Trade Credit Insurance policies covers the non-payment of trade receivables in an event of the debtor’s insolvency or default of its trade obligations. The policy indemnifies up to 90% of the invoice value, capped to the approved credit limit of trade buyers, and the insurance policy can cover both domestic & exports credit sales of up to 180days credit terms.
In setting up the policy, Trade Credit insurers will provide evaluation of buyers to determine the credit worthiness of existing or new buyers. Through their global database of millions of companies, insurers internal credit report will assist companies in their selection of buyers before going into a sales contract. The insured will be indemnified of losses should these invoices went unpaid due to non-payment or if their buyer were to go bankrupt. Collection services will be provided to recover these debts through litigation or arbitration.
Fundamentally, for the credit risk to be insured under a standard trade credit insurance policy, it should fulfil 3 guidelines:
i) It must have a direct link with an underlying trade transaction, i.e. the delivery of goods or provision of services. If no direct link exists for example a loan given by you (as the seller) to one of your buyers on personal favour, this outstanding loan amount is not insurable under a standard trade credit insurance policy.
ii) There must exist a legally and enforceable trade debt. If the trade debt cannot be enforce legally for example if you are supplying prohibited goods to buyers, then the transactions are uninsurable.
iii) The transaction itself should not be subject to disputes. For example, if you supplied a wrong specification or quantity of goods, naturally your buyer would be entitled to refuse payment on the ground of breach of contractual terms.
Disputing parties are usually requested to resolve any dispute through arbitration or legal means (if necessary), prior to involving the insurer.
Trade credit insurance insures suppliers like yourself against the non-payment risk for goods despatched or services rendered by your buyers. The buyer may be located in the same country as you (domestic risk) or another country (export risk).
The basic coverage usually insure the risk of non-payment resulting from:
1) Commercial risk – i.e. non-payment due to (i) insolvency of your buyer or (ii) non-payment after a specific time period usually 6 months (vary depending on the insurers’ wordings) after the invoice due-date (often referred to as protracted default).
2) Political risk – i.e. non-payment following a government’s action outside the control of your buyer or yourself (as seller), for example money cannot be transferred from your buyer’s country to your country known as Exchange Transfer risk.
Credit insurance can include a wider range of coverage such as pre-shipment, depending on your specific circumstances and needs.
No it is not compulsory by law to get in place a trade credit policy before trading. From a financing perspective, borrowers whom have sought out a invoice financing facility would sometimes be required to purchase a trade credit insurance policy to protect receivables financed by the banks, and this policy would in turn be assigned to the bank as loss payee. In some cases, banks would require the existance of a trade credit policy as a condition to lending as it greatly reduces the bank’s risk knowing that the unpaid receivables will be admitted to the insurance policy as claims payout.
Corporate companies adopting a stringent risk management approach would also require all trades to be insured through a purchase of a Trade Credit Insurance policy in the absence of statutory requirements
In setting up the policy coverage limit & the individual buyer limit required, the business needs to check its maximum exposure at any one point in time during their business cycle, and also the maximum exposure on each of its top buyers.
For each buyer, a credit limit amount needs to be established before future trades can be insured under the policy. In determining the amount required, the company needs to consider the credit terms granted to the buyer, the frequency of shipment and the value of each shipment. Assuming each cargo shipment is valued at 100k each, and there is 2 shipments each month, the requested credit limit for this buyer should be 400k if credit terms granted is 60days (600k credit limit if credit terms is 90days)
Using the same analogy, if there are multiple buyers insured under the policy, the total sum insured of the policy needs to at least cover its top buyers’ exposure ( comfortably top 2-3 buyers). If the top 2 buyers credit limits are 400k and 350k respectively, the total sum insured of 750k should be able to fully protect the exposure against possible default of their top VIP customers.
No, but the percentage of your receivables that is insured is still high – usually between 80%-90% (which is still very good protection).
The percentage of coverage will depend on these major factors:
a. How much coverage you choose
b. The premium you are willing to pay
c. Your trade credit insurance claims history (if any)
d. The financial risk of your buyer
e. The country of your buyer
f. The insurer’s risk appetite for your industry
There are myriads of ways credit insurance policies are being priced. Most ‘whole turnover’ and ‘selected buyers’ credit insurance policies are priced based on a percentage of insurable turnover. Whereas ‘single risk’ credit insurance policies are often priced based on a percentage of credit limit that is being supported by the credit insurers. Some of the variables that can influence the premium rate as follows:
- Level of risk sharing option elected.
- Level of insurable annual credit turnover
- Basis of buyers elected for coverage e.g. domestic sales, export sales, top 10 buyers or buyers in a specific segment etc.
- Creditworthiness of the insured buyer(s) proposed to be included into the policy.
The premium rate is generally given as a percentage of the insured’s insurable turnover. Obviously, the actual annual insurable turnover is not known at inception of the policy and so the final dollar amount of the premium is also not known. Therefore, a minimum premium amount is usually first established based on the applicable premium rate to the estimated annual insurable turnover as an integral part of the contract. Usually 80% to 85% of the estimated annual insurable turnover is used to compute the minimum premium amount.
At the end of the policy year, the actual insurable turnover is used to calculate the final premium amount dues, and where it is higher than the minimum premium, an additional adjustment premium is paid by the insured to the insurer.
Some of the variables influencing the premium rates include:
Pool of Customers offered for Insurance
Customer Location (domestic or international, country risk)
Creditworthiness of Customers
Terms of Payment/ Payment Period
Loss History (for past 3 years)
Corporate Credit Management
Trade Credit policies will 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.