Credit insurance is a branch of casualty insurance. It protects
the manufacturers, merchants and other suppliers of goods and services
against nonpayment losses and defaults that may result from their granting
terms (click for definitions) to customers. It does not
cover physical damage to the products shipped to the buyer, or any of
the risks for which coverage is available through marine, fire, casualty
or any other form of insurance. By taking out a credit insurance policy,
the seller can do more business with a greater degree of confidence
because it can offer reasonable credit facilities to qualified buyers
with assurance that its receivables will be collectible up to a pre-determined
percentage of their face value and within predetermined credit limits.
There are three primary reasons why most exporters use credit insurance:
For the small exporter, financing, is generally the principal reason for obtaining credit insurance. The company's balance sheet and cash flow may be such that it cannot afford to carry foreign receivables for 30/60/90 days. However, if its competition is offering extended repayment terms, letters of credit and prepaid cash in advance are out of the question if it wants to maintain on increase its sales.
In many cases, a seller maintains no inventory of product, such as a commissioned distributor or trading company. In these instances the only assets may be trade receivables and, for an exporter, foreign trade receivables. Supplier financing may be limited so the only option for companies such as these is to obtain financing from financial institutions who will demand some form of credit enhancement on the trade receivables. Credit insurance provides this resource and enables outside loans to be obtained.
Credit insurance policies are assignable to third-parties (most normally financial institutions) to facilitate trade receivable financing. Normally, these assignments take two forms:
1) Standard assignment of policy proceeds (joint payees
on claims payments), and
The U.S. Government insurer ("Eximbank") is the principal issuer of Hold Harmless assignments only to smaller businesses whose access to external financing would be limited or precluded without them. It is unusual for private market insurers to issue any assignment beyond the standard assignment. Without access to policy assignments many lenders would not accept the credit enhancement afforded by the credit insurance policy.
Exclusions from coverage, other than the normal breach of contract provisions and standard exclusions from all insurance policies, usually surround disputes. Disputes take the form of formal disagreements surrounding: 1) the product (fitness for its intended use); and 2) contracts of sale. Because many so-called trade "disputes" are merely smoke screens masking underlying credit problems, insurers will override the dispute exclusion if the insured demonstrates that the dispute is bogus or that it has taken steps to remedy the alleged conditions involved in the dispute.
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