What Is Trade Credit Insurance? — How Cover Works, Credit Limits, Policy Types and Cost

Trade credit insurance covers a set percentage of the loss when receivables cannot be collected because a buyer becomes insolvent or pays late. For companies that sell on credit, receivables are one of the largest assets on the balance sheet, yet unlike fire or liability, relatively few companies insure them.

This article sets out how it works and what to check when considering it, based on public material from credit insurers and non-life insurers. Product details vary by insurer and wording, so it focuses on concepts common to all.

What is covered: commercial and political risk

The events covered fall into two broad groups.

Policies covering domestic sales generally cover commercial risk, and policies covering export sales cover political risk as well. Non-life insurers' descriptions of export credit insurance also list both the buyer's insolvency or default and import restrictions, foreign exchange restrictions and war in the buyer's country as covered.

What is covered is short-term receivables arising from selling goods or providing services. Loans, lease receivables and long-term deferred payment receivables are not covered by ordinary trade credit insurance.

Late payment becomes a loss after a set period

The timing of insolvency is clear, but for late payment it must be decided when it counts as a loss. Credit insurers give examples where non-payment continuing for six months or more after the due date is covered as protracted default. Government trade insurance treats non-payment for three months or more after the settlement date as commercial risk. The length of the period depends on the insurer and the policy.

This period is called the waiting period or similar in policy wordings. It is set by the policy, and when it expires the overdue receivable is treated as covered. Some policies give the insurer the right to collect from the buyer during this period.

When estimating the effect on cash flow, check how many months it takes from the loss to receiving the claim payment, together with the insured percentage discussed below.

Credit limits: the core of trade credit insurance

In trade credit insurance, the insurer sets a credit limit for each buyer. Credit insurers analyze credit risk based on factors such as the buyer's financial health to set the limit, and this limit is the level up to which claims are paid if the buyer cannot pay. Insured sales must also be made within the limit set.

In other words, buyers without a limit, and sales above the limit, are not covered.

Credit insurers keep monitoring buyers during the policy period and revise limits if credit standing changes. This has two implications. First, a change in a limit is itself information about the buyer's credit standing. Second, whether your key buyers get the limits you want determines the real value of the policy. Even with a low premium, if your largest buyers have no limits, the receivables protected are limited.

Discretionary limits

When a company has hundreds of buyers, having the insurer review every one is unrealistic. Credit insurers explain that limits are in principle set buyer by buyer by the underwriting department, but discretionary limits set by the policyholder may be allowed when certain conditions are met. This lets small buyers be covered broadly, but claims are not paid if the agreed conditions are not actually followed, so it must be designed together with how internal credit management is run.

How claims are calculated

According to credit insurers, the claim is calculated as the lower of the loss on the insured receivable and the credit limit, multiplied by a pre-set insured percentage.

* An illustration of the calculation. The insured percentage, deductibles and other terms vary by policy.

The full loss is not paid so that policyholders keep an incentive to manage buyer credit after taking out insurance. Depending on the policy, the following conditions may also apply:

• Deductible: the policyholder bears losses up to a set amount, either per loss or as an annual aggregate.
• Maximum liability: the cap on total claims paid during the policy period.
• Small loss exclusion: losses below a set amount are not covered.

When comparing quotes, it is essential to calculate how much would actually be recovered including these conditions, not just compare premium rates.

Main policy types

Other structures include top-up cover, which adds cover above the credit limit under an existing policy, and excess of loss (XoL), which covers the part of cumulative losses during the policy period above a set self-retention.

Some non-life insurers' products are whole turnover policies covering all buyers in principle, but allow the scope to be defined by criteria such as "the top N buyers by balance" or "buyers with balances within a set range". Because insurers are wary of policyholders insuring only buyers with credit concerns, whole turnover policies with objectively defined scope tend to obtain better terms.

