Navigating the Risks of Non-Payment with Trade Credit Insurance

Matt Vail | Account Executive

The prospect of customers failing to pay their accounts receivable debt is a looming risk for businesses in all industries, especially in the uncertainty of today’s economic landscape. According to Allianz Trade, business insolvencies experienced double-digit increases in 55% of countries, accounting for more than 60% of global GDP, in 2023. This trend in increasing business insolvencies is expected to accelerate in 2024. Additionally, total bankruptcy filings as of January 2024 increased by 17% from January 2023.

For manufacturing businesses, the repercussions of unpaid invoices can reverberate with unique challenges and particular intensity, making them more vulnerable to financial distress. Whether contending with high capital costs, intense competition from low-cost producers, or heavy dependence on volatile commodity markets, the risks loom large. In this environment, safeguarding against losses stemming from customer non-payment isn’t merely prudent—it’s imperative for sustaining growth and stability.

Enter trade credit insurance—a way to insulate against the risk of customer non-payment that threatens to destabilize businesses of all kinds. By extending credit terms, amplifying sales, and fortifying profits, trade credit insurance emerges as a cornerstone of financial resilience. This article will illuminate the nuances of trade credit insurance, as well as discuss its importance in mitigating the risk of non-payment and ultimately improving the financial stability of your organization.

Understanding Trade Credit Insurance

Trade credit insurance is a tool that protects your business from the non-payment of commercial debt by insuring your business-to-business accounts receivable. If your clients do not pay due to a buyer’s bankruptcy, insolvency, or other issues, or if payment is late, a trade credit insurance policy will pay out a percentage of the outstanding debt.

Globally, trade credit insurance supports nearly $3 trillion in trade on open terms each year. According to the World Trade Organization, somewhere around 80 to 90% of global trade is supported by some type of trade credit insurance. On a more local scope, trade credit insurance protects $600 billion in U.S. sales.

The Importance of Trade Credit Insurance

Businesses are driven to secure this vital coverage for several key strategic reasons. By safeguarding against customer non-payment and offering dynamic policy adjustments, trade credit insurance not only protects businesses but also empowers them to pursue strategic growth and market expansion. Below are some of the common reasons that businesses may seek trade credit insurance placement:

• Globalization Initiatives and Enhanced Financing Terms: Organizations venturing into new international markets often face heightened non-payment risks due to potential differences in business practices, legal frameworks, and credit cultures. Trade credit insurance acts as a safety net, providing confidence to explore international markets without succumbing to the fear of non-payment. Additionally, lenders are more inclined to offer favorable financing arrangements when they are assured that accounts receivables are protected against default, enabling businesses to access the capital needed to fund international expansion initiatives. On average, banks lend up to 80% more on insured receivables.
• Supply Chain Resilience: Manufacturing firms rely on a network of suppliers and vendors to procure raw materials, components, and other inputs necessary for production. Trade credit insurance can be extended to cover trade payables as well, providing protection against the risk of supplier insolvency or non-performance. This helps ensure continuity of supply and production, minimizing disruptions and mitigating risks throughout the supply chain.
• Bad Debt Reserve Reduction/Tax Deduction: Trade credit insurance not only shields against non-payment but also offers a tax-deductible alternative to maintaining high bad debt reserves. This allows businesses to bolster their cash flow, facilitating unrestricted growth.

Risk Mitigation Strategies

The role of trade credit insurance transcends mere risk mitigation; it allows businesses to extend aggressive credit terms without unduly escalating risk. Trade credit insurance allows businesses to offer credit to customers without the risk of non-payment, thereby facilitating more sales and enabling better payment terms negotiation. By safeguarding against bad debt, it protects cash flow and enhances access to financing, offsetting the cost of the insurance policy through increased revenue and financial stability. Trade credit insurance enables a company to increase sales by up to 20% by mitigating the risk associated with extending credit to customers.

In addition to securing a trade credit insurance policy, here are some other risk mitigation strategies your organization can implement to mitigate trade credit risk:

1. Thorough Credit Assessment: Conduct comprehensive credit assessments of potential customers before extending credit terms. Evaluate their financial stability, payment history, and creditworthiness to assess the risk of non-payment accurately.
2. Establish Credit Limits: Set appropriate credit limits for each customer based on their creditworthiness and risk profile. Avoid overextending credit to high-risk customers and regularly review and adjust credit limits as needed.
3. Diversification of Customer Base: Avoid reliance on a small number of customers for a significant portion of sales. Diversify the customer base to spread the risk of non-payment across multiple clients and industries.
4. Monitoring and Early Warning Systems: Implement monitoring systems to track customer payment behavior and detect early signs of financial distress. Establish clear criteria for triggering alerts and take proactive measures to address potential risks promptly.
5. Payment Terms and Conditions: Clearly define payment terms and conditions in contracts and invoices. Specify due dates, late payment penalties, and consequences for non-payment to encourage timely payments and deter default.
6. Invoice Factoring or Financing: Consider invoice factoring or financing arrangements to improve cash flow and mitigate the risk of non-payment. These arrangements involve selling accounts receivable to a third party at a discount in exchange for immediate cash.
7. Supplier Trade References: Seek trade references from suppliers to assess the payment behavior of potential customers. Previous relationships with suppliers can provide valuable insights into a customer’s creditworthiness and reliability.
8. Collateral or Guarantees: Require collateral or guarantees from customers to secure credit transactions, especially for high-risk or large-scale transactions. Collateral can include assets or securities that can be liquidated in the event of non-payment.
9. Contractual Protections: Include contractual protections such as retention of title clauses or personal guarantees to secure payment obligations. These provisions help enforce payment obligations and provide recourse in case of default.

Conclusion

In an era of tenuous economic circumstances, trade credit insurance emerges as a crucial risk mitigation strategy, resonating with businesses seeking new revenue streams and navigating strategic growth. Here, commercial insurance brokers serve as advisers guiding clients toward effective risk management. With a comprehensive understanding of trade credit insurance, brokers empower businesses to chart a course of financial resilience in an ever-evolving economic landscape.

Resources and References

1. Allianz. (2022). A Guide to Trade Credit Insurance. Allianz Trade. https://info.allianz-trade.com/rs/133-WKC-682/images/guide-credit-insurance.pdfmkt_tok=eyJpIjoiWXprM1lXTmpaVGt3Tm1NeCIsInQiOiJcL2FZNjhENzM3QTRod21iNXVMWlNHTUxMZ1hjSHBSdjRZVkNaUzV0c2lDZ3VtS3RZQ1B3cUdxZTVuMmpQSG9hXC9mXC9ic2RmMkVQWXRQTjhSbGxkaUdXcUlMcGlOWEsyVXZlclwvRnpzNitON0J3OVhyTVpMSGpVcXl1MVZ2UzA0Y2oifQ%3D%3D
2. American Bankruptcy Institute. (2024, April). Bankruptcy Statistics. https://www.abi.org/newsroom/bankruptcy-statistics
3. Boata, A., Kuhanathan, A., & Lemerle, M. (2023). Allianz | Global Insolvency Outlook 2023-25: From maul to ruck?. Allianz . https://www.allianz.com/en/economic_research/publications/specials_fmo/2023_10_18-Global-Insolvency-Report.html
4. Rosanes, M. (2023, November 9). What is trade credit insurance?. Insurance Business America. https://www.insurancebusinessmag.com/us/guides/what-is-trade-credit-insurance-116055.aspx
5. World Trade Organization. (n.d.). Trade finance. World Trade Organization . https://www.wto.org/english/thewto_e/coher_e/tr_finance_e.htm

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