Credit insurance: A holistic and cost-effective risk management solution (Part 5/6)
Credit Insurance, Receivable management
Credit insurance is a comprehensive and cost-effective risk management tool that protects businesses from losses arising from a buyer’s inability to pay for goods sold or services rendered.
Helping sellers to expand their business by allowing them to trade safely and confidently on open account terms – increasingly the preferred mode of transaction in global trade – credit insurance offers a solution that can be tailored to suit a company’s business model and thus serves a variety of supplier needs across markets and geographies.
Here’s a quick look at the main types of credit insurance products and the range of needs they fulfill.
Whole turnover cover
A common form of credit insurance and scalable from the largest multinational company to an SME, it can be used to protect both domestic and international sales, and extends to include a seller's entire customer base trading on credit.
Selective portfolio cover
This is suitable for when the bulk of your company's revenues are generated by trading with a single customer or a few large customers, and you want a policy that insures against default by this small but important group of clients.
Project-based risk cover
This form of credit insurance provides long-term protection spanning several years as it is designed to last for the duration of a specific project.
Such versatility and flexibility also mean that companies of all forms and sizes can easily combine credit insurance with other solutions to refine and strengthen their cashflow and risk management processes.
How does credit insurance work?
Credit insurers will start with an assessment of your customer and assign them a risk rating. Also known as a buyer rating, it examines the likelihood of a customer defaulting on a payment and will be used by the insurer to guide how much of your credit they are willing to insure and on what terms.
The coverage, which normally extends up to 90% of the debt, usually applies to all transactions with a specific customer and covers a range of events that impact a customer’s ability to pay, such as bankruptcy, protracted default or changes to trade laws, as well as political risks which prevent performance of the contract such as acts of terrorism or war, import license cancellation or foreign currency unavailability. It can also extend to other causes of non-payment as agreed in the policy terms.
Most credit limits will be granted in line with open account trade terms – for example 60-, 90- or 180-days credit – that are typical for the insured’s industry sector. Premium, or the cost of your policy, will depend on a number of factors, such as the type of coverage you choose, your sector, your annual turnover that needs to be insured, your history of bad debts, your internal credit management procedures and your customer’s creditworthiness.
Nonetheless, average premiums for full protection against non-payment as well as the debt collection service that comes with it add up to between 0.1% to 0.4% of the invoice value, which is significantly lower than the cost of other risk and cashflow management tools.
And if a buyer defaults or becomes insolvent, the seller is promptly compensated, ensuring that the company's daily operations do not suffer significant disruption, and providing vital reassurance to the company's financiers and shareholders.
For a detailed look at how credit insurance works, watch this video.
Why choose credit insurance?
When considering purchasing trade credit insurance some companies question the need to protect against the risk of non-payment. But it is crucial to recognise that outstanding receivables often represent some of the largest assets on a business’s balance sheet, so the consequences of default by customers can be considerable. On the other hand, most companies that choose to invest in a credit insurance policy find that its benefits far outweigh the cost. The security provided by the policy enables them to grow customer relationships and enter new markets without worrying about the risk of non-payment, and the additional sales and profits generated as a result of this bad debt-free expansion effectively pay for the cost of the insurance.
The main benefit is that a credit insurance policy helps companies transfer the risk of non-payment from both domestic sales as well as exports to the insurer, and pursue their growth ambitions with confidence and peace of mind. And because it offers protection against del credere risks (protracted default and insolvency) as well as political risk, credit insurance also allows sellers to begin a new trading relationship or enter new markets they may have otherwise steered clear of. Crucially, credit insurance continues to be useful long after a business is well-established and flourishing in a new market by protecting sellers from these ever-present risks.
Credit insurance also provides crucial support for a company’s working capital management system as it not only quickly compensates companies for non-payment but also helps them filter out customers with unsatisfactory payment records. It is an efficient way to secure cashflow – the lifeblood of any business – as it helps reduce the time taken to get paid after a sale, and protect earnings and capital, which can then be ploughed back to fund growth.
With working capital at risk of being tied up in overdue B2B invoices for longer periods of time, a growing trend according to Atradius’ Payments Practices Barometer survey, credit insurance can play a significant role beyond just indemnifying companies for unpaid invoices. For instance, credit insurance acts as an excellent gateway to obtaining funds – and at lower rates – as banks are more comfortable offering trade finance facilities to insured sellers.
Further, credit insurance allows sellers to conduct their business on a continuous basis with both domestic and international buyers with no further administration costs once a credit limit is approved. Sellers also have the flexibility to tailor a policy to suit their requirements. This can include acquiring additional cover against pre-credit risks, which is ideal when selling goods customised for a buyer and hence may be difficult or even impossible to resell if the buyer becomes insolvent or events on the ground prevent a seller from fulfilling delivery.
Sellers also get access to an insurer’s global resources and regional expertise. For instance, insurers have local offices around the world as well as access to detailed financial information on millions of buyers, which help sellers pre-vet buyers and seek advice on the appropriate level of credit to extend to them. The insurer will also help sellers assess the general political stability and economic strength of a particular market as well as operational issues, such as the availability of sufficient foreign currency reserves to process payments.
Additionally, credit insurers have in-house collection units as well as a network of lawyers and debt collectors that can be relied on to help recover dues – services that are typically covered under a policy. Debtors know that they are reliant on positive credit ratings from credit insurers in order to obtain credit from insured suppliers and are therefore more likely to attempt to avoid any credit default which may lead to a negative rating and withdrawal of credit cover. In the majority of cases, the debt will eventually be fully recouped and losses avoided once sellers seek support to recover the payment.
Overall, credit insurance offers a complete package including risk assessment, protection and debt recovery solutions – backed by professional expertise and in-depth knowledge of regional and sectoral risks – that can enhance a seller’s financial stability and capacity to grow and serve new clients and markets.
The popularity of credit insurance is picking up across Asia and other emerging markets around the world as corporates from these regions become increasingly sophisticated in their knowledge of global trade and expand beyond their domestic markets. There is also a growing awareness among the region’s corporations of the benefits of using a holistic solution like credit insurance alongside other needs-specific tools, such as letters of credit, invoice financing and bank guarantees, in order to optimise their risk management function. You can read more about these solutions via links below.
Read our blog series that will provide an in-depth look at each of these credit risk management tools and their strengths and weaknesses.
1 of 6: Credit risk management instruments driving trade around the world
2 of 6: Letters of Credit: The traditional solution to secure payment
3 of 6: Invoice financing: A cashflow management alternative
4 of 6: Bank guarantees: Facilitating and securing high-value transactions
5 of 6: Credit insurance: A holistic and cost-effective risk management solution
6 of 6: Credit risk management: Choosing the right solution can make all the difference
All content on this page is subject to our Disclaimer, available here.