How cost is determined

Premium is usually calculated by applying a rate to covered sales or receivables. The rate depends on buyers' creditworthiness and sector mix, payment terms, past bad debt, and the insured percentage and deductible. In addition to premium, there may be a credit limit assessment fee per buyer or a minimum premium per policy. For companies with many buyers, whether credit limit assessment fees apply affects total cost.

Group schemes where a chamber of commerce or industry association is the policyholder may have a pre-set insured percentage and rate structure and simpler procedures than individual policies. Checking whether an association you belong to has a scheme widens your options.

Information needed for a quote

Insurers consider limits and rates for each buyer based on the information provided. When requesting a quote, you are generally asked for the following. Formats and scope vary by insurer and policy type.

• Buyer list: buyer name, location (country), annual sales, current balance, payment terms
• Overall sales and receivables: annual sales covered, trend in receivables, split between domestic and export sales
• Bad debt and overdue history: bad debt losses and overdue payments over the past few years
• Credit management: how internal credit limits are set, use of credit reports, procedure when payments are overdue

The more specific and up to date the information, the easier it is for the insurer to decide limits on key buyers.

Conditions to follow after binding

Most claims that go unpaid under trade credit insurance fail not because of the buyer's insolvency itself, but because policy conditions were not followed. The main conditions are:

• Trade within the limit: amounts above the limit are not covered. If you expect sales to grow, apply for an increase in advance.
• Notify late payment on time: receivables past their due date must be notified to the insurer within the deadline set in the policy.
• Stop shipping to buyers who are paying late: new shipments to buyers overdue beyond a set period are generally not covered.
• Keep documents proving the receivable: contracts, purchase orders, delivery notes, invoices and other documents showing the existence and amount of the receivable are needed when claiming.
• Do not change payment terms without approval: extending due dates without the insurer's approval can affect cover.

For non-life insurance in general, the General Insurance Association of Japan explains that the policyholder must notify the insurer if the assumptions of the policy change after binding, and must notify the insurer without delay on learning of a loss. In trade credit insurance, buyers' situations change daily, so running this notification process is particularly important. Policy conditions need to be built into the day-to-day work of sales and accounting.

Differences from guarantee factoring

Guarantee factoring offered by bank-affiliated factoring companies is also widely used to protect receivables. Its features are that you can choose which buyers to guarantee and that it pays 100% within the guarantee limit. Trade credit insurance covers many buyers together and brings the insurer's ongoing reviews into your credit management. The differences are set out in trade credit insurance vs. guarantee factoring.

Link to financing

Receivables covered by trade credit insurance can be easier for lenders to value as collateral. Using insurance in receivables-backed lending and securitization is explained in our insight on insured ABL.

Using an insurance broker

Different insurers grant different limits and rates on the same buyer. An insurance broker is not tied to any insurer; it approaches several insurers and compares limits, premium and terms. After binding, it applies for limit increases, requests reviews when limits are reduced and negotiates terms at renewal, on the policyholder's side.

Credit Hills is an insurance broker specializing in trade credit insurance. In addition to new policies, we can review the limits and terms of existing policies.

See our trade credit insurance services →

Frequently asked questions

Q. Are domestic buyers covered?
A. Yes. There are policies covering domestic sales only, export sales only, or both.

Q. Can we insure a buyer who is already paying late?
A. No. Insurance covers uncertain future losses, and buyers already overdue or with credit concerns at the time of application are usually excluded.

Q. What if the limit is lower than we wanted?
A. Options include providing additional information and requesting a review, approaching other insurers, or considering top-up cover. See When the credit limit falls short for details. The limit you want is not guaranteed.

Q. Once insured, do we no longer need credit management?
A. No. You bear the part above the insured percentage, and you have policy obligations such as managing limits and notifying late payments. Insurance supplements credit management; it does not replace it.

References (in Japanese)

• Atradius — Credit insurance FAQ (protracted default, claim calculation, discretionary limits)
• METI — What is trade insurance provided by NEXI?
• General Insurance Association of Japan — Non-life insurance Q&A (duty to notify)
• General Insurance Association of Japan — Non-life insurance Q&A (making a claim)