When considering global risks, companies doing business internationally must take a hard look at credit risks. Customers in other countries may not have a credit rating to justify selling product on credit or it may be hard to find a company's credit history to justify selling on credit terms. Many countries are rather lax when it comes to reporting financials and in some countries, insolvency laws are unheard of. So how does a company selling product internationally cover itself without selling via a letter of credit? The answer is credit insurance. Commercial credit risk insurance, sometimes called “trade” credit risk insurance, can help a company protect its account receivables (A/R) from unexpected losses due to nonpayment or slow payment by the company’s buyers or debtors. It usually covers nonpayment because of a buyer’s insolvency but may also cover nonpayment due to political events that hinder payment or distributors on credit. A/R is the money owed to a company by its customer for products and services sold on credit. Normally, a sale is only treated as an account receivable after the customer has been invoiced for the product or service.
Depending on the industry and size of the company, it may or may not sell many or all of its products via credit. In some cases, a letter of credit may not be practicle or may be too expensive. The risk, therefore, of nonpayment or slow payment (90 or 180 days after invoice, etc.) can be quite serious and expose the company to a potential crisis if the A/R is not paid. This is a major concern for any company selling product on credit.
When looking at credit risk from a global or geopolitical risk perspective, it helps to look at the various kinds of credit risks when deciding how to handle the risk. There are several kindds of credit risk such as:
Credit risk insurance normally covers two kinds of risk: commercial risk and political risk.
Benefits of Credit Insurance
There are numerous benefits for using credit insurance, if applicable. The most obvious benefits are:
Transfer or mitigation of risk. Credit insurance assures a company that its A/R will be paid if one of its customers declares bankruptcy or is unable to pay. This is subject to the terms and conditions of the insurance policy.
When a company initially sets up its risk management processes it should pay attention to credit insurance or trade insurance if that insurance is available in its industry and for the products its sells. It is another way of transferring risk when debtors are unable to pay outstanding A/R. Remember, insurance is a way of transferring risk. Use credit risk as a way of handling global risks when it comes to the crea of credit related transactions to the extent possible. Obviously, this will require a conversation with your local insurance broker or in-house insurance team. Your credit deaprtment may also be able to help in this regard.