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Trade Credit Insurance Explained - with working examples

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What is credit insurance?

Credit insurance is a type of business insurance which covers losses arising from non-payment for goods or services.

It means that should the worst happen – a customer’s insolvency or protracted default – the policyholder can protect their bottom line and maintain their cashflow.

How does trade credit insurance work?

Trade Credit insurance protects you against bad debt. So if the worse happens, you still get paid.

Why do you need credit insurance?

Credit insurance gives you essential cover against credit risks such as non-payments or late payments. If a customer doesn’t pay, you can simply claim against your insurance policy.

The COVID-19 pandemic, current recession, and rapidly changing financial health of many businesses have made credit insurance more important than ever. In uncertain times, you need to be certain your cash will keep flowing. Which is where credit insurance helps.

“We would recommend Coface because the policy is so flexible and easy to manage. When we had to make a claim, the service was very good and they paid within a month.”

Irene Rous, Credit Control Supervisor, Smeg UK

What does credit insurance protect against?

Credit insurance covers you against bad debt, late payments, political risk, natural disaster, pre-shipment risks and more. Policies will vary depending on the business and the insurer.

Types of credit risk

  • Bad debt due to customer insolvency
  • Protracted default (late payment)
  • Political risk – non-payment because of events like wars, disasters or exchange restrictions

Risk level

There were 17,196 underlying company insolvencies in 2019, according to the Insolvency Service.

  • Coface economists forecast insolvencies will be 33% higher in 2021, compared with 2019.
  • According to Pay.uk, UK SME late payment debt stood at £23.4 billion in 2019, with 54 per cent of SMEs affected by overdue payments.
  • Research by the Federation of Small Businesses (FSB) showed 62% of small businesses were subject to late or frozen payments because of the Coronavirus pandemic.

The possible consequences

  • The UK Small Business Commissioner reports that 20% of UK small businesses have experienced cash flow problems due to late payments.
  • It is estimated that a quarter of company failures are due to defaults on payments.
  • Bad debt could wipe out a company’s profits and force it to increase productivity just to make up lost revenue. For example, a company with a margin of 4%, would need to increase turnover by £250,000 to make up for a loss of £10,000.
  • Chasing unpaid debts incurs additional costs (collections agencies, legal proceedings etc) and demands on your time, causing an unwelcome distraction from your real purpose.

What are the benefits of Coface credit insurance?

Coface has been a global leader in credit insurance for 75 years. With Coface, you can:

  • Safeguard your business against bad debt and establish realistic credit limits for customers
  • Run credit risk checks to monitor the financial health of your customers and assess risk before you trade
  • Access our debt collection service to rapidly collect late payments
  • Unlock better financing options, including more favourable borrowing terms
  • Identify opportunities for growth both domestically and in new markets

 

What is credit insurance diagram

 

Coface are a valuable source of information about potential and existing customers and will go out and meet a customer if necessary. That adds significant value for us.”

John O’Connell, Group Treasurer, Origin Enterprises

How does credit insurance work?

When you set up a credit insurance policy, you provide information on your business and customers. This includes a list of top buyers and a recent loss history. We review the financial health of your buyers to establish credit limits and terms of business, such as the maximum invoicing period.

In some cases, automatic coverage up to a certain amount or percentage of sales is granted to give greater trading flexibility.

During the course of the policy, we continually monitor your customers and adjust coverage accordingly. Likewise, as your company expands its sales, new customers can be added to the policy.

You can file a claim when a customer is insolvent or financially unable to pay the balance owed.

“It was very easy to get up and running with Coface. We gave them a list of our account customers and all the credit limits were in place before we made the transition.”

Rob Bowrey, Chairman Stanley Gibson

How Credit Insurance works diagram

Is a credit insurance policy different from other types of insurance?

With most types of business insurance, such as employers’ liability or buildings insurance policies, the provider has little contact with their policyholder between renewal times, unless they receive a claim.

By contrast, the best credit insurers actively support a company’s trading throughout the year and provide an early warning system about changes in the risk status of customers so it can avoid foreseeable losses.

To be effective, credit insurance should be a partnership between both parties. The policyholder tells the insurer about customers’ payment behaviour and notifies overdue payments. The insurer feeds this customer information into its database alongside data from other sources, such as financial statements and public records.

Meanwhile, the insurer gives the policyholder access to its wealth of business intelligence and expertise in credit risk. Working together, they can determine the level of credit risk, adjust the level of cover and agree credit limits, assess the financial health of customers and focus on the most profitable.

How much does credit insurance cost?

There are credit insurance policies to suit all budgets. Premiums are generally set according to turnover and business profile – including industry sector, number of customers and previous loss history.

After an assessment, the credit insurer will provide a quote that sets out price and policy terms, including amount of cover, level of self-retention (typically 10%), and whether there’s a deductible or minimum threshold for claims.

How else can credit insurance benefit businesses

Better banking terms

Banks are more likely to lend to businesses that have credit insurance, as well as provide larger lines or reduced financing fees for covered receivables. Borrowing costs are also often lower. The opportunities and cost savings provided by trade credit insurance can offset the cost of the policy.

“As traders, we obtain working capital from our bank and then we receive our money when the customer pays. The banks themselves make credit insurance a condition for access to trade finance.”

Sergio Vignone, Credit Manager

Mitigate against loss

For example, a manufacturer with a margin of 4% that experiences a non-payment of £50,000 would need 25 equivalent sales to make up for a single instance of non-payment. Credit insurance mitigates against this loss.

Save money on expenses

You can cut spending on credit information as that’s covered, and you won’t need to waste resources on chasing collections. Your company can also deduct the cost of the policy as a business expense.

Free up bad debt reserves

Capital set aside as reserves can be freed and converted to earnings.

Increase sales

Credit insurance lets you offer more competitive credit lines to existing customers as well as identify new market opportunities. Making it easier to grow your business. Multiplying this increase by several customers could easily offset the cost of a policy

A real life example of using credit insurance to increase profits

A business wanted to expand sales with its current customers but was not completely comfortable offering them higher credit limits. They contacted Coface credit insurance to cover the higher credit limits so they could increase the amount of credit offered to customers without risk. This let them grow revenues and deliver more profits.

This business was able to capture £300,000 of incremental gross profit from just one trading partner. These benefits can be multiplied across a broad portfolio of its customers.

A real-life example of using credit insurance to improve lending terms

A wholesaler of chemicals and raw materials improved its ability to secure credit by adding credit insurance. The company, which sells to overseas customers, needed to provide more transparency to its lender, who was concerned about foreign receivables in the borrowing base.

“We purchased trade credit insurance initially to facilitate the perfection of our credit line facility,” says the managing director and CFO. “From the initial objective of providing comfort to our banks, the service added depth to our business decisions.”

The interaction allowed the company to assess its clients’ condition more accurately and has been a valuable tool in business development.

Additional services

We also offer two additional services to enable you to trade safely;

  1. Information Services, check the financial health of your suppliers, monitor your sector, make stronger deals and avoid risk.
  2. International Debt Collection, use our professional and effective service to collect late payments. Leaving you free to focus on your core business.

Want to know how Coface can help your business know more and grow more?

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