Companies take out credit insurance to protect themselves from the credit risk of a trade customer going bust before it has paid for goods it has already received. It is particularly important in sectors such as construction and retailing, where payment may not be due for up to six months. If there is no business insurance in place, the firm supplying the goods would have to bear the cost of the bad debt themselves.
How trade credit insurance works
Trade credit insurance is provided by specialist credit insurers. If they agree to take you on, then before your business starts trading with another firm the insurer will set an individual credit limit for that company, based on its cash flow, order book and previous defaults, as well as its own view of current trading conditions and the market the customer is operating in.
If it agrees to provide cover for a particular customer, your firm can trade with that customer within the credit limit set by the insurer throughout the year without further reference to the insurer. If the customer subsequently goes bust, the insurer will pay an agreed percentage of what is owed.
- Trade credit insurance is provided by three main insurers in the UK – Atradius, Euler Hermes, and Coface.
- You can choose to take out insurance for all your customers, or only some of them – just your export customers, for example, or just your key customers. You can also choose the risks you want the insurance to cover too – from insolvency to commercial or political events and natural disasters.
- Premiums are paid annually and are typically a percentage of the company’s turnover – your annual turnover if all your customers are being covered, or just the turnover of the customers you want to cover for.
- Insurers typically pay out 90% of the value of the loss suffered.
- Some insurers provide policies which have been specifically designed for small and medium-sized businesses – one insurer, for example, offers a fixed-price policy for small firms with a turnover of up to £5 million, which covers 90% of any losses and includes a free debt-collection service.
Things to consider
If a trade credit insurer refuses to provide cover for one of your customers because they deem them to be too risky, you can still trade with them, but you take on all the risk of doing so. In other words, if your customer can’t or don’t pay you, your business must bear the entire loss. The best option in this situation is to insist on upfront payment or at the very least payment in instalments as the work is done – and if the customer does not agree to that, then walk away.
Trade credit insurers sometimes reduce or withdraw cover entirely from certain industry sectors in tough economic times, often at short notice, which can seriously affect a small firm’s ability to trade. The government has occasionally stepped in with a scheme to provide cover of its own, but the last time this happened, the scheme flopped because it was too narrowly focused.
Remember that it works both ways: trade credit insurers will also be checking up on your company on behalf of your suppliers to see if you are a suitable candidate to trade with. So don’t give them any reason for concern – always pay your bills on time, keep up to date records and always file your accounts and pay your VAT within HMRC deadlines.
After Devon sausage makers Ilona and Charles Baughan suffered a £22,000 bad debt, they realised it was time to take out trade credit insurance to cover their risk. Now the husband and wife team, who run Westaway Sausages in Newton Abbot, spend close to £10,000 a year with Euler Hermes on trade credit insurance.
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“Having credit insurance gives us peace of mind and enables us to sleep at night,” said Ilona, who is the finance director of the company, which turns over more than £2.5 million a year and employs 20 people. “If our credit insurer will provide cover up to a certain limit, then we will trade. If they will not, then we think again. We either do not do business with that customer, or we trade on different terms, perhaps asking for money upfront.”