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Is Credit Insurance Right for Your Company?
Trade Credit Insurance 101
Granting open credit terms to customers benefits both parties. Open terms facilitate the shortest possible order fulfillment process, assuming the customer has an adequate credit limit, thereby greatly enhancing the Customer Experience (CX), while at the same time avoiding the need to deal with payments in advance, cash on delivery (COD) or other secure arrangements, which can get complicated.
A great CX in turn facilitates more commerce between the seller and buyer, but there can also be challenges.
How do you ascertain the appropriate level of credit to extend?
What do you do if you are not paid on time?
How can the risk and responsibility of extending credit terms be mitigated?
One answer is simpler than you may expect: Trade Credit Insurance, also known as business credit insurance or export credit insurance, is an insurance policy that protects accounts receivable while also offering significant ancillary benefits. The protection provided by a policy equips businesses with the confidence necessary to extend credit to their business customers, enter new markets and increase sales to existing customers. With a Trade Credit Insurance policy in force, a company can safely offer open account credit terms ideal for creating a positive CX.
How Credit Insurance Works
Policyholders request coverage on their buyers (customers). The insurance carrier will perform an analysis of the creditworthiness and financial stability of the buyer.
The credit limits requested will be approved, partially approved or refused. Each buyer is assigned a credit limit by the insurer, which is the maximum indemnification if that customer fails to pay you.
Business continues as usual. Purchase orders are fulfilled, shipments are released, and invoices are issued with the non-payment risk mitigated up to the approved buyer limit.
Portfolio monitoring. The carrier will continuously monitor the insured buyers (i.e., evidence of slow pay to other suppliers, reduced spending, etc.) and alert the policyholder to potential changes in the creditworthiness of their buyers.
Vetting prospects. The creditworthiness of potential new customers can be ascertained prior to the sale.
Making a claim. Should a customer fail to pay, the policy is triggered by filing a claim with the insurer, with the policyholder paid by the insurer according to the terms of the policy.
What About Pricing?
Each Trade Credit Insurance policy should be a bespoke contract, To get the optimal coverage and value for your firm, you will need to compare multiple carriers. You can do that on your own, but a savvy broker, who keenly understands your business needs, will save you a lot of time and effort negotiating a contract, as well as save your firm a lot of money in terms of both premiums and the avoidance of bad debt losses.
For example, a policy contract can offer cancel-able coverage (the credit limit on an account approved by the insurer can be reduced or revoked) or non-cancel-able coverage. Some policies may offer no-fee collection services. Furthermore, different ranges of indemnification are offered.
Consequently, pricing can vary significantly. A carrier’s pricing algorithm includes many variables such as volume of sales, average AR, industry sector exposure, terms of sale, and the buyers’ country of origin. That’s why Trade Credit Insurance is a product best purchased through a broker who will secure quotes from multiple carriers in order to ensure that the best terms and pricing are achieved.
Typically, a trade credit policy will be a fraction of 1 percent of sales, which is less than 100 basis points. Please note: private market carriers have minimum premium requirements (fully earned and due at policy inception) ranging from $10 thousand for domestic policies to $25 thousand for export policies depending on the specific coverage and terms of the policy contract.
Your Virtual Credit Manager stands ready to help you assess if Trade Credit Insurance is right for your company. We can also match you up with a knowledgeable broker who can customize a policy that fits your needs.
A Great Option for Exporters
The Export–Import Bank of the United States (EXIM) is a government agency that provides a variety of tools intended to aid the export of American goods (i.e. goods at least 51% manufactured in the US) and services. The Bank is chartered as a government corporation by the US Congress and has been achieving its mission of supporting US jobs since its inception in 1934. EXIM does not compete with but fills in the gaps left by the private market insurance carriers. Unlike the private insurers, there are no minimum premium requirements, but a small $500 refundable deposit may be required. Additionally, premiums are collected monthly and are calculated on actual shipments, making EXIM’s policy offerings budget friendly.
