With trade customers holding the potential to both make and break a business, financial protection is top of the agenda for most business owners – and this is precisely the role of credit insurance.
Transferring risk away from the business and over to an insurer, credit insurance protects the policyholder in the event of a customer becoming insolvent or failing to pay its trade credit debts. Not only this, but insurers can actually help to reduce the risk of financial loss through credit management support.
What types of cover are included in a credit insurance policy? And in which circumstances might you need one?
Types of credit insurance
Firstly, let’s look at the types of credit insurance available. There are several key options to choose from depending on the risk you might be exposed to, which are detailed here:
Whole turnover credit insurance
This is the most common type of credit insurance policy and it covers all (or most) of a business through a comprehensive policy based on its turnover – protecting a business from non-payment from all current and future customers over a typical 12 month period. It allows a company to offer its customers credit up to a fixed limit, with an overall premium priced on its annual turnover. Businesses can choose a fixed policy with a set premium price, or they can declare their turnover both at the start of the policy and at its end to receive a rebate, if their turnover was less than initially forecast.
Major buyer policy (critical customer cover)
Unlike a whole turnover policy, major buyer cover allows you to insure your business against a named customer failing to pay. As a rule, this type of cover allows you to name up to 10 key customers, which are likely to be the customers who would cause the most impact through non-payment. Also known as a key accounts or named buyer policy, this type of credit insurance is also useful for covering customers with a poor credit rating or who might be likely to go bust, which could leave your own business vulnerable. You can select the limit level, but you remain completely responsible for all customers not named on the policy.
Single risk cover
Also known as specific risk insurance or a single buyer policy, this type of cover protects a business from non-payment from a single customer or contract. The price of the premium is based on the size of the turnover of the customer or value of the contract, and it’s often taken out by companies who rely on a main byer for the majority of their sales. This type of credit insurance can be requested by funders or investors who want the business to buy protection against a primary customer. Often this is seen in public companies but it can cover any company with a good quality of credit.
Export trade credit insurance
This type of trade credit cover safeguards a business from their overseas customers failing to pay. Businesses can take out a policy that covers purely their exports or their domestic trade, but most policies will accommodate both. As such, export trade credit insurance is often integrated into a standard policy for businesses who trade internationally, and it can offer a breadth of protections as well as standard cover for insolvency and defaulting customers. For example, businesses can take out cover for anything from political risk to currency shortages to social and economic instability to government intervention.
When does trade credit insurance come into play?
Laurence Hill, Director of S-Tech Insurance Services Ltd in Cambridge, has worked in the finance sector for more than 30 years and is a specialist in the field of credit insurance. He explains: “Insolvency, where a business cannot pay its debts, is a common scenario. If you receive a note from an insolvency practitioner saying that one of your customers has been put into insolvency, that’s the point at which a claim would be triggered.
“Credit insurance policies also cover defaults,” he continues. “Any business owner will know it’s fairly common for customers to pay after the due date of an invoice. However, there comes a point where the payment becomes so late – it might be 60 or 90 days past the due date, depending on the policy – that the insurer should be notified. A certain number of days after the notification, they will consider a claim.
“By that point you could be taking some sort of legal action against the customer to recover your money. However, the insurer may still consider and pay a claim while your litigation continues. This is usually only if the debt isn’t under dispute, unless you have dispute cover. In that case, the insurer will pay out regardless and recover the funds once the dispute is resolved.”
Protection against international risks
“The other key situation where a credit insurer would step in is a political event,” Laurence explains. “For example, a company might have exported goods to another country. The government of that country subsequently imposed sanctions on the UK, preventing the customer from paying for those goods. If the company had political risk cover added onto their credit insurance policy, a claim would be triggered by this event.”
Political intervention isn’t the only potential problem facing exporters. “They are also particularly vulnerable to loss due to the lack of information available on customers abroad. This can be coupled with language barriers, which can become more apparent when discussing overdue debts!”
Credit insurance: added value
Credit insurance providers can offer expert assistance as well as cash-flow protection – particularly when setting credit limits. Relying on credit reports and trading history as a form of risk assessment often proves to be inadequate and time consuming for businesses. However, a credit insurer can manage trade credit risk effectively and efficiently on behalf of policyholders.
“Credit insurers have huge databases of information, which they can use to quickly set credit limits (i.e. the maximum amounts that can be owed to a policyholder). The insurer can then monitor the situation in case of any positive or negative changes in the customers’ risk profiles, and alert the policyholder accordingly,” Laurence explains.
“As a policyholder, you could request a credit check (a.k.a. limit application) on a customer. Your insurer would assess the risk and send back a decision on the levels of credit you should extend. It may or may not be what you hoped for, but at least you’d know it had been properly risk assessed and that you’re insured.”
Most insurers require policyholders to carry out this process for each of their customers, but some offer ‘discretionary limits’. These allow policyholders to set their own credit limits based on certain criteria. Others offer ‘non-cancellable limits’. That means they’ll write a limit – either at the outset of the policy or during the policy period – and then hold it there regardless of any problems that might arise with a customer’s risk profile, such as late-filed accounts (providing, of course, that the customer continues to pay their debts to the policyholder in a timely manner!).
