Credit Insurance, also know as Trade Credit Insurance, is a risk-transfer tool used by businesses to facilitate accounts receivable (AR) terms or transactions in new markets requiring more risk than a business may otherwise be comfortable with (i.e. international markets).
This insurance coverage provides the ability to transfer the risk of default, insolvency, or bankruptcy to a third-party for a predetermined premium. The ability to transfer this risk has allowed companies, large and small, to become global players in their markets. Without this tool companies would have to assume an unreasonable amount of risk offering payment terms to customers in locations that offer no recourse if they default on their debts. Without payment terms and time to generate cash from sales, many supplier transactions simply would not happen and global trade would come to a crawl.
The premium for Credit Insurance is typically paid by the insured (the seller) but can be passed along to the buyer through pricing or terms within a sales agreement. In order to avoid adverse selection, the tendency for riskier buyers to purchase insurance, companies generally must insure their entire portfolio of buyers rather than the one or two they feel are most likely to cause a problem. The premium rate reflects the average credit risk of the insured portfolio. In certain circumstances credit insurance can cover single transactions or trade with only one buyer.
Credit Insurance is a tool all business owners should investigate before walking away from an opportunity that may require AR terms they are not comfortable with. A competitor down the road with an inferior product may win the opportunity simply because they figured out how to transfer the risk to a third party to make the deal happen.
