Cash Flow Management
Trade Credit Insurance
|What is trade
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.
(i) help their customers to manage credit risks more effectively
(ii) provide the protection of insurance cover within the terms
of the policy.
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|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
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.
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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.
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
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|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
- 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
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|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.
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|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
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.
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|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.
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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
BIIBA House, 14 Bevis Marks London EC3A 7NT.
Tel: 020 7623 9043 Fax: 020 7626 9676
The Association of British Insurers represents around 440 insurance
companies, which between them account for over 95% of the business
of UK insurance companies. The Association represents insurance
companies to the Government and to regulatory and other agencies,
and it provides a wide range of services to its members. It also
publishes a range of information sheets on insurance for businesses.
Association of British Insurers
51 Gresham Street London EC2V 7HQ
Tel: 020 7600 3333 Fax: 020 7696 8999
Export Credit Insurance The British Insurance and Investment Brokers'
Association can also provide support information to businesses interested
in export credit insurance.
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