Credit Insurance - protection from late payers
Credit insurance (also known as trade credit insurance or business credit insurance) is one method that businesses use to assist in managing their credit risk. Trade credit insurance can protect firms against the risk of bad debt by insuring them against the possibility that customers will default or become insolvent.

Trade credit insurance can be arranged through brokers and insurance companies. The major providers in Australia include: Coface, Atradius, QBE and Euler Hermes. The costs (called a "premium") are usually charged monthly and are calculated as a percentage of sales or as a percentage of all outstanding receivables.

This form of insurance can provide a range of benefits for firms however companies generally utilise credit insurance for the following reasons:

  • sales expansion - if receivables are insured a company can safely sell more to existing customers, or go after new customers that may have otherwise been too risky. This includes expansion into new international markets
  • better financing terms - in some instances a bank will lend more capital or provide a better funding rate against insured receivables
  • reduce bad-debt reserves - credit insurance provides indemnification from customer non-payment, freeing up cash for the company.

Credit insurance can be an important component in a firm's credit management process as it assists firms to manage their credit risks and provides the protection of insurance cover within the terms of the policy. However it is not a substitute for prudent, thoughtful credit management. The intent of a trade credit insurance policy is for both parties - the business and the insurer - to share the risk and therefore, sound credit management practices must be in place before a trade credit insurance policy is bound. 

Before developing or granting a policy, an insurer will make certain that the policyholder is capable of meeting a range of obligations. For example, the insurer will require evidence that a business meets minimum standards of efficiency in credit control, including proof that trading terms are clearly defined and agreed between the parties and that credit application forms are always completed by customers.

In addition, as part of the process to ensure that the risk threshold of the insurer and the business are aligned, the provider will examine the following elements of a business:

  • the annual turnover of the business
  • previous experience of bad debt losses
  • the length of credit given by the business
  • the status of the buyers
  • the trade sector in which the business operates
  • the size of individual accounts and the proportion they represent of the total turnover.

The insurer will then set a credit limit on each buyer, with the premium reflecting the average credit risk of the insured portfolio of buyers.

A trade credit insurance policy, if used properly, provides a valuable extension to a company's credit management practices. It can provide an objective perspective when approving buyers, as well as an early warning system should things begin to decline. Used together, an effective credit policy and trade credit insurance will ensure that exposure is effectively managed and that the firm's revenue and bottom line are protected.

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