Because there are certain risks involved in international trade, there are a number of ways sellers can reduce the risk of not getting paid. There are several financial products on the market to facilitate this, including letters of credit and invoice factoring, and trade credit insurance is one of them.
As the name suggests, trade credit insurance is an insurance product designed to pay out in the event that your customer fails to pay their invoice. This may be for a number of reasons including issues concerning the customer themselves such as default, bankruptcy or insolvency, or even wider issues such as political risk in the country, for example currency issues, political unrest, and expropriation.
It is usually offered by private insurance providers backed by governmental export credit agencies, like UK Export Finance (UKEF).
As with any insurance policy, trade credit insurance provides a safety net should invoices not be paid.
Premiums are usually calculated as a percentage of sales within any given month or as a percentage of all outstanding amounts payable. They will also be based on the average credit risk of the buyers. Policies usually cover a portfolio of buyers (though you can cover individual buyers or single transactions if required) and will pay out a proportion of an invoice that remains unpaid. Credit limits will need to be applied to each customer insured.
The advantage is clearly the reduction in risk around getting paid.
Trade credit insurance can also be used as a finance tool. By insuring any accounts receivable the risky asset (the unpaid account) becomes more secure because it has been de-risked by the insurance. It can then be viewed as collateral to secure funding such as business loans.
The disadvantage is the cost of the insurance, which has to be accounted for (ideally in your selling price) and the riskier your customers are, the higher the premiums are likely to be. It is important to compare costs against the other options for de-risking getting paid to work out which is the best for your business.
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