Fast Facts: Trade Credit Insurance explained
Trade credit insurance is an important tool in a small business’ arsenal to protect against the risk of debts not being paid.
Australian businesses owe around $950 billion to other businesses. Which means it’s essential to have protections in place so that in the event a creditor does not meet its obligations, the business can still recoup its money. Taking out trade credit insurance is one way you can do this.
Trade credit insurance provides cover when a customer either becomes insolvent or does not pay its debts after a certain period (which is set out in the insurance policy).
Michael White, Steadfast’s broker technical manager says one of a business’ biggest risks is customers not paying their bills. Trade credit insurance is one way to mitigate against this risk.
“A number of insurers offer specialist trade credit insurance for small businesses, there are also specialist insurance brokers that only arrange this type of insurance,” says Michael.
The way this insurance works, when businesses take out a trade credit policy, they are usually required to disclose the specific debtors they want to insure. Although some policies are more general in nature and insure all the firm’s debtors.
“In the event a debt is unpaid, the policy holder may be able to claim up to 90 per cent of the amount of that debt, taking into account any excesses that may be relevant,” he adds.
“If you are doing business overseas, it’s important to ensure the trade credit insurance policy covers debts held by overseas customers”
When it comes to collecting the debt, often the insurer will have its own debt collection agency and will pursue the debt on behalf of the business. The policy usually covers the cost of debt collection by the insurer.
If you are doing business overseas, it’s important to ensure the trade credit insurance policy covers debts held by overseas customers.
But, says Michael, proper debtor management involves more than just trade credit insurance. It’s essential to have the right processes in place to reduce the risk of bad debts in the first place.
“The starting point is to make sure you’re dealing with people who are genuinely creditworthy. You should not have to claim against the policy if you make sure that you have watertight policies around checking the creditworthiness of your customers. But businesses can quite quickly go from being creditworthy to insolvent. So, there is always a risk a business will fail and not be able to meet its obligations. That’s why trade credit insurance is so important,” he adds.
Specialist trade credit insurance applies in some industries, for instance in the advertising sector. It’s also a popular product with family businesses. But in some other sectors, there is only limited knowledge of the way trade credit insurance works. So there’s an opportunity for businesses that offer their customers credit through their terms of trade to take advantage of this type of insurance. This may help to help protect against bad debts and support cash flow, the life blood of every business.
Says Michael: “small businesses need to know this is an option to protect against bad debts which they can take advantage of to manage their exposure to unpaid debts.”
Trade credit insurance is typically sold through an insurance broker and it’s important for small businesses to use a broker that specialises in this area. That’s the best way to ensure the policy is fit-for-purpose.