The importance of trade credit insurance

South Africa is currently experiencing difficult political and economic conditions, which has a direct impact on the financial and trading performance of businesses.  Vulnerabilities to external shocks have also increased in a post-downgrade economy, with the impact of it slowly manifesting in financing becoming more difficult to secure and dwindling foreign direct investment.   

“It paints a picture of a distressed economy where the occurrence of defaulting debtors on a company’s books is increasing in response to the weak trading conditions.  Regardless of whether a business operates locally or across borders, and whether it is a large or small business, trade credit cover is essential to manage and mitigate the credit risks associated with customer debtor debt. The failure of a major customer or even several smaller customers to pay their dues can severely impact the financial health of a business,” says Maria Teixeira, Trade Credit, Surety and Political Risks Business Unit Manager at Aon South Africa

What is Trade Credit Insurance?
Trade credit insurance indemnifies a seller against losses from non-payment of trade debt arising from slow pay, insolvency and political risk in case of cross border transactions.  Coverage is designed to prevent disruptive losses, reduce risk of key account concentration levels and provide risk transfer of bad debt issues. 

“With trade credit in place, companies can enhance their bank financing in terms of improving the lending relationship, improve their balance sheet by insuring their debtors and gain access to more capital at reduced rates.  Trade credit solutions can also support sales in new or riskier markets, grow existing accounts, and strengthen customer relationships by helping buyers with letter-of-credit requirements gain credit terms. Trade credit across borders also covers political risks such as currency inconvertibility, importation risk, conflict and repudiation risk,” explains Maria.  

Accounts receivable are often the largest uninsured asset on a company’s balance sheet and yet often account for up to 40% or more of a company’s total assets. Aon highlights a few scenarios that highlight the importance of trade credit insurance:

• Business Rescue and Liquidations are increasing - Business rescue applications are increasing across all sectors by 15% year on year, with over 90% of business rescues ending in liquidations.  If your business has debtors on its book that are going into either of these proceedings, there could be a protracted delay in payment, with the prospect of only receiving a percentage of the debt owed, or even none at all.  

With trade credit insurance in place, the insured will have the support of the insurer at business rescue or liquidation-related meetings, in addition to you proving that the company in question owes you money for goods or services delivered.  As an added extra, legal fees and legal processes that are typically associated with these proceedings are shared with the insurer, freeing up your time, saving you from the added expenses and allowing you to focus on your business.  If no payment is forthcoming, your trade credit insurance will indemnify your claim. 

• Trading Pressure - It is becoming a buyers’ market across many industries where clients play suppliers off against each other leading to lower margins, in addition to demanding credit facilities in very short timeframes.  Do not fall into the trap of giving an unknown client a credit line when they have not been properly vetted or in the absence of trade credit insurance.

Trade credit insurance will provide credit investigation of insured buyers and advice on appropriate credit limits that are within a debtor’s means.  If a debtor defaults on payment, your trade credit policy will also provide for debt collection on your behalf.   A trade credit insurer deals with these matters on a daily basis, so they have access to extensive debtor information and credit records on a quick turnaround, which is particularly handy when potential clients are putting you under pressure for credit terms. 

• Trading in Africa - Africa offers an avenue of investment, with many multinationals investing in countries such as Zambia, Kenya, Nigeria and many other African countries.  But in the face of economic, political and regulatory uncertainty across the continent, it can be very difficult to recoup losses in unfamiliar territories.  A professional trade  credit insurer is able to assist clients in vetting potential clients or buyers in cross-border transactions, set credit limits and provide debt collection services if needed, significantly mitigating the potential risks on foreign soil. 

• Small Business – There’s a misconception that trade credit insurance is only suited to large corporate companies and that it is expensive.  The reality is that even small businesses can insure from as little as R3 000 and up.  You furthermore have the option of insuring a single debtor or your debtors’ book for a percentage of the loss, meaning that if you insure your debtors for 80% of the loss, you agree to carry 20% of the loss if anything goes wrong.  These options make trade credit insurance flexible and affordable even for smaller companies. 

Small and medium businesses are certainly at greater risk if a major debtor defaults as their balance sheets usually cannot carry them through a major default.  It would also be foolhardy to believe that large businesses don’t default on payments as recent corporate failures have shown.  The question to ask is whether you are prepared to deal with a potential bad debtor and not know about it?

In the current environment where credit facilities are increasingly in demand, credit insurance becomes a necessity.  “Payment protection through properly scoped credit insurance is a non-negotiable given the current market volatility and threats to business sustainability,” concludes Maria.