Trade credit insurance protects manufacturers, traders and service providers against losses from non-payment of a commercial trade debt. If a buyer does not pay (often due to bankruptcy or insolvency) or pays very late, the trade credit insurance policy will pay out a percentage of the outstanding debt.
The primary function of trade credit insurance is to protect sellers against buyers that do not or cannot pay. It insures against a buyer that has declared bankruptcy, insolvency or a similar legal status, as well as protecting insureds against buyers who delay payments under a bankruptcy protection arrangement.
The International Credit Insurance & Surety Association explains: “If a buyer does not pay, the trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.
The risk being transferred has to connect directly to an underlying trade transaction. If no direct trade link exists, outstanding debts cannot be covered by a trade credit insurance policy.
The main alternative to trade credit insurance is self-insurance, a practice particularly popular in the US where trade credit insurance take-up is lower than 5%. Businesses that choose to self-insure can put a reserve on their balance sheet to cover any bad debt that may incur over a financial year.
Firms tend to turn to trade credit insurance when they have a credit problem or foresee exposure in the near future – but that’s often too late for insurers to take on the risk. QBE North America chief economist Yue Ma commented: “Trade credit insurance can help companies apply longer term risk management strategies.
The shift in the distribution of insurance towards digitalization and technology platforms presents huge opportunities in the trade credit insurance space. Daly explained: “Today, if you want to buy a trade credit insurance policy, we’ll talk to you around all the business you’re doing on open credit, we’ll take a look at the clients you’re supplying to and we will underwrite those buyers. Then, during the year, if any of those buyers go bust or don’t pay, then we will make the payment. We look at the whole turnover of a company and we underwrite the entirety.
“At Euler Hermes, we believe there’s going to be a shift in the way trade credit insurance is distributed. We’re at the dawn of a very exciting period.”
