There has been a lot of buzz in the credit industry lately over trade credit insurance. Should I consider it? Would it be valuable protection for my company? What does it cover? Many of us assume that with the onset of COVID-19 we are going to need insurance to protect our companies, but is that really true?
Before I get into my opinion, let's define what type of insurance this is.
What Is Trade Credit Insurance
This coverage can be purchased to insure your receivables against non-payment from foreign and domestic customers. If your customer goes bankrupt or insolvent, the insurance policy will pay you a percentage of your amount owed.
According to Insurance Business Magazine, a trade credit insurance publication, the percentage one can expect to receive after claiming the policy is anywhere between 75 to 95 percent but could be higher or lower depending upon the type of coverage purchased.
The insurance policies are also very flexible. Purchasers can have the policy cover all receivables or only select customers. Usually selected customers are ones "key clients," which generally account for 80% of a policyholder's revenues. It may not be worth the cost to insure the remaining 20% of your receivables and instead rely upon regular due diligence (credit management).
The trade credit insurance industry publication, Insurance Business Magazine, noted that only 5 percent of American creditors purchase trade credit insurance. Instead, American creditors choose to self-insure, meaning they employ credit teams to manage risk and place a bad debt reserve on their balance sheets to account for losses in a specific period. If this type of insurance provides so many advantages, then why do 95% of creditors set aside so much capital in their financial statements to cover the potential bad debt?
The Answer Is Cost
95% of American creditors would rather self-insure than pay the associated premiums and deductibles in connection with trade credit insurance policies. The vast majority of creditors, when self-insuring, would do well then to quickly engage a professional third party to assist with the recovery of bad debt. Acting quickly will cost you a commission fee to the third-party collection agency, but only if they are successful in recovering your money. Faster recovery of a commercial creditor's receivables could mean they can free up some of the bad debt reserves held on their balance sheets and redeploy that capital to make additional investments and profits. Otherwise, money just sitting there is "dead money."
As of the date of writing this article, the world is amid a viral pandemic, the likes of which have never happened in modern history. Given the state of uncertainty (second wave infections, ending of government assistance programs, and no definitive end-date) trade credit insurers are covering fewer and fewer transactions. Remember, an insurance company's job is to collect premiums and not pay out claims. Writing trade credit insurance policies in today's market will be extremely difficult for insurers. If you are shopping for this type of coverage, expect to have some degree of difficulty finding a carrier. And if you manage to find a carrier, expect the policy to be equally expensive, with more restrictions than the past.
So, What's The Bottom Line?
Never underestimate the power of a group to solve its problems. If fully 95% of American creditors choose to self-insure, rather than purchase trade credit insurance, that statistic alone is pretty compelling. However, if you are a firm that exports most of your products or services to foreign jurisdictions (another country), then we recommend trade credit insurance.
If a debt goes bad in your own country, you have the tools and resources to manage a domestic problem. Should you have an international bad debt, then trade credit insurance will cover your loss. They will take on the task of the collection in the foreign jurisdiction by hiring a local law firm or in-country collection agency to recover the debt.