What is Trade Credit Insurance?
Trade credit insurance is a tool used to reduce or eliminate the risk of non-payment of a companies Accounts Receivable. If a policyholder’s client fails to pay, the insurance company will pay for the loss. This allows a company to reduce the risk it might incur when taking on new—particularly unknown—clients, or when unforeseen economic, business, or other factors that can affect its clients’ abilities to pay their bills. It enables a company to cultivate clients in sectors or geographies that are outside its normal client base or geographic market, do more business with existing clients, and extend more credit to its customers, all without increasing the risk of non-payment.
Trade credit insurance accomplishes this by giving the company access to the insurance company’s credit risk analysis and management expertise, and ability to monitor domestic and global developments that could affect a customer’s ability to pay its bills. Few companies on their own can rival the expertise or database of a major global trade credit insurance provider, but nearly everyone can access that expertise by purchasing insurance.
Key Benefits of Trade Credit Insurance
Many companies initially purchase trade credit insurance to protect capital, cash flow and earnings. They also find that the product allows them to safely and strategically expand their businesses, thereby increasing sales and profits.
Take, as an example, a wholesale company whose credit department had restricted a customer’s credit line to $100,000. The company then purchases a trade credit insurance policy and, after an analysis of the customer’s credit and financial performance data, the insurer approves a limit of $150,000 on that same customer. With margins of 15% and an average days sales outstanding (DSO) of 45 days, the wholesaler is able to increase its sales to realize an incremental annual gross profit of $60,000 on just that one customer account.Trade credit insurance can also improve a company’s relationship with its lender. In some cases banks actually require trade credit insurance to approve a loan. For example, a $25 million scrap metal dealer might have extreme concentration in its accounts receivable because it only has eight active customer accounts. The smallest of these customers has receivables balances in the low six-figure range, and the largest is into the low seven-figure range. The company’s bank becomes concerned about this concentration and requires trade credit insurance to fully leverage the accounts receivable as collateral. The scrap metal dealer purchases a trade credit insurance policy that specifically names all of its buyers, providing the bank the comfort level it needs to increase the eligible receivables.
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