Good payers are welcome, however, they are not immune to adverse situations. The promise of timely payment can be summarized in the old proverb: “It’s no use locking the stable door after the horse has bolted”. When purchasing trade credit insurance, the company is guaranteed that eventual losses will be covered and indemnified within the time frame specified in the policy. This product provides additional advantages, like the possibility of reducing the provision for bad debts and increasing liquidity, since the company’s “accounts receivable” will be guaranteed. Furthermore, insurance expenses can be deducted from income tax and social contribution.
The differences between bank activities and insurer activities are substantial. The contractual relationships are different, and the risks assumed are also different. The credit insurer protects the company against debtors’ default, by issuing a policy with coverage that is adequate for its type of business and risk. The insurer is exposed to the risk of third party default when it assumes the risk of the original creditor who purchased the insurance. The bank lends money and runs the risk of not being repaid if the debtor is incorrectly evaluated. A bank may even contract trade credit insurance to protect itself from this risk.
The most common reason for default is bankruptcy of a buyer / debtor prior to payment of his debts. The company that finances its customers should purchase a trade credit insurance policy to guarantee payment. Bankruptcy or its equivalent, due to competition, is a recognized cause of loss under this type of insurance, and it triggers the processing of legal claims and debt collections.
Although it is difficult to foresee a default situation, with 100% certainty, the insured may opt to purchase a policy that excludes its major clients, due to the low probability of default. On the other hand, it is also possible to insure only those major clients that could represent a significant negative impact on the balance sheet in the case of nonpayment.
Credit insurers do not always require to be informed about the identity of all buyer or debtor clients of the insured company (especially, of the smaller ones). Generally, the credit assessment of the insured results in a credit limit covered by the policy. Any exposure in excess of that limit has to be informed, in writing, to the insurer for confirmation of the new credit limit. Credit insurers are not always exactly aware of the use of the credit limit granted, though its average use is known. However, this high risk exposure is strictly monitored.
It is a form of insurance whose purpose is to guarantee faithful fulfilment of obligations assumed by the principal to the insured, as established in the policy. It is a substitute product for a bank guarantee.
The Bank Guarantee and the Surety Insurance policy are two instruments frequently used as guarantees for contracts. However, the differences between these two options should be closely observed. If the contract requires an unconditional bank guarantee, upon default of the contracted party being proven, the contracting party will have the sole possibility of receiving monetary indemnification from the bank (guarantor) and bear the cost of contracting another service provider to give continuity to the contract. In the case of surety insurance, the insurer will fully answer for the mentioned operation, up to the amount of the insurance cover specified in the policy.
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