What is trade credit insurance?
In short, trade credit insurance is a way of protecting your business against customer non-payment. Should a customer refuse or be unable to pay their debt to you, your insurance provider will foot a percentage of your bill, protecting your bottom line.
Why you haven't heard of trade credit insurance
Many small businesses are unfamiliar with trade credit insurance because it has historically been unaffordable for most. Now though, technology is bringing this form of insurance from which large corporates have long benefitted, to the small business world.
The vast majority of UK businesses (around 85-90%) trade on credit terms with other businesses. Credit facilitates trade, but it’s also a source of risk: it is thought that around a quarter of insolvencies are caused by bad debt. Credit risk is a pain point for small businesses, whose cash flow can suffer as a consequence of larger business partners’ failure to pay promptly. As a result, many small businesses are rightly wary of offering credit terms on large orders that would leave them high and dry if they became overdue. But concerns about credit risk exposure can prevent businesses from entering new markets and hinder their growth.
Trade credit insurance liberates businesses from this deadly catch-22. When considering offering credit or negotiating terms with a customer, a business can ensure the trade so that if the customer fails to pay on time, their insurance provider will reimburse them a percentage of the outstanding payment, leaving their bank balance unscathed. This opens up new revenue opportunities that would previously have involved an unworkable level of risk.
Though insolvency looms behind inadequate risk management like an anxiety-precipitating rain cloud, the positive impacts of securing your business’ trade are also numerous. Trade credit insurance can give a company the confidence it needs to extend more credit lines to new and existing customers. It can also enable businesses to become more agile, adapting quickly to changing market circumstances, innovate and offer more attractive payment terms than competitors. If it's affordable for you, trade credit insurance is a springboard to significantly increased profitability and cash flow protection, especially in uncertain times.
Business benefits of the Government trade credit reinsurance scheme
The Covid-19 crisis has brought exogenous risk to the forefront of all of our minds, demonstrating that the unimaginable can occur. Especially in small business ecosystems, the interdependency of supply chain members accentuates the need for bad debt protection. Even highly trusted, long-term supply chain partners can be subject to unforeseeable vicissitudes of fate, and thus to cash flow problems resulting in late payments. For small businesses that are typically less able to absorb losses than corporates with more diversified revenue streams, the risk of trading in our current environment is acute.
To mitigate against the risk of post-Covid insolvency contagion in European supply chains, you may have noticed that governments (including our own) are temporarily backing trade credit insurance. What this means for small businesses is that trade can still be affordably insured, curtailing business' exposure to bad debt flowing through their supply chain. Compared with the government's loan schemes, this form of financial support has the benefit of providing economic stimulus by nurturing trade, and tying financial aid more directly to risk analyses. Luckily for small businesses looking to pivot, technology presents a plenitude of opportunities for cash flow enhancement and protection. SMEs can access the government’s trade credit support indirectly via a raft of new products such as invoice insurance, invoice finance and credit risk analysis software. Sometimes it takes a crisis to bring such solutions to the fore.
Factoring versus trade credit insurance
Rather than insuring your trade ledger against non-payments, you can also opt for factoring. This means selling your accounts receivables to a factoring company at a reduced price. The factoring company will then shoulder the risk, and collect your debt for you. Like trade credit insurance, factoring offers businesses improved confidence due to greater payment certainty.
However, the factoring company will take a proportion of the amount that's payable to you. Factoring companies are also unlikely to undertake the debt collection themselves, typically outsourcing this along with the risk to a credit insurance provider. Nor does factoring offer you the benefits of indemnification against loss that come with in-house debt collection.
Trade Credit Insurance: Key Facts
- Trade credit insurers typically cover two kinds of risk: political (e.g. earthquakes, wars, currency shortages), and commercial (e.g. customer insolvencies).
- Trade credit insurance protects against bad debt on payments for products and services that are due within 12 months.
- Trade credit cover ranges from whole turnover to a group of customers, single customer of individual invoice, depending on your business' needs.
- The amount your insurer will pay out in the event of a claim ranges between 75-95%.
- The price of trade credit insurance will correspond to the risk level. Traditionally, this is assessed by an actuary.
- Trade credit insurance is often used to obtain invoice finance, which improves a business' cash flow and can help to accelerate its growth.
Is trade credit insurance worth it?
Several factors are worth considering when determining whether your business would benefit from trade credit insurance. The first and most obvious is the volatility of the industry in which you operate. Bear in mind that the impact of a bad debt on cash flow in high volume, high churn businesses is likely to be greater than businesses with a higher margin. There may also be exogenous factors such as market forces that could impact your customers' ability to pay.
Another consideration is the financial stability of your customers. This can be difficult to access, especially at the moment due to the new Corporate Insolvency and Governance Bill 2020 (more on this in an upcoming blog). Finally, have a look at your level of exposure should one or two of your major customers default on their payments. If a non-payment from an important customer is likely to jeopardise the solvency your own business, then trade credit insurance may be a worthwhile investment. If you need help deciding whether trade credit insurance is for you, you can use this calculator to quickly check the impact of a bad debt on your business.