In addition, some insurers offer a free worldwide debt collection service. They will step in to collect a debt on the policyholder’s behalf if it remains unpaid after a certain amount of time. They may even sue the buyer and pay the policyholder’s claim if the debt cannot be collected.
As ever, it’s important to keep a paper trail, should the need to make a claim arise. “Claims are submitted to the underwriter via a claim form, along with evidence of the cover and loss, as well as any related documents. That means invoices, statements of accounts, evidence of insolvency and proof of delivery, etc.,” explains Laurence.
Business growth risks
“Business owners also need to consider the risks associated with growth,” adds Laurence. “New customers, new markets and requests for higher credit limits from existing customers all bring additional risk to a business. Growth can stretch a business’ cash flow and leave it less able to sustain a loss.”
Speaking of growth, credit insurance can be looked upon favourably by lenders when a business seeks funding. “Any funder holding a charge over book debts will take comfort in the knowledge that this part of their security is backed by insurance. It may also be formally assigned to them. So, in the event of a loss, the claim funds are routed directly from the insurer to the funder,” Laurence explains.
Navigating the post-Covid market
As with any insurance product, it’s important to choose the right policy and level of cover to ensure you have adequate protection. And with a wide and competitive marketplace, specialist credit insurance brokers are well-placed to ensure their clients receive the most affordable and appropriate deals.
“A specialist broker will not only provide its clients with a wider view of the whole market, but should also be able to drive the best deal. They will also remain on hand to support clients through the policy period and assist with the renewal process when the time comes,” Laurence affirms.
This is particularly true in the current market. At the moment, trade credit companies are focussed on helping their clients manage and maintain credit limits, influenced by two main factors – the first of which is the pandemic. Currently, insurers are underwriting against balance sheets being filed that are all pre-Covid, which is making them nervous. As Laurence explains: “While insurers can see a company’s financials are fine leading up to the pandemic, they can’t see what has happened during the Covid crisis so they are reducing limits where they can.”
The second factor is the government moratorium on winding up businesses coming to an end on 30th September 2021. “Insurers are anticipating a pent-up tidal wave of insolvencies coming from October and into next year,” Laurence says. “And with the furlough scheme coming to an end too, plus the upcoming repayments of the Coronavirus Business Interruption Loan Scheme (CBILS), there’s a lot of financial pressure that will come to bear on businesses after 30th September, which is when we expect to see claims rise and an influx of new business enquiries as more people look to protect their credit.”
Until then, Laurence says the ongoing pause on companies going insolvent has led some to believe they don’t need trade credit insurance “because the government has been pumping so much money into the economy and pressed pause on businesses winding up, so they can’t see the evidence of insolvency.” That looks more than likely to change, however, so while insurers are concentrating on maintaining and writing limits for their existing customers, and renewal rates remain soft, now represents a good time to explore trade credit cover in advance of the wave of claims and enquiries that is expected from October onwards. And a specialist broker is perfectly placed to find the best solution.
Key trade credit companies
Brokers have the right relationships with a range of insurers that enable them to get the most suitable cover for each client. Laurence highlights the following companies as being some of the key providers Alan Boswell Group works with:
- Euler Hermes – one the world’s leading trade credit insurers with a history spanning more than a century and offices operating in over 50 countries. Its global reach is down to key acquisitions of specialist trade credit companies, such as Trade Indemnity in the UK, and today it’s well known as an international expert in the areas of surety, debt collection, fraud insurance, structured trade credit and political risk.
- CoFace is driven by their belief in business as a force for good in the world. They have an international network dedicated to credit insurance and risk management, and they help customers with credit decisions to strengthen their ability to sell domestically and overseas.
- Nexus is a London-based group founded in 2008, which has since grown into an international independent specialty managing general agent (MGA). Represented in nine key countries, Nexus offers perceptive trade credit policies and guidance among their specialties.
- AIG – a global insurance company offering a range of products, AIG is one of the largest companies specialising in the UK business insurance market – covering thousands of mid-sized and smaller companies, as well as many public sector organisations.
- QBE – headquartered in Sydney, QBE is a general insurance and reinsurance company with offices in 27 countries and a focus on commercial specialty products and risk management solutions.
- Chubb is the world’s largest publicly traded property and casualty insurance company, who we occasionally work with for specialist cases.
Laurence adds: “On some occasions we also partner with UKEF, the UK’s export credit agency, to write single risk insurance for exports outside the UK. In these instances, we will write a single limit to protect from insolvency for a single buyer-based transaction.”
A case in point
During his career, Laurence has seen countless examples of the value of credit insurance. “For example, I encountered a business that had only decided to purchase a credit insurance policy after a year of trading. It previously used local knowledge and trading history to set credit limits for its customers. Almost immediately after taking out the policy, the business suffered a loss against a customer with an insured credit limit of £20,000. Unfortunately, the loss amounted to around £80,000. Because most of the debt was accrued before the policy – and a carefully researched credit limit – put in place, £60,000 of the loss wasn’t covered by the insurance.
“This demonstrates the need for using an expert to manage your credit exposures and set appropriate levels of credit for customers – preferably from the very start.”
If your business is trading with customers under open credit terms (as opposed to pro forma or with letters of credit), then credit insurance could prove to be a life-support machine, especially in a post-Covid world. After all, your trade debtors are likely to be among your most valuable assets – and that makes them well worth protecting.