Trade credit insurance when customers can’t pay

If goods deliveries or services are not paid for, the company that provided the service incurs a loss of receivables. In order to cushion the financial loss, trade credit insurance (WKV) can be taken out. It belongs to the credit insurance segment and occupies the most important place in it.

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Trade credit insurance as the most important form of credit insurance

Overall, three forms of credit insurance can be distinguished, which are essentially the same, but have differences in insurance coverage:

Trade credit insurance Capital goods insurance Export credit insurance

It covers payment claims arising from the delivery of goods and the provision of services with a payment term of up to 6 months.
Secures payment claims from deliveries of goods and services rendered for which the payment period exceeds 6 months.
Insures payment claims from deliveries of goods and services rendered, primarily in the case of exports abroad and prevailing political risks in the target country.

Of these three forms, trade credit insurance, also known as bad debt insurance or credit insurance, is the most important. Del credere insurance is the most important form of insurance. According to euler hermes, the world market leader in trade credit insurance, the total value of all supplier credits that can be insured with trade credit insurance in germany amounts to around 340 billion euros per year.

What is trade credit insurance and for whom is it useful??

If goods are delivered or services provided, they are often not paid for immediately. There is then a more or less long time gap between the provision of the service and the payment for it (usually approx. 30 to 180 days). As long as the goods or. Service is not paid for, it functions like a loan that has been extended but not yet repaid. In this case, it is called a supplier credit (also trade credit).

Clearly, this creates a risk for the company that provided the service, whether in the form of a good or a service. Because what if the customer does not pay for the goods or services immediately?. Cannot pay for the service on time because he is currently experiencing a financial bottleneck or – in the worst case – even has to file for insolvency before the payment deadline? To protect against this risk of non-payment, trade credit insurance can be taken out to cover the financial value of the supplier's credit.

Example of a claim in practice

Metal screws for furniture

The medium-sized company AK metall produces nails, screws and other metal and wire nails, which it delivers to customers in the manufacturing industry. One of these is mobeling, a furniture manufacturer that produces cabinets and shelves in series production. Both companies have agreed on a supplier contract, which provides for regular deliveries of goods from AK metall to mobeling.

One day mobeling announces absolute inability to pay and becomes insolvent. Shortly before, however, AK metall produced and launched another delivery. Since mobeling can no longer pay for this delivery of goods, AK metall is threatened with financial loss due to this loss of receivables. However, thanks to the trade credit insurance taken out in advance, which covers the default, this loss can be averted.

As the loss example shows, trade credit insurance makes sense for all companies that deliver goods. However, companies that provide services are also well advised to take out trade credit insurance to protect themselves against payment arrears and defaults. The size of the company is irrelevant. Even freelancers and self-employed persons belong to the target group of this insurance policy. In addition, trade credit insurance also protects against the company's own liquidity bottlenecks or insolvency. Against own insolvency. If a supplier or service provider does not take out trade credit insurance and bad debts then arise, the receivable must be written off. This is reflected accordingly in the balance sheet and can lead to negative equity capital – insolvency is imminent.

How does a trade credit insurance work?

In trade credit insurance, insurance and financial services come together. The policyholder is always the person who delivers the goods or who has to pay for them. Provides the services and can demand payment for them. If the buyer is unable to meet this payment claim on time or sufficiently, the insured event occurs: the trade credit insurer then settles the financial loss incurred by the policyholder.

Credit assessment of the policyholder and the customer

Credit check with laptop and writing pad

The creditworthiness of a buyer can be conveniently checked online via the customer portal of the trade credit insurer.

Before a trade credit insurer agrees to take out trade credit insurance, it checks the creditworthiness, i.E. The creditworthiness, of both the policyholder and the buyer. For this, the insurer can fall back on:

  • Credit agencies (for example creditreform)
  • Bank information
  • Publications in the federal gazette (banz)
  • Own payment experiences or information

The creditworthiness of the policyholder is only checked once. However, it is an important factor in determining the premium, whereby the better the credit rating of the policyholder, the more favorable the premium for the trade credit insurance.

The modalities of the credit check of the buyer, on the other hand, are a bit more complicated. As a rule, the insurer has to contact credit agencies (e.G. Credit rating agencies) from a value of 20.000 or. 25.The insurer checks the creditworthiness of the buyer in any case for an amount of EUR 000. In case of a lower value of goods, the policyholder has the option to either have the creditworthiness checked by the insurer or to carry out the check itself. The check can be done comfortably online via the customer portal of the insurer. Of course, costs are usually incurred as soon as the insurer checks the creditworthiness of the buyer.

Free credit checks for new VHV insurance product

In june 2017, VHV launched its first trade credit insurance product, "forderungsausfall BONIPLUS," which offers all credit checks free of charge, regardless of the value of the goods and whether the buyer is based in germany or abroad.

Determination of the coverage

If the buyer's creditworthiness is sufficient, the trade credit insurer and the policyholder determine the level of coverage. Cover" in this context means the maximum amount up to which the goods or. Services shall be deemed to be insured. This is also referred to as a "limit.

