Trade Credit Insurance: a Worked Example

An open account sale leaves the seller with nothing but an invoice. Lending against a ledger of such invoices means taking a view on every customer in it, including overseas buyers the bank knows nothing about. A policy puts a second party behind part of that ledger, one that has assessed each buyer and is paid to go on watching it. A financier may then fund debts it would otherwise leave out, or allow a larger concentration limit for an insured name.

The value to the bank depends on the money reaching it. A policy pays the insured, which is the bank's customer, so a lender commonly takes an assignment of the policy or its proceeds, or has its interest noted by the insurer, in the manner of a loss payee. Issue 13 turns on this kind of choice: an exporter's open-account book, uninsured when the file opens, with insured debts proposed as the only ones eligible for borrowing.

A policy can cover the whole turnover or selected buyers. The insurer sets a credit limit for each buyer, the most it will insure on that name, and many policies add a discretionary limit under which the seller can trade with smaller accounts on its own assessment. Payouts cover a share of the loss: the industry body ICISA gives 75% to 95% as the usual range. Insolvency is the core event. Protracted default, where a buyer neither pays nor enters a formal process, is often covered after a waiting period, which ICISA says can run up to six months. Political risk is usually an option.

The conditions are where cover is lost. Policies commonly require overdue accounts to be reported within a set time, and stop cover for goods shipped to a buyer already seriously overdue. Details differ between insurers and policies, so the wording in hand is what counts. Insurers can also reduce or cancel a buyer limit when they receive bad news about that buyer.

A maker of commercial shelving, constructed for this page like every figure in it, insures its whole turnover. One dealer group has a buyer limit of US$600,000 and the policy pays 90%. The policy stops cover on goods shipped once any invoice from that buyer is more than 60 days overdue. The dealer group enters administration owing US$800,000, of which US$150,000 was shipped after an earlier invoice passed that point. The limit, percentage and condition belong to the example and are not a market norm.

The maker thought it was insured on US$800,000 and is paid about two-thirds of it. Each reduction has a different cause: the last shipments failed a condition, the limit capped the rest, and the 90% left the insured its own share of the loss. Now add the bank, which advances 80% against insured debts and has the proceeds of the policy assigned to it.

The difference is a line in the borrowing base definition. A bank counting insured debts up to the buyer limit, and leaving out invoices past the policy's stop date, stays inside what the policy can pay. How far a missed condition defeats a claim also depends on the law. Where Australia's Insurance Contracts Act 1984 applies, section 54 can stop an insurer refusing a claim only because of something done or left undone after the policy began, and limit it to reducing the claim for its prejudice. The insurer may still refuse where the act could reasonably be regarded as capable of causing or contributing to the loss, unless the insured proves it caused none of it. The High Court in 2014 ([2014] HCA 33) declined to separate terms that define the cover from conditions on claiming, but how the section meets a particular credit policy remains arguable. New Zealand and the UK have their own rules on breached terms. A lender does not advance on the prospect of winning that argument.

A letter of credit is a bank's promise to pay on compliant documents, on a known date, for the full amount. Trade credit insurance is an indemnity: it responds after a loss, for a share of it, and after the insurer has satisfied itself that the claim falls within the policy. One gets the exporter paid. The other limits what a failed buyer costs, some months later.

It also sits apart from two near neighbours. Non-recourse finance moves a debtor's failure to the financier, often with a policy behind the promise; here the seller holds the policy itself. Export credit agency cover is government-backed, and tends to reach longer terms and riskier markets than commercial insurers will write.

DEFINED IN ONE PARAGRAPH → · PRODUCT FILE: INVOICE FINANCE → · ISSUE 13 · TRADE TERMS →

A desk asks for the policy itself, the schedule of buyer limits, recent overdue reports and any past claims, and it tests a sample of the ledger against those limits. The credit question is what happens when a buyer turns. An insurer that hears bad news can reduce a limit, usually for shipments not yet made, at the moment the seller most needs it. A facility whose borrowing base leans on insured debts loses availability at the same time as the buyer slows.

So a lender reads the policy as a support to the ledger and not as a replacement for assessing it. Renewal dates, the insurer's standing, and who at the borrower is responsible for overdue reporting all belong in the file. A business that cannot show that its reporting is done on time has a policy whose value is uncertain.

ELIGIBLE RECEIVABLES → · HOW BANKS READ EXPORTERS →