Trade Credit Insurance
Although it's of little importance to most consumers, trade credit insurance is a highly valuable risk management asset for most businesses. An innovative form of insurance designed to minimize most risks associated with extending credit to other businesses, trade credit insurance protects companies from being financially hurt by another company that they have extended a line of standard credit to.
In simple terms, it allows a business that operates on a weekly, monthly, or quarterly billing cycle to insure itself against the risk of a partner going bankrupt, bailing out on an invoice payment, or using external events to avoid making a complete payment. Known colloquially as credit insurance, it's a form of debt insurance that's exclusive to the business world, albeit different to consumer versions.
This type of insurance can be quite valuable to businesses, particularly those that extend thousands of dollars, or occasionally even millions of dollars, worth of credit to their partners or clients at any one time. A missed payment can, in some cases, bring cash flow to a halt, forcing the business into a state of temporary insolvency or paused operation until the owed payment is completely received.
For a large business, or even a SME, this can result in disaster. Employees may need to cease doing their jobs due to incoming funds issues; production may need to cease as the running costs of taking care of equipment become too much, and the business as a whole may need to stop. Although these issues can, in part, be cleared by diversified income, they're not entirely preventable on their own.
It's for this reason that trade credit insurance is considered so valuable to most businesses. A small business that lacks this form of insurance could, in many cases, find itself unable to function when one of its partners fails to make a payment before the deadline. Trade credit insurance, like almost every other form of insurance, fills a gap that could otherwise cause major disruptions to business.
Let's look at this form of insurance – a fairly complicated purchase for most businesses – using two real world examples. Both of these economic events occurred in the last twenty years, and both had the potential to become major export disasters. Thanks to the presence of trade credit insurance, far more businesses managed to survive these economic hiccups than most analysts would expect.
Trade Credit Insurance and Currency Crises
The Asian Financial Crisis was one of the defining economic events of the 1990s. After decades of immense growth in countries such as Thailand and Malaysia, the vast majority of economic forward movement stopped to a halt. The reason for this sudden crash? A growing currency and supply crisis in two of Asia's most influential developing economies, and the crisis's subsequent financial fallout.
Let's look at this one from the beginning. In the early 1990s, the economy of Thailand was growing at a rapid pace. Economic growth held steady at over eight percent annually – an incredible level in a country with a relatively high population. Construction was booming alongside the fast growth of many high-value companies, prompting many to hail the country as an economic miracle.
However, there was a downside to this growth. As Thai companies borrowed large sums from many overseas lenders – most of these loans were in US dollars – the value of the then-pegged Thai baht began to decrease. As the country's reserve bank grew short in currency reserves, the financial plug was pulled and Thailand's economy crashed, with the baht dropping form 25 USD to over 50 USD.
This left many merchants within the country unable to repay their international bank loans. Should the lenders have lacked trade credit insurance, the sums may have gone unaccounted for for years, due to the insolvency of many Thai firms. Thankfully, businesses with trade credit insurance were able to recover much of their lost loans without extensive negotiation or relentless legal pursuits.
This is just one example of how trade credit insurance can be used to protect exporters and overseas lenders from being caught up in currency-related events. Although the value of these loans changed for the Thailand-based companies, the foreign exporters that were lending the money and exporting construction materials were able to recover their owed income through trade credit insurance plans.
Trade Credit Insurance and Bankruptcy or Insolvency
Here's another interesting example of how trade credit insurance can protect businesses, particularly businesses engaged in international commerce, from the risk of a partner going bankrupt. For about ten years, the value of the US dollar and UK pound has been shooting upwards and downwards on a seemingly unexplainable roller-coaster-style trajectory.
It's been the cause of numerous trade-related issues, particularly those that concern exporters based in either of the countries. Despite the two countries' 'special relationship,' these changes in currency value have pushed many exporters and importers into bankruptcy. The most recent, just under three months ago, resulted in a significant amount of pain for US-based importers due to price increases.
Should a company in this setting go bankrupt due to the relative value of an order, or otherwise be unable to complete a routine payment, trade credit insurance can help the exporter receive their full payment properly. When a line of credit is extended across borders, even those with close economic and financial ties, a comprehensive insurance policy can make sure that it's never left insecure.
This risk elimination is the most obvious use for trade credit insurance. While the service itself is an asset used only by businesses and export/import companies, its value should be clear for consumers that depend upon it for stable pricing. Without measures such as trade credit insurance, the value of many goods would change on a daily basis due to missed payments and relative financial hiccups.
So be thankful for trade credit insurance, and in the case of many businesses, invest heavily in it for stable international and domestic business partnerships. Although not all credit-based businesses are in need of trade credit insurance, the service is one of several insurance forms – along with liability insurance – to offer a massive amount of value to both consumers and the businesses they rely on.