If the coverage is exceeded and the insured event then occurs, the policyholder must accept a loss. This is the case, for example, if a delivery of goods is covered up to a maximum of 15.000 euro is insured, but in fact goods with a value of 20.000 euros are delivered. For the uninsured value of goods in the amount of 5.000 there is no entitlement to financial compensation in the event of an insured event. In a sense, this situation is similar to underinsurance.

When determining the coverage, there is also the possibility of insuring the so-called manufacturing risk: if a product is produced for a customer and the customer becomes insolvent during production, the trade credit insurer reimburses the supplier for the advance payments already made.

Compensation in the event of an insured loss

The insured event can occur in two different ways:

  • The buyer becomes insolvent and has to declare bankruptcy.
  • The customer defaults on payment.

If the customer defaults on payment, the supplier first initiates its own dunning procedure. If this remains unsuccessful, the trade credit insurer comes into play and takes over the collection of the receivables. Here, too, the customer is granted a further period of time in which to make the required payment to the supplier. If payment is not made within this period, the so-called "protracted default" occurs.

Non-payment event – what is it actually??

In the case of non-payment, this is an early insured event, as the insured event already occurs in the case of late payment and the supplier does not have to "wait" for the customer's insolvency to be reimbursed for the financial loss. However, the non-payment event must have been contractually agreed with the trade credit insurer.

Irrespective of whether the insured event occurs due to insolvency or default, the indemnity amount is between 70 and 90 % of the net claim. The fact that indemnification is not provided at 100% of the sum insured is initially misleading from the policyholder's point of view, but implies the following considerations:

  • The insurance premium for the trade credit insurance would otherwise be much higher.
  • The missing percentages represent an indirect deductible.
  • Part of the risk is passed on to the policyholder, so that the policyholder should always make an effort not to deliver to customers with weak liquidity or. Not to provide services for them.

Adjustment of the trade credit insurance contract

As a rule, the trade credit insurance contract stipulates the right of the insurer to reduce or completely cancel the insurance coverage by either reducing or completely cancelling the coverage. The policyholder then enjoys only limited or no insurance cover at all.

Normally, such an adjustment of the trade credit insurance contract does not take place. However, if the policyholder's creditworthiness suffers (e.G. Due to bad business practices) or the risk of an insured event occurring increases (e.G. Due to risky transactions), the insurer can take this measure and, in the worst case, withdraw insurance cover altogether.

Against what the commercial credit insurance does not offer protection?

The protection of trade credit insurance also has its limits. Among others, the following items are not insured:

  • Claims against the federal government, states, counties, municipalities and legal entities under public law
  • Interest on arrears or late payments, reminder fees, exchange losses, contractual penalties, compensation for damages, claims for reimbursement of expenses, claims for unjust enrichment
  • Legal or foreclosure costs, taxes, duties or other costs
  • Receivables due to transfer of use of movable and immovable property (for example, rent, lease, loan, lease)
  • Commission and brokerage receivables
  • War, warlike events, civil unrest, riot, revolution, strike, confiscation, obstruction of the movement of goods and payments by authorities or government institutions
  • Natural disasters
  • Nuclear energy

What are the premiums and fees for trade credit insurance?

Since trade credit insurance combines insurance and financial services at the same time, it incurs both an insurance premium and fees. The premium clearly outweighs the costs, especially since some of the fees are only charged when the insured event has occurred.

Incurring insurance premium

Cost calculation with laptop and writing pad

The turnover premium can be calculated exactly for a complete insurance year.

The insurance premium is distinguished between the turnover premium and the balance premium:

  • Turnover premium: the premium for trade credit insurance is calculated based on insured turnover. This is a lump sum for non-covered commodity deliveries or. Services, which can usually be calculated in advance for a complete insurance year.
  • Balance premium: this is a premium paid only on claims that are actually insured. The prerequisite is that all outstanding receivables be accurately identified on a monthly basis. That's why – unlike the sales premium, which is based on a lump sum – the exact amount of the balance premium can't be determined in advance of an insurance year.

The insurance premium is basically calculated in percents, either of insured sales (in the case of a sales premium) or of outstanding items (in the case of a balance premium). It is usually between 1.0 and 3.0 per thousand. How much of a premium you actually get depends on a number of factors. In addition to the general economic situation, the financial strength of the commercial credit insurer is also relevant. Beyond that naturally also various circumstances on sides of the policyholder play a role, so for example:

  • In which branch of industry is the policyholder active and in which is the buyer active?
  • What is the average payment received?
  • How high is the export share?
  • What is the nature of the policyholder's accounts receivable management (dunning frequency, due dates, etc.)?.)?
  • Have there been bad debts in the past?

Incurring fees

While the insurance premium covers the insurance services, there are various fees for financial services under the trade credit insurance policy. Generally, fees are charged for credit checks and collection services. Fees vary from insurance to insurance.

What are the useful additions to the trade credit insurance??

If you want to win business, you must also be able to offer your clients assurance that all contractual obligations will be fulfilled as agreed. In practice, this is done in the form of guarantees, which can be provided either by the respective house bank or by an insurance company. In most cases, the choice falls on an insurance company and thus on a so-called surety insurance, which offers several advantages over a bank guarantee, for example: