time of whatever net terms are part of the outstanding invoice needs to pass. If the terms are net 90 days, that time will pass without payment.
Next, you need to make a claim for the outstanding invoice. And then there’s the process of the insurance company approving and issuing the payout. Companies generally pay claims within 60 days of the loss if it’s a domestic claim.
International coverage (which is also offered by trade credit insurance companies) may take longer to process claims. As you consider the political risk that may impact your international trade customer’s ability to pay invoices, this becomes a type of export credit insurance that allows you to continue doing business with multinational and international companies. Insurance for international customers may also be called political risk insurance, as one of the aspects covered is the inability of a customer to pay an invoice because of political events.
There is an alternative to trade credit insurance. It’s an approach called digital net terms, or net terms as a service. Resolve is a company that offers this. Instead of running invasive credit checks on your customers or struggling to know what credit terms to extend to your customers, Resolve handles this for you.
They offer complete credit management solutions where they conduct discreet credit checks on your customers and provide specific amounts of recommended credit to extend as well as net terms. With every customer that is approved, you now have protection from Resolve. And they issue payment on these invoices of up to 90% of the invoice within one day of issuing them.
This can be a complete game-changer for companies. Instead of waiting months for payments, you can count on quick payouts. Companies working with this service report significant benefits, including the ability to extend larger credit limits to customers (based on the reliable recommendations from Resolve) which leads to closing larger contracts.
Businesses are also able to negotiate better terms from suppliers because they have secured working capital, and they can cover the cost of business needs while expanding their business. One more important aspect of Resolve: their credit solutions are based on each customer’s credit, not your own business.
Trade credit insurance companies use information about your company to determine your premiums. This includes any prior business losses, turnover history, loss history, and the overall financial history of your company.
While other types of insurance you purchase fit into the category of ‘set it and forget it’, trade credit insurance is different. It’s dynamic, meaning that there are ongoing assessments and reviews of your customer’s credit risk, additional risks that may be facing your business or your industry, and other risk management activities.
While debt collection services happen after an outstanding debt is determined, trade credit insurance is ongoing coverage that considers each situation before a policyholder may need to make a claim. If things change with a customer, your insurance provider may require changes to credit limits in order to continue to work towards lower risks and more peace of mind. This occurs with both large multinational organizations and small businesses.
Part of the process of constantly evaluating credit risk may include the underwriter visiting your customers, reviewing public records, obtaining information from other companies who also work with your customer, and considering financial statements.
As the policyholder, you can always speak to your insurer to ask for more coverage for an existing customer or coverage for a new customer. The insurer will conduct a review before proceeding. If they do deny coverage, they’ll provide information about how they came to the denial. Although being denied trade credit insurance for a customer may present a challenge, it also provides valuable information about the customer that you can use as you determine what type of relationship you want to establish with them.
Trade credit insurance covers a wide range of businesses and industries. They offer different policies for different sized businesses.
Policies are available for SMEs (usually covering up to $200,000 in exposure), media and marketing communications companies, multinational businesses, as well as businesses in distribution, manufacturing, and exporting. Regardless of what type of policy you have, there are some cautions about trade credit insurance. First off, companies will not issue payouts for invoices that are disputed. If your customer isn’t paying an invoice because they dispute it for any reason, this dispute must be resolved before you can file a claim.
Also, it’s important to keep the fact that you have trade credit insurance confidential. While we all hope that the companies we do business with are ethical, it is possible that a business that knows their invoice is covered by insurance will be motivated to default.
Startups or young companies may not qualify for trade credit insurance. And, even if you’re an established business, a policy may not cover every customer you work with. Lowering risks to your business may include purchasing trade credit insurance.