Trade credit insurance (TCI) is a method for protecting a business against its commercial customers’ inability to pay for products or services, whether because of bankruptcy, insolvency, or political upheaval in countries where the trade partner operates.
TCI—sometimes referred to as accounts receivable insurance, debtor insurance, or export credit insurance—therefore helps businesses protect their capital and stabilize cash flows. It can also help them secure better financing terms from banks, which have the confidence that their customers’ accounts receivable will be repaid.
- Trade credit insurance (TCI) reimburses companies when their customers are unable to pay because of insolvency or destabilizing political conditions.
- Insurers typically price their policies based on the size and number of customers covered under the policy, their creditworthiness, and the risk inherent to the industry in which they operate.
- Companies can choose to indemnify all their buyers, a group of specific buyers, or even just one particular trading partner.
- Businesses that wish to mitigate their credit risk can also self-insure, although doing so can be more expensive, especially for smaller firms with fewer buyers.
What Is Trade Credit Insurance (TCI)?
Many commercial buyers request credit in order to make large purchases of goods or services, but lending to those customers puts a supplier at risk that it won’t be repaid. If, for example, the customer files for bankruptcy, the creditor often receives only a portion of what it was owed or nothing at all. That’s especially true for unsecured debts, wherein the creditor doesn’t have collateral backing up the loan.
TCI mitigates that risk by compensating policyholders for the unpaid debt up to the applicable coverage limits. One of the advantages of TCI is that companies can more confidently extend credit to new or existing customers, secure in the knowledge that they’ll be paid back regardless of the customer's financial position. Therefore, insurance can help companies grow their business without assuming undue risk.
The leading providers of TCI include carriers such as AIG, Zurich Insurance Group, Chubb, Coface, Euler Hermes, and Atradius. The Export-Import Bank of the United States (EXIM), the country’s official export credit agency, also provides credit insurance that protects foreign accounts receivable against insolvency and political risk. Businesses that are insured through EXIM receive 85% to 95% of the invoice amount should the buyer fail to pay.
How Trade Credit Insurance Works
As with any insurance product, the cost reflects the projected risk that the policyholder poses to the insurer. When evaluating a business’s risk, insurers look at a variety of criteria, such as the volume of trades a client engages in, the creditworthiness of its buyers, the industry in which it operates, and the repayment terms to which buyers have agreed. Typically, coverage costs less than 1% of the insured sales volume, according to Meridian Finance Group, a specialty insurance brokerage.
Businesses can often scale their insurance coverage to fit their budget and risk profile. For example, they may have the option to cover one particular client—especially if it’s a large or particularly risky account—or a select number of clients. Some policies also provide secondary coverage that only kicks in when the primary policy fails to cover the full amount of a claim.
Based on the financial strength of a client’s covered trade partners, insurance providers typically assign each one a specific credit limit. Should the buyer fail to pay for goods or services, the insurer will only cover losses up to that indemnity ceiling.
Though some carriers include nonpayment due to trade embargoes or other government-related events in their TCI coverage, other insurers offer a separate product known as political risk insurance. Such protection can be especially important for firms that operate in traditionally unstable regions, including multinational corporations and large hospitality chains.
Advantages of TCI
For some companies, the ability to offer generous credit terms to buyers can attract larger buyers or open the door to possible expansion into new geographic markets. TCI generally makes businesses more comfortable extending credit because the risk of default is significantly mitigated. In industries where most of the major competitors already carry TCI, having a loss-mitigation strategy can be a necessity just to stay competitive.
Offering greater credit limits to one’s buyers also helps companies generate economies of scale. Because customers can buy larger quantities, a company may find itself purchasing larger amounts from its own suppliers, creating the ability to negotiate better pricing.
Alternatives to TCI
TCI isn’t the only option on the table for companies worried about lost receivables. Here are three other possible strategies.
One alternative is to self-insure, which means the business creates its own reserve fund specifically designed to cover losses from unpaid accounts. The downside to this strategy is that a company may have to set aside a considerable amount of capital for loss prevention instead of using that money to grow the business.
Another alternative companies have is to sell their receivable accounts to a third party known as a factor, which then attempts to collect the receivables itself. However, a factor typically purchases the right to those receivables at a considerable discount—usually 70% to 90% of the invoiced amount. The creditor may receive a larger percentage if the factor manages to collect the full debt, but it still has to pay a substantial fee for the factor’s services.
Buyer’s letter of credit
Finally, companies that do business overseas can obtain a letter of credit from the buyer. Essentially, it’s a guarantee from the purchasing company’s bank that the seller will be paid in full by a specific date. One of the drawbacks is that these can only be obtained and paid for by the buyer, which may be reluctant to pay up to 3% of the transaction amount for the bank’s guarantee. What’s more, the letter of credit only pertains to a single buyer, putting the onus on the supplier to protect its other receivables.
Growth of TCI Market
According to a 2021 report by Allied Market Research, the adoption of TCI accelerated during the economic downturn of 2020, which served as a reminder of the potential for market disruption and lost receivable revenues. The global market for TCI reached $9.39 billion in 2019 and is expected to reach $18.14 billion by 2027, according to the research firm’s projections. That represents a compounded annual growth rate of 8.6%.