What is trade credit insurance ?
For all businesses, extending credit to customers involves a certain amount of risk. You can, however, minimise this risk by insuring yourself against the possible default and insolvency of your customers. Trade credit insurance covers businesses against the risk of bad debt due to the insolvency or protracted default of their buyers. Credit insurance covers thousands of businesses who trade within the UK, but has perhaps been better known for its application to export businesses. Trade credit insurance can be an important tool in credit management. It can also provide a replacement of working capital when bad debts and late payment impact on cashflow. Credit insurers
(i) help their customers to manage credit risks more effectively and
(ii) provide the protection of insurance cover within the terms of the policy.
Types of Policy and Cover
Most trade credit insurance is tailor-made. The needs of businesses vary so widely that a standard policy will not fit all cases. A number of insurance companies underwrite trade credit insurance but many tend to specialise in particular areas. Some companies, for example, concentrate on insolvency and default, usually on a 'whole-turnover' basis. Other companies concentrate on 'specific accounts' cover. Again, some companies cater mainly for 'bulk buying' businesses whereas others underwrite businesses involved in one-off special situations. The cost of the insurance premium will vary and will be dependant upon the type of cover required. As with any commercial transaction it is important that businesses shop around to obtain the widest possible cover at the best available price. Whole-Turnover Policy covers the whole of the policyholder's business and allows the policyholder to grant credit up to a stated limit. Above this limit, credit must first be agreed with the insurer. Insurers are geared up to give their customers speedy and accurate decisions on credit limits for new buyers. Specific Account Policy can be on a fixed or adjustable basis and will cover a number of named buyers. The premium will be based on the amount of debts outstanding, among the named buyers, at any one time. If a specific account policy is underwritten on a turnover basis this will apply to a single contract or series of deals with one or more named buyers, generally for a period of 12 months only. The premium payable will be based on the value of the contract or on the volume of turnover during the lifetime of the policy. Another form of specific account cover can protect against loss arising from the policyholder's failure to complete contractual obligations of a financial nature. Supplier Default Cover protects against any loss as the result of the insolvency of a supplier. Delivery Guarantee Cover compensates a customer in the event of a supplier failing to meet delivery commitments. This form of cover originally applied only to British exporters to the EU but is now available, from some insurers, for transactions within the UK. Credit Guarantee Cover requires full consultation between the purchaser and the insurer. It enables a purchaser to provide the seller with a specific credit insurance on that purchaser. Variations are available to all forms of policy.
For example: First loss can be included on each and every account which is insured. An amount is deducted from every loss before the insured percentage is applied to the balance. Again, this helps to lower the cost of insurance. Annual aggregate first loss is a limit set within a policy up to which accumulated qualifying losses are not payable by the insurer. The insurer is only liable for qualifying losses once the aggregate first loss is exceeded. By accepting an aggregate first loss it will usually mean a lower cost for insurance as the policyholder is bearing the first part of the risk themselves. Threshold is a level of loss below which there is no claim under the policy. Policies can be worded to protect a buyer where whole or part payment has to be made in advance of manufacture or delivery. Some form of cover against pre-delivery risks may also be included.
Trade credit insurance can provide a range of benefits for small and medium sized companies. However, they are not necessarily suitable or available for all businesses. There are a number of considerations to be made by both the insurer and the business seeking cover. Credit Control The insurer will want to see certain minimum standards of efficiency in credit control. They will, for example, want evidence that trading terms are clearly defined and agreed between the parties and that credit application forms are always completed by customers. Once in force, a well designed credit policy will not only help a business to avoid late payment and bad debts, but also to increase sales. Credit Limit The credit limit amount is the key element in credit insurance policies and is the maximum amount for which a business can be insured in respect of a buyer at any one time. This limit is set by the insurer. Premium Rating and Cost Determining costs of trade credit insurance can be difficult because 'tailor-made' policies are so common. Insurers will, however, look at a range of criteria before designing a policy and setting a premium rate.
The main criteria include:
- The annual turnover of the business.
- Previous experience of bad debt losses.
- The effectiveness of the credit control system.
- 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.
Policies can be either a 'whole turnover' basis or a 'specific account' basis. Whole-turnover policies generally cost between £0.20% and £0.50% of annual turnover. Specific account policies may also be calculated on turnover but are more often rated on the amount of insured debt owing at prescribed intervals. Obligations As with all forms of insurance, the policyholder must meet certain obligations. The business must be prudent in granting credit to insured buyers. A percentage of debts will not be covered by the policy. In effect, the insurer and the policyholder share the risk, with the insurer taking 75% or 95% of the loss. The policyholder must not agree, without consulting the insurer, to postpone the due date for payment of an insured debt. The insurers can usually cancel or alter the limit of credit approved on any particular buyer. These cancellations or reductions, however, can usually be applied to future business only.
