Companies who trade with other businesses are always at risk of loss from a range of credit risks, such as their customers going bust or being unable to pay their debts. More than four out of five daily business-to-business transactions in the UK are based on credit terms, which means companies can wait weeks or months until they receive funds owed to them for goods delivered or work already completed.
If one of your commercial customers cannot pay their debts on time or goes bust during this period, this can put your business at risk of bad credit. If you rely on one or two large customers, non-payment could have a devastating impact on your company or even threaten its survival. Fortunately, trade credit insurance is a way for companies to insure their accounts receivable when buyers can’t pay.
Find out all about trade credit insurance in this helpful guide, which takes you through the following sections:
- What is trade credit insurance?
- How does it work?
- What is covered by a trade credit insurance policy?
- Types of trade credit insurance products
- Who needs trade credit insurance?
- How much does trade credit insurance cost?
- How to find a trade credit insurance provider
- Final thoughts & FAQs.
What is trade credit insurance?
Trade credit insurance, sometimes known as business credit insurance, export credit insurance or simply credit insurance, protects businesses against the risk of their customers being unable to pay for goods or services they have already received. It’s a risk management product which enables companies to protect their accounts receivables from losses incurred by a customer defaulting, going bankrupt or becoming insolvent.
This type of insurance is designed to help businesses mitigate the risk of non-paying customers, while also giving them the confidence to grow profitably, as it can allow them to extend credit to new customers without fear of bankruptcy or insolvency for itself. In this way, it can protect a company’s working capital, allowing them to reconcile their cash flow and grow their profits even when customers cannot pay their debts.
How does it work?
To obtain trade credit insurance, a company submits an application to an underwriter, who then assesses the company’s level of risk using actuarial techniques. This process involves inspecting the credit history of the company’s customers and any history of bad debt experience, while taking into account the sector in which the company operates, among other factors.
Based on these calculations, the underwriter determines a credit limit for each commercial customer included on the trade credit policy. The insurance remains valid for any debts owed by each client up to the limit specified by the underwriter. Sometimes, credit limits are established by a discretionary limit detailed on the policy, rather than by formal application. Your company is then typically indemnified for the cost of any services it has already delivered to named customers on the policy, up to these defined limits.
During the lifetime of the policy, your company must report any overdue accounts to the insurer. This means if one of your customers misses their payment date, you must inform your insurance provider straight away. Most insurers specify in the policy document how long you have to report an overdue account, as well as how they define overdue. Typically, this is 15 to 30 days after the end of the maximum extension period. This refers to the period beyond which the insurer will not cover any further provision of goods and services to this customer.
Who collects insured debts?
Many trade credit insurance policies mandate that you pursue any non-payments promptly. Sometimes, insurers offer a debt collection service included in the price of the policy, or for a reduced rate. If you have a debt collection service as part of your policy, any debt which exceeds the maximum extension period passes to the insurer, and it becomes their responsibility to pursue the customers for money owed.
What is covered by a trade credit insurance policy?
Broadly, trade credit insurance protects businesses against bad debt caused by non-paying clients. Generally, it covers two types of credit risk:
- Commercial risk. This constitutes the risk that your customers are unable to pay their outstanding invoices for work completed or goods received because of their financial situation. This could include protracted default, whereby a customer accepts a service or product and fails to pay for it after 90 days of the due date, as well as insolvency or bankruptcy. Indemnity tends to be 90% for commercial risks.
- Political risk. This is where non-payment is the result of events outside the control of either the policyholder or the customer. Events of this nature could include political events such as wars and revolutions, natural disasters such as earthquakes or hurricanes and economic difficulties such as currency issues that mean businesses are unable to make foreign transactions. Most insurers offer indemnity of 95% for political risks.
As well as covering these trade credit risks, policies tend to come with credit risk management services. Insurers can provide a wealth of knowledge on your sector and your customers, which you can then use to make decisions to strengthen your company. This might be avoiding a customer that the insurer has flagged up as a potential risk, or by taking an opportunity to expand into a new market, pointed out by your insurer’s analysis.
Types of trade credit insurance products
A trade credit insurance policy tends to mould to the insured company to reflect their credit needs. However, there are several types of standard policy available, which are typically purchased by smaller companies with a more straightforward sales ledger.
Whole turnover
This blanket policy is the most common trade credit solution and can insure against non-payment from all current and future buyers. Businesses can typically choose whether they want to insure all their domestic sales, all their export sales or both. Each customer which contributes to the insured turnover must have a credit limit established by the insurer. The premium is typically calculated based on the turnover of the business.
Major buyer
A major buyer policy, sometimes known as key accounts or critical customer cover, can insure your business against non-payment from several named customers, typically up to ten. Companies tend to insure their largest clients under this kind of policy, as their non-payment is likely to make the most detrimental impact. It’s also useful to cover customers under threat from insolvency or those with a poor credit rating. With this type of policy, your business remains liable for all remaining customers who aren’t named under the policy.
Single buyer
A single buyer policy, sometimes known as specific risk cover, typically insures against non-payment from just one customer. Companies commonly take out this kind of plan if they rely on one primary buyer for the bulk of their sales. With this type of policy, you tend to pay a premium based on the value of the insured contract or the turnover of the customer over the period of the policy.
