Trade credit insurance protects the policyholder’s business against risks which are beyond his control. It insures the manufacturers, traders and other businesses against the risk when their buyer does not pay them or pays very late.
Thus, it protects the accounts receivable from loss due to credit risks such as:
When the buyer becomes insolvent and does not pay the manufacturer or the trader for the receivable sold to him
When the buyer is unable to pay the receivable amount within a pre-defined period calculated as per the agreement
When the buyer is unable to pay the amount as he has gone bankrupt
- Political risks:
When the insured is unable to receive the payment due to political uncertainties like war, natural calamity, import/export restriction, license cancellation, and moratorium.
If the insured is not paid by his buyers either due to insolvency, default, or bankruptcy, the trade credit insurance policy protects him as it covers a portfolio of buyers and pays an agreed percentage of an invoice or receivable that remains unpaid.
Credit insurance can also cover the trade with only one buyer. In case of multiple buyers, the manufacturer or the trader needs to apply a credit limit on each of his buyers. This ensures that the sales to those buyers are insured. Thus, with the proper credit insurance to protect the receivables, the company is able to seize the opportunity to protect its balance figures. The premium rate is calculated based on the average credit risk of the portfolio of buyers.
Following are the benefits of the trade credit insurance policy:
- Helps maintain cash flow and profitability
- Paves the way for better borrowing and financing options for the business
- Helps to prevent losses before they occur
- Protect budgets and business plans
- Provides a secure path for client’s information screening
- Improves credit decisions
- Shields the business’s investors and stakeholders
- Protects the company’s Income Statement and Balance Sheet against bad debt
- Reduces and quantifies bad debt provisions
- Increases the business’s profitability
- Helps to grow sales with self-assurance
What are the exclusions of a trade credit insurance?
- Disputes with the buyer resulting in the withholding of the payment either partially or fully
- The insurance company does not pay the cost incurred in resolving disputes between the insured and the buyer
- The insurers also do not account for any penalties or damages which is entitled to payment by the buyer
- Amount owed by governmental department
- The interest accruing after the due date of payment is not paid
- Banking cost is not paid except any amount contractually agreed
- Radioactive contamination
- Buyers who are under direct or indirect control
- Sales contract made with any private individuals
‘Akash Manufacturers’ was a wholesale cloth manufacturing company, which did business locally as well as exported their cloth products. Since the company had many buyers to whom it had given credit, the manufacturing firm had brought a trade credit insurance policy to protect itself against any bad debts, insolvency and the political risks. The profit margin of the company was 5%.
The wholesale company’s credit department had given a credit line to a specific customer. It amounted to 1,00,000 rupees. The same buyer defaulted this payment due to insolvency. Since the profit margin of the company was 5%, the company would have had to generate an additional sale of 2,00,000 rupees to make up the loss.
However, the company had taken the trade credit insurance policy, which approved a 75% limit on the same buyer. Hence the manufacturing firm got reimbursed 75% amount of 1,00,000 rupees, i.e. 75,000 rupees as per the agreed percentage of the default stated in the trade credit insurance policy. The company was able to manage their account receivables and mitigate the loss in this event of non-payment.
The business of Akash Manufacturers was likely to be affected by risk which was beyond their control. However, credit insurance policy saved the day for the company.