For credit insurance, where 'tailor-made' policies are so common, it is difficult to list the underwriting principles in every case. They do, however, include:
- Terms of payment must be appropriate to the goods or services being provided.
- Both parties - that is the business and the insurer - should share the risk. For this reason policies generally cover between 75% and 95% of a loss.
- The policy gives no guarantee of payment at the due date.
- Only agreed debts are covered. There can be no claim unless a dispute is resolved.
- In the event of an insolvency you must be admitted as an insecured creditor.
In considering whether or not to grant trade credit four basic decisions are needed. To whom, how much, for how long and under what terms. When granting cover credit insurers will look closely at the way these decisions are taken and may well suggest that the business changes or improves its credit control system. In short, trade credit insurance is designed to minimise the credit risk and to provide cover against late payment and/or insolvency.
How to buy Credit Insurance
Trade credit insurance can normally be arranged through insurance brokers or insurance intermediaries. Insurance Brokers are full-time specialists offering advice and help in arranging insurance cover. Any individual or firm using the title 'insurance broker' must, by law, be registered with the Insurance Broker's Registration Council, the body with responsibility for ensuring that the requirements of the Insurance Brokers' (Registration) Act are met. The requirements include financial controls and professional qualifications. Company Agents/Insurance Intermediaries who are not able to use the title 'insurance broker' may be company agents representing a maximum of six insurance companies, or independent intermediaries with no limit on the number of companies with whom they can deal. Both independent intermediaries and company agents selling non-life insurance must follow the ABI Code of Practice for the Selling of General Insurance. Where policies are arranged through an insurance broker or independent intermediary there is usually no charge for the service as they are paid by the commission which is met by the insurance company. Sometimes brokers are willing to arrange cover net of commission by charging a fee to the policyholder. The usual procedure is for policyholders to declare all their business undertaken with other independent businesses/third parties. Clearly, the policy cannot cover business involving associated companies, local authorities or government bodies.
As with other forms of insurance the proposer must disclose all material facts. Questions usually posed on the proposal form concern:
- The annual turnover to be insured together with any overseas territories to which cover will apply.
- The number of accounts and details of trading terms.
- For whole-turnover policies - an analysis of the number and size of active accounts together with details of bad debt experience.
- A description of the business itself and of the trade sector within which it operates.
- Details of the method of credit control. This is an important factor in the underwriter's decision.
- Details of any accounts which enjoy special trade terms.
- Details of accounts which are seriously overdue.
- As far as the main buyers are concerned, names, addresses and credit limit requirements.
Insolvency claims are payable if the underwriters are satisfied that the insured debt is admitted as an unsecured debt against the insolvency estate. For this purpose, insolvency is defined clearly in the policy wording. Protracted default is defined as existing when a buyer, having accepted delivery of goods, has failed to pay for those goods at the end of a period of 90 days after the due date. Claims for protracted default are payable within 6 months from the date on which the default occurred.
Which Businesses are Suitable for Trade Credit Insurance
Trade credit insurance is available to many businesses including wholesale. It is not so appropriate to the retail sector where the viability of buyers is far more difficult to assess and underwrite.
When seeking appropriate insurance cover it is worth taking advice on not only the cover available but on where to obtain such cover. Information on appropriate brokers can be provided by the United Kingdom Credit Insurance Brokers Committee. This body operates under the auspices of the British Insurance and Investment Brokers' Association.
British Insurance and Investment Brokers' Association
The British Insurance Brokers' Association (BIBA) is the UK 's leading general insurance organisation representing the interests of insurance brokers, intermediaries and their customers.
BIBA membership includes 1700 regulated firms . Insurance brokers and intermediaries distribute nearly two-thirds of all UK general insurance. In 2007, insurance brokers and intermediaries generated £1.5 billion of invisible earnings and they introduce £22 billion of premium income into London 's insurance market each year.
Association of British Insurers
The ABI (Association of British Insurers) represents the collective interests of the UK's insurance industry. The Association speaks out on issues of common interest; helps to inform and participate in debates on public policy issues; and also acts as an advocate for high standards of customer service in the insurance industry.The Association has around 400 companies in membership. Between them, they provide around 90% of domestic insurance services sold in the UK. ABI member companies account for almost 15 per cent of investments in the London stock market.