What is Trade Credit Insurance?

In an increasingly interconnected and globalized economy, the risks associated with doing business have become more complex and multifaceted. Companies, especially those engaged in Business-to-Business (B2B) transactions, face a constant challenge: how to protect themselves against the financial instability of their trading partners. Enter Trade Credit Insurance (TCI), a specialized insurance product that offers a safety net for businesses, ensuring that they can navigate the uncertainties of the market with greater confidence. While TCI is a well-established requirement in European markets, it remains underutilized in the United States. However, as economic volatility increases and corporate bankruptcies rise, more U.S. businesses are starting to recognize the value of this essential coverage.

The Fundamentals of Trade Credit Insurance

Trade Credit Insurance, also known as Accounts Receivable Insurance, provides protection to businesses when a customer fails to pay for goods or services rendered. This insurance is particularly crucial in B2B transactions, where payment terms are often extended without any upfront payment. For example, a company might deliver $1 million worth of goods to a customer with an agreement that the payment is due within 90 days. If the customer defaults—perhaps due to bankruptcy—the supplier could face significant financial losses. Without TCI, the supplier might have to write off the debt as a loss, jeopardizing its financial stability. However, with TCI in place, the insurance company steps in to cover the loss, allowing the business to continue its operations without a substantial financial hit.

Why TCI Matters More Now Than Ever

The relevance of Trade Credit Insurance has grown significantly in recent years, especially in the wake of economic downturns and global crises. The financial crisis of 2008, for instance, exposed the vulnerabilities of many businesses, leading to an increased interest in protective measures like TCI. More recently, U.S. corporate bankruptcies hit a 13-year high in 2023, with 642 filings, a clear indication of rising economic uncertainty. In such an environment, businesses need to be proactive in safeguarding their accounts receivable, which often represent a substantial portion of their assets.

One of the key reasons TCI is gaining traction is its simplicity and effectiveness. By transferring the risk of non-payment to an insurance company, businesses can focus on growth and expansion without the constant worry of bad debt. This is particularly important as companies look to scale their operations or enter new markets, where the risks of non-payment may be higher due to unfamiliar business environments or economic instability.

How Does TCI Work?

At its core, Trade Credit Insurance is about mitigating risk. When a business decides to insure its accounts receivable, the insurance company conducts a thorough assessment of the creditworthiness of the business’s customers. This involves analyzing credit histories, transaction records, and other relevant data to determine the likelihood of non-payment. Based on this assessment, the insurance company sets credit limits for each customer and issues a policy that covers potential losses up to a specified amount.

In practice, this means that if a customer defaults on a payment, the insurance company will compensate the insured business for the loss, up to the policy limit. The insurer then assumes the responsibility of recovering the debt from the defaulting customer. This process not only protects the insured business from immediate financial harm but also provides peace of mind, knowing that potential losses are covered.

Beyond Protection: The Strategic Advantages of TCI

While the primary function of Trade Credit Insurance is to protect businesses from bad debt, its benefits extend far beyond simple loss coverage. For many companies, TCI is a strategic tool that enables growth and expansion. By mitigating the risk of non-payment, businesses can confidently extend larger lines of credit to their customers, facilitating higher sales and revenue. Moreover, companies with TCI are often viewed more favorably by lenders. When a bank sees that a business’s accounts receivable are insured, it is more likely to offer favorable loan terms, knowing that the company’s revenue sources are protected.

TCI also plays a crucial role in international trade, where the risks of non-payment are often amplified by factors such as political instability, currency fluctuations, and differing legal systems. For businesses looking to enter or expand in foreign markets, TCI provides a layer of security that can make the difference between a successful venture and a costly failure.

Underwriting TCI: The Importance of Risk Assessment

The effectiveness of Trade Credit Insurance hinges on the underwriting process. Insurance companies have access to a vast array of data, both public and private, that allows them to accurately assess the risk of non-payment. This data-driven approach ensures that the coverage provided is both comprehensive and tailored to the specific needs of the insured business.

For example, if an insurance company identifies that one of a business’s customers is at high risk of bankruptcy, it can advise the insured to take preventive measures, such as reducing credit exposure or renegotiating payment terms. In some cases, the insurer may even decline to cover a particular customer, prompting the business to reconsider its relationship with that customer. This level of insight and guidance is invaluable for businesses that may not have the resources or expertise to conduct such in-depth risk assessments on their own.

Costs and Limitations of TCI

While Trade Credit Insurance offers significant benefits, it’s important for businesses to understand the associated costs and limitations. The cost of TCI coverage typically hovers around 0.0025% of the annual coverage amount, with a 10% co-insurance and a possible deductible, depending on the industry and risk profile. However, TCI does not cover all scenarios. For instance, if a customer refuses to pay due to a dispute, the insurance company may not cover the loss. Additionally, coverage may be excluded for businesses operating in high-risk countries or industries, such as those involved in cannabis production or trade with sanctioned nations.

Despite these limitations, the cost of TCI is generally seen as a worthwhile investment, particularly for businesses with significant accounts receivable. By protecting against the risk of non-payment, TCI helps businesses maintain a healthy cash flow and avoid the financial strain that can result from bad debt.

The Growing Market for TCI

The global market for Trade Credit Insurance has been expanding rapidly, reflecting the increasing demand for this type of coverage. Valued at approximately $9.2 billion in 2023, the market is expected to grow to $23.9 billion over the next decade. This growth is driven by a combination of factors, including rising economic uncertainty, increased awareness of TCI’s benefits, and the ongoing globalization of trade.

For businesses operating in the B2B space, now is an ideal time to consider adding TCI to their risk management strategy. As the market for TCI continues to evolve, businesses that adopt this coverage will be better positioned to navigate economic challenges and capitalize on growth opportunities.

The Bottom Line

Trade Credit Insurance is more than just a safety net for businesses; it’s a strategic tool that supports growth, stability, and resilience in an increasingly volatile economic landscape. While it is not a substitute for sound credit management practices, TCI enhances and complements these practices by providing a layer of protection against the unforeseen risks of non-payment. Whether a business is looking to protect its profit margins, expand into new markets, or secure favorable financing, TCI offers the peace of mind needed to pursue these goals with confidence.

As economic volatility continues to rise, now is the time for businesses to explore the benefits of Trade Credit Insurance. At DOXA, we understand the challenges that businesses face in today’s fast-paced, globalized economy. Our team is here to help you navigate these challenges and protect your business from the risks of non-payment. Reach out to us today to learn more about how Trade Credit Insurance can support your business’s growth and success.