Trade Credit Insurance covers you if your customers don’t pay their invoices. Essentially, it’s insurance against bad debts.
For example, let’s say you have a client who owes you money. This client’s invoices are almost 100 days past due, and they still haven’t paid you. If you have Trade Credit Insurance, you can activate your policy. The insurer would then compensate you for your unpaid invoices.
Trade Credit Insurance can cover the following payment terms:
1. Short-Term policies: Coverage for invoices with payment terms up to 180 or 365 days.
2. Medium or Long-Term policies: Coverage for invoices with payment terms up to 7-10 years long. These are typically used for companies selling capital equipment, like complex factory or construction machines.
1. Non-Payment due to Breach of Contract: For example, if you delivered a wrong type or amount of goods, your customer would not have an obligation to pay your invoice, since you have not satisfactorily performed your contract. Trade Credit Insurance would not cover customer non-payment if you deliver incorrect goods or services.
2. Illegal or Non-Enforceable Trade: For example, if you sell goods that are prohibited under Singapore law, Trade Credit Insurance would not cover any bad debts from that sale. If you force another party to enter into a trade agreement under duress, your contract is not enforceable and therefore Trade Credit Insurance would not provide coverage.
Trade Credit Insurance covers:
1. Protracted Default Cover: If your customers do not pay your invoices after a set period of time (typically 4-6 months, depending on the policy), the insurer will step in to compensate you.
2. Insolvency Cover: If your customers go bankrupt, the insurer will also compensate you for the invoices the now-bankrupt customer owes you.
3. Political Risk Cover: Some specific political risks are covered. For example, if your customers cannot pay you due to their/your government banning money transfers between your respective countries, the insurer can step in to compensate you.
Trade Credit Insurance is not compulsory by law. However, if you take out a bank loan or invoice financing loan, your lender may require you to have a Trade Credit Insurance policy in place before the loan can be disbursed. This is a fairly common requirement we see from clients.
Even if the law or a lender is not requiring you to have Trade Credit Insurance, it’s still incredibly helpful to have a Trade Credit policy for your business.
There are 2 key benefits:
1. Increase profit: Having an insurer pay for your bad debts will increase your profit
2. Increase cash flow and working capital: Having an insurer pay for your bad debt will increase the amount of cash coming through your business, reducing strain your working capital. It will improve your DSO (Days Sales Outstanding) metrics, help you pay your own suppliers quicker, and strengthen the ability for your business to deploy cash to grow faster.
For a basic start, you should calculate the total amount of potential bad debt you could incur at any one time. You should also calculate the total amount of receivables you have for your top 10-20 customers.
For instance, let’s say your historical bad debt ratio is, on average, 5%. Your annual revenue is $10 million. This means that you can expect to have $500,000 worth of bad debt every year. You’ll need at least $500,000 in coverage for your Trade Credit Insurance policy.
Your top 10 customers make up 50% ($5 million) of your annual revenue. Since it’s such a large percentage of your turnover, it’s best to protect against potential bad debt from these customers.
In this example, you should consider having at least $5 to $5.5 million in Trade Credit Insurance coverage. This would protect you against your average bad debts, plus protect you against the possibility of losing huge amounts of uncollected revenue from your top customers.
No. Trade Credit Insurance will cover up to 90% of your annual revenue, or 90% of your Accounts Receivables amount with your customers. 90% is still extremely good protection.
The primary reason that Trade Credit insurers do not cover 100% of your receivables is to avoid moral hazard. Companies that are covered by Trade Credit Insurance must still have skin in the game. If 100% of their receivables risk were covered, then companies would have no reason to perform good due diligence on their customers. They would sell to any and every customer without performing credit checks, since all the risk would be borne by the insurer. This would end up increasing claims for insurers. The cost ultimately would be passed back to the companies themselves via increased premiums. This would raise insurance costs for all companies who have Trade Credit policies.
Premiums are typically 0.2% to 0.8% of your insured annual revenue.
Some key variables that influence the premium are:
- Insured annual revenue amount: You don’t have to insure 100% of your revenue. You can choose to insure any percentage.
- Deductible amount (also known as the “First Loss” amount – this is the amount of loss you bear first, before the insurer pays the rest of your losses)
- Types of customers you’re selling to: e.g. domestic customers, overseas customers, top 10 customers, only customers in a specific industry, etc.
- Your payment terms: How long you allow your customers to pay your invoices
- Your credit controls: What kinds of credit controls do you exercise to reduce the risk of non-payments
- Creditworthiness of your insured customers: The more creditworthy your insured customers are, the better your premium.
Trade Credit policies can cover non-payment due to specific political risks outlined in the policy. It does not cover all political risks, like strikes, riots, or nationalisation of your company assets.
If you need broader coverage for political risks, it would be useful to consider Political Risk Insurance.
Political risks concern situations where your buyer cannot pay, or goods cannot be delivered due to war, terrorism, riots, or actions by governments. Failure to pay by a public buyer is always considered a political risk.
Interested in purchasing Political Risk Insurance for your company? Get in touch with our expert brokers today.