How to qualify for an EXIM Trade Credit Insurance policy
The following are EXIM’s published criteria, though experience dictates they are often relaxed:
In the same line of business for at least three years
Must have a D&B number and no derogatory info
One year of exporting experience
Recent financial statements
The Benefits of Trade Credit Insurance
Increased competition is benefiting policyholders. In the past, mono-line carriers strictly offered whole turnover coverage but increased competition from international carriers entering the Trade Credit Insurance market have forced carriers to be more creative and flexible.
For example, carriers now offer key account policies, allowing companies to choose to segment their insured accounts. In addition, coverage can be purchased to protect only your largest accounts. Or, if your large accounts are considered low risk, they can be excluded from coverage in favor of insuring only your small accounts. A savvy broker can suggest many strategies for carving out a portfolio of accounts which will provide an attractive spread of risk for the carrier and help you avoid the situation where the carrier only insures your low risk accounts to leave you without coverage on your higher risk accounts.
Here’s a summary of the benefits offered by Trade Credit Insurance:
Loss Protection - Ultimately, bad debt is eliminated and cash flow is preserved as a result of claim payments. Subrogation efforts are led by the carrier.
Peace of Mind - All credit risk is transferred to the carrier, so the executives can focus on building the business.
Increased Competitiveness - Your competitive edge is maintained when you are able to offer open account terms to a marginal account when your competitors won’t take the risk.
Funding Facilitated - An insured Accounts Receivable (AR) is valuable collateral for asset based loans. Without the insurance, you will be charged a higher interest rate and offered a smaller loan or revolving credit line.
Enhanced Working Capital - Greater access to credit and the backstop against bad debt losses will improve your liquidity.
Customer Insights - Access to the insurer’s business intelligence can facilitate sales contract negotiations with both customers and prospects.
Drives Growth - Facilitates safe expansion and allows you to deal confidently with new clients and increase credit lines to existing customers
Cost Effective - The annual cost of the policy is typically less than half the price of a letter of credit and requires much less administration. Also, other business expenses are eliminated such as the cost of credit reports, the need to hire a credit analyst and the performance of other credit and collection tasks, which are instead handled by the credit insurer.
A Lesson Learned…
A company decided to investigate using Trade Credit Insurance in order to comply with the terms of their asset based loan. The bank was willing to accept all their export accounts as collateral with the exception of the Mexican accounts. Insuring all their export accounts was discussed, but ultimately the decision was made to purchase a policy only insuring the Mexican accounts, meeting their banks’ minimum requirement. Mid-policy period, one of their Canadian accounts, a loyal customer with a long history of on time payments, declared bankruptcy causing a loss of $250,000. At renewal, the decision was made to insure all of their export accounts.
Some Final Considerations…
Trade Credit Insurance gained popularity in Europe as a tool to rebuild those economies following WWI and WWII, and is now supporting businesses worldwide. In fact, many companies consider Trade Credit Insurance a necessity rather than a discretionary purchase.
For startups and other smaller growth companies, there comes a point at which Trade Credit Insurance becomes a viable option for cost effectively managing a very significant portion of the credit function. This is especially true for small businesses involved in exporting. Exporting on open terms is quite simply much riskier than domestic sales.
The key to reaping the benefits of Trade Credit Insurance is to work with a savvy broker who endeavors to teach their clients how to leverage their Trade Credit Insurance policy. It’s an investment which pays for itself in saved expenses and safe credit sales growth.
About the Authors
Kimberly Kelly is the founder of Trade Credit Specialty, a credit insurance brokerage that offers a consultative approach to their client’s needs. She is a 20+ year insurance industry veteran with a proven track record of client success.
David Schmidt is Managing Director of A2 Resources, a business credit consultancy founded in 1994, as well as being the Founder of YVCM. He is also co-author of “Power Collecting: Automation for Effective Asset Management” (J. Wiley & Sons, 1998).