The Business Benefits of Trade Credit Insurance

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The Business Benefits of Trade Credit Insurance


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Trade credit insurance—also known as credit insurance or export credit insurance—protects a seller’s accounts-receivable asset in the event of a buyer’s protracted default, insolvency, or bankruptcy. For instance, if your recycling com-pany sold $500,000 of ferrous scrap to a buyer in Turkey, you could take out a policy on that single transaction or on all transactions with the buyer. If the buyer defaults or becomes insolvent, the policy would indemnify your business for the loss, subject to the policy limits, deductible, and/or co-insurance. In addition to protecting your company from receivables-related risks, however, trade credit insurance can help your company grow. How? By allowing you to sell to new markets or buyers with little risk, sell more to existing buyers, and secure your accounts-receivable asset to increase your working capital. Let’s look at each of these business benefits in greater depth.

Opening new markets. Perhaps you’ve considered selling to a new scrap buyer in India, but you’re uncomfortable with the potential risk of sell-ing to the prospect on open account. With trade credit insurance, let’s say you’re willing to increase your credit limit to $1 million to the new buyer. Let’s also assume you’re able to turn the accounts receivable four times, giving you $1 million of sales to this customer each quar-ter, or $4 million a year. If we further suppose your sales margin is 10 percent, then your com-pany has netted $400,000 of potential gross profit by trading with one new customer in a market it considered too risky without trade credit insurance.

Expanding existing sales relationships. This type of insurance also can help your company grow by allowing you to increase the credit limits of existing customers. Say your firm does $5 mil-lion in sales each quarter—or $20 million annu-ally—with a key trading partner on open account terms regarding the receivables. If your company could use credit insurance to extend the terms to $10 million a quarter, or $40 million a year, and make four turns on the accounts receivable, it could increase its annual sales by $20 million. Assuming the same 10-percent profit margin, your company could increase its gross profits by $2 million.

Increasing your working capital. Accounts receivable on open terms is much like a loan, with your company serving as the lender and the buyer serving as the borrower. The accounts-receivable asset is not secure until it is paid, but if you have trade credit insurance on the asset, your com-pany’s bank or other lending institution would view it as secure and would allow your com-pany to use it as collateral. If your company does, say, $30 million in domestic sales and $15 mil-lion in international sales, your bank generally might advance you 50 percent on the domestic receivables and zero on the foreign ones, allowing your company to borrow $15 million based on its domestic receivables. With credit insurance, how-ever, your bank might be willing to advance you 90 percent on the domestic sales and 70 percent on the foreign receivables. Under those terms, your firm could borrow $37.5 million against the same accounts receivable—a $22.5 million poten-tial increase in its borrowing base. The secure status of the receivables also would allow your company to reduce any bad-debt reserve it might carry.

The above benefits don’t come for free, of course. The cost of trade credit insurance depends on a number of factors. The collective credit rating of your company’s buyers is one key consideration. The location of a specific buyer is important and is a factor in calculating the buyer’s credit risk, but insurers also will con-sider the political risk associated with the buyer’s location. Other cost factors include the limit or amount of coverage you seek as well as the poli-cy’s other terms and conditions, such as deduct-ibles, co-insurance, and the carrier’s ability—or inability—to reduce your limit during the policy period. These basics give you a general idea of the benefits of credit insurance, but there’s always more to learn. For additional information, contact your insurance agent or broker.

 

Dan Curran is senior vice president and underwriting officer for Willis Programs (Portsmouth, N.H.), which underwrites RecycleGuard, the ISRI-sponsored insur-ance program. Reach him at 603/334-3027 or daniel.curran@willistowerswatson.com. RecycleGuard has prepared this ar-ticle for informational purposes only. It is not intended to provide legal advice. Readers should not rely on this document or act upon any of the information it con-tains without first consulting competent legal counsel.