How and when to use trade credit insurance

Insurance is a form of protection and risk mitigation tool to protect against contingencies or unexpected loss. It serves its purpose in several instances—whether it’s your car, health or even your pet. Most people want to have a cushion to be prepared for unexpected circumstances, so, they pay for the protection. But how exactly does insurance function in the B2B trade credit industry?

Why it matters: Uncertainty is an ever-present companion in B2B trade. Businesses constantly face the challenge of balancing opportunity with risk. Trade credit insurance is one of the many tools available to mitigate risk, but you must know when and how it should be used.

Trade credit insurance protects the accounts receivables of a seller in exchange for a premium. An insurance policy can cover the entire AR portfolio, a specified segment of the portfolio or a single buyer. It also serves as protection against customers’ inability to pay due to circumstances such as bankruptcy or insolvency. Credit insurers can be public insurers, such as government agencies, or non-governmental firms, referred to as private insurers.

When evaluating the risk of a business or customer, most insurers do so based on sales volume, creditworthiness, the industry of operation and repayment terms agreed upon. For a lot of companies, credit insurance is a way to increase sales of existing customers without taking additional risk. Others argue their use is to protect against catastrophic losses for larger accounts. But companies that do not use credit insurance may argue that the cost of insurance is not worth the loss.

By the numbers: A recent eNews poll revealed that most (78%) credit professionals do not use trade credit insurance. For the 22% who do use insurance, they have a few reasons why:

Offering generous credit terms to customers can attract larger buyers and expand opportunities into new markets—creating a competitive advantage. Businesses that use trade credit insurance tend to feel more secure when extending credit because the risk is shared.

“We buy credit insurance for our higher risk customers because usually the larger balance has more exposure,” said Kenneth Zanolini, CCE, director of credit at Temperature Equipment Corp. (Tinley Park, IL). “A big part of the insurance is customer history. Whether it’s a long- or short-term customer, payment patterns and average days to pay are some key factors to consider. For example, in the insurance policy, you may ask for a $1 million coverage plan and they may only cover half a million or $100,000 based on the customer’s history, risk assessment and likelihood of default.”

Businesses can scale their insurance coverage to fit their budget and risk profile. Depending on the structure of the credit insurance policy, insurers can take on the credit underwriting process, eliminating or reducing the cost of credit investigations by the seller.

Global economic uncertainty is a popular reason why companies may have adopted insurance in recent years. As the trade credit market has grown in recent years, the compound annual growth rate (CAGR) is predicted to grow 9.2% this year compared to 2023, according to the Trade Credit Insurance Global Market 2024 report. Companies are more likely to use insurance to protect against unexpected bad-debt losses beyond the control of those who are insured due to current commercial, political or economic risks.

Valarie Hardesty, CCE, CICP, director of credit at Elevate Textiles, Inc. (Charlotte, NC) said her trade credit insurance policies are used for all non-U.S. receivables. “It gives us more security when making credit decisions,” Hardesty said. “We only pay a premium for our insurance if the company we’re selling to does not pay us. Rather than taking the full risk ourselves, we pay every month to be able to get that security. Based on the country we’re selling to, we get a discretionary credit limit that is allowed.”

If they need more than the discretionary limit provided, Hardesty’s company will apply for a special buyer’s credit limit. “To get the special buyer’s credit limit (SBCL), we have to give our credit insurance company a credit report, two years of financials on the customer and pay the premium every month,” she said. “It typically doesn’t matter the size of the customer, it’s more based on the country risk. We’ve been turned down from the SBCL before, but we’ve had overall good luck with putting the policy into place.”

Yes, but: Companies that do not use credit insurance or are self-insured see how insurance can be more disadvantageous than beneficial. For example, companies that rarely face bad debt—even in the current economic state—do not think third-party insurers are worth the premium.

Self-insured companies put a reserve on their balance sheet to cover any bad debt that may occur over a financial year. If the losses are predictable, the company is more likely to lean toward self-insurance. “Though we’ve seen a little bit of an uptick in economic disturbance, tremendous sums of money are not at risk, so it’s better for us to self-insure,” explained Barry Hickman senior director of credit at Dal-Tile Corporation (Dallas, TX). “I also find that credit insurance policies can be very complicated. One of the big disadvantages I find is that insurance puts a cap on a certain dollar value whether it’s a portfolio or a single account, and if you go over that value, you are no longer insured.”

Hickman said insurance caps can limit quick-strike sales opportunities as well. “As a credit professional, when you begin to weigh the cost of credit insurance with the ability to make sound risk decisions on your own with the tools you have, it can become a lopsided opportunity or business decision,” Hickman explained. “However, in other parts of the world, it’s essential. Some countries don’t have access to third-party vendors, so they rely heavily on credit insurers.”

The bottom line: Trade credit insurance serves as a risk mitigation tool in the B2B industry, protecting sellers against customers’ inability to pay. However, it is important to know what is best for your company’s needs and balance the benefits for expanding opportunities and managing unexpected losses.