Export trade credit insurance
An export trade credit insurance policy can cover a business against non-payment from their overseas customers. This is a very common type of trade credit insurance, which is sometimes integrated into a standard trade credit policy for companies trading outside of the UK. It can offer extensive cover, typically insuring against risks such as political risk, social and economic instability, currency issues and government intervention, alongside typical cover for insolvency and defaulting customers.
Top-up cover
Top-up cover typically allows the insured to increase their protection on a particular buyer, to extend the limit set. This type of policy is not commonly available, and premium rates tend to be far higher than the rates for the other policies.
Who needs trade credit insurance?
Trade credit insurance can be helpful for any business of any size that sells goods or services on credit terms to other companies, no matter the industry or type of goods or service being traded. It’s particularly popular among companies with long payment terms, such as businesses in construction and retail, where invoices may not be due for up to six months. If the threat of a non-paying customer could strain your cash flow or even threaten to buckle your business, then trade credit insurance is something to consider.
Any company trading with customers based in other countries may also want to consider trade credit insurance. Trading abroad carries additional risks when compared with domestic trade. Customs can slow the transaction of money or introduce delays into the supply chain. It’s also more difficult to assess the financial stability of clients based overseas or predict instances which could result in delayed payment. These risks can be absorbed by political risk cover, sometimes specifically referred to as export credit insurance, as the insurer can typically pay out for any outstanding invoices from foreign clients.
Advantages of trade credit insurance
There are many advantages to acquiring trade credit insurance. If you’re unsure whether a policy is right for you, consider whether the following benefits could apply to your business:
- Trade credit insurance can protect your company accounts, profit and cash flow
- Insurers can offer risk management to help you understand your company’s risk profile and implement measures to mitigate risks your business faces
- Insurers also have access to a wealth of information on existing or potential customers, including credit information, to help companies decide whether to accept new clients or make strategic decisions regarding existing clients
- Having trade credit insurance in place can allow you to grow your customer base as you can offer more attractive credit terms to new clients
- Trade credit cover can provide reassurance, allowing you to expand your market with fewer risks
- Enhanced credit terms typically allow for better communication and stronger customer relationships
- Trade credit can improve your access to finance.
How much does trade credit insurance cost?
How much your premiums cost depends on several factors. First of all, it commonly depends on the nature of the cover you need – that’s to say whether you’re looking to insure your entire sales ledger or a select few clients.
Secondly, the higher the limit of indemnity you require, the more you will typically have to pay for your premiums. Thirdly, insurers take into account the credit rating and history of your existing and potential clients to work out their potential risk, which may include factors such as the industry in which you operate.
Your premium will either be fixed or rated. A fixed premium is set for the duration of the policy, and companies can pay the premium in a series of monthly instalments or one lump sum. A rated premium, however, works by applying a percentage rate to the total amount of revenue you are insuring, or the estimated insurable turnover for the policy period. This gives an estimated premium amount, which is typically paid by deposit through the policy.
Then, at the end of the policy, you would have to supply a declaration of turnover to your insurer, which provides the actual insurable turnover. The premium rate is applied, and the actual premium amount is calculated. If the company has overpaid, the insurer will refund the difference. If the actual premium amount is more than the estimation, then the customer must pay the excess to the insurer.
How to find a trade credit insurance provider
Trade credit insurance is one of the most concentrated insurance markets, with just three insurance groups accounting for 85% of the global market. That said, there is a wide range of insurance suppliers offering trade credit insurance in the UK, for businesses who trade both domestically and abroad.
Approaching insurers directly
Trade credit policies tend to only be available from specialist insurance providers or suppliers that specialise in commercial insurance. You can find details of the products offered by such insurers on their websites. Some sites provide an online tool to generate a quote, while others give contact details of underwriters and advisers to contact directly.
Going through a broker
Trade credit insurance is one of the trickier products to find, as it’s based on intricate data analyses concerning your business’ sector, markets, financial standing and customers. While only a few suppliers have the lions share of the market, it isn’t as straightforward as it may seem to find a trade credit insurance policy that ticks all the boxes for your company. It can, therefore, be beneficial to go through a specialist credit insurance broker. A broker can establish your insurance needs and conduct a fair assessment of the market to find an appropriate policy that fits with your risk profile.
Not only that, but brokers have access to a broader portion of the market than individual companies. Indeed, owing to the complex nature of trade credit, many trade credit insurance suppliers insist on an intermediary, meaning their products are available only through a broker.
Final thoughts & FAQs
Trading with other businesses using extended payment terms presents a huge risk for any company. Just one large customer not paying up can devastate your balance sheet, drain your working capital or even threaten your company’s survival. Even financially-sound, creditworthy customers pose a significant risk, which is why many companies don’t have the confidence to take new opportunities for business growth.
That’s why trade credit insurance can be a solution with multiple benefits, not only securing your working capital but giving businesses the financial reassurance and expert advice they need to grow their operations and expand into other markets. A trade credit insurance is a consideration for any company with commercial clients at home or abroad.
More questions on trade credit insurance? Check out answers to popular queries, below.
What about credit life insurance?
Trade credit insurance must not be confused with credit life insurance, a very different type of insurance policy, taken out by individuals and designed to pay off their outstanding debts if they die. Trade credit insurance is only available to businesses and is used to cover non-payment of business customers.
What is an Excess of Loss policy?
An Excess of Loss structure is only available to very large, multinational corporations. They typically come with high discretionary limits, meaning there’s less of a need for approved credit limits and underwriting involvement, affording such companies greater freedom and autonomy. For this reason, they are usually only offered to companies with proven credit management.