About Export Credit Insurance
Credit insurance is insurance for companies against the risk that their business customers do not pay for goods or services they bought.
The credit insurance market
Credit insurance was born at the end of the nineteenth century, but it was mostly developed after the First World War. Customers include companies of all sizes, and banks and factoring companies that finance trade of these companies.
Credit insurance is offered by private credit insurance companies, public Export Credit Agencies (ECAs) and multilateral institutions. Most developed and emerging markets, and some developing countries, have at least one credit insurer operating in their territory.
As a trade association, the Berne Union mainly focuses on risk related to cross-border trade. Of all cross-border trade in the world (around 20 trillion dollars) Berne Union members support about 13%.
What is credit insurance used for?
The direct benefits of credit insurance:
- Risk mitigation: It protects the seller company against payment losses, thus safeguarding its continuity
- Credit management: Thanks to a more stable cashflow, it makes planning and budgeting for companies easier
- Financing: It enables credit for the seller and the buyer. When credit insurance is available – either as a collateral or as direct cover to the bank, banks are more prepared to finance working capital, sales and exports as it reduces the capital banks need to set aside for these credits
The wider benefits are:
- It makes marketing by the seller more efficient. If a credit insurer has rejected a credit limit on a potential buyer due to its weak creditworthiness, then there is no longer a need to invest in sales opportunities to that buyer. The seller can thus focus on creditworthy buyers
- It opens up opportunities with less-known buyers or in less-known markets
Types of credit insurance
There are several ways to distinguish between types of credit insurance.
A first distinction is between:
- Short-term credit insurance, i.e. typically credit insurance for trade goods and services.
- Medium/Long term credit insurance, i.e. credit insurance for capital equipment transactions and infrastructure projects.
Another split is:
- Whole-turnover or revolving cover: The insurance of a company’s entire turnover or large parts of it. The seller company receives a framework insurance policy under which it applies for credit limits on companies it wants to sell to. This cover is mostly used for short-term credits
- Single situation or single transaction cover: The insurance of credit risk of a specific transaction. This cover is mostly used for structured and medium/long term credits
A further dichotomy is:
- Insurance against commercial risk, i.e. the risk that a receivable is not paid due to insolvency of or protracted default by a private company
- Insurance against political risk, i.e. the risk that a receivable is not paid by a public buyer or due to political events, such as
- Force majeure, for example war, political violence or natural disasters
- Inability to transfer currency
- A government-imposed moratorium on payments
A fourth distinction can be made between:
- Pre-credit (or manufacturing) risk: The risk that manufacturing costs are not reimbursed if the buyer has become insolvent before delivery of the goods, or if political events in its country prevent delivery
- Credit risk: The risk that the buyer will not pay after delivery of the goods or services
Lastly, a split could be made between:
- Domestic credit insurance, i.e. the insurance of credit risk under sales contracts to buyers in the same country as the seller
- Credit insurance of cross-border (or export) transactions. This often includes insurance against political risk in the buyer country.
Short term credit insurance
This is typically insurance for credit terms ranging from 1 to 360 days. These credits are known as supplier credits. Usually the credit term is related to the economic life of the goods. Fresh flowers would attract shorter payment terms than e.g. machinery.
About 90% of trade credits are short term, reflecting the composition of the types of goods traded worldwide. Most short-term credit insurance is on whole-turnover basis. By insuring an entire company’s portfolio, the insurer has a better spread of risk and the premium per transaction can be lower.
In many high-income countries there is a well-developed private insurance market for short-term risk which can be offered direct or through specialised brokers. In emerging markets, and to a lesser extent also in developed markets, ECAs play an important role in short-term credit insurance as well.
Medium/Long Term credit insurance
Medium/Long term (MLT) credits range from 1 year to over 15 years. This type of cover is mostly offered by ECAs and multilaterals, although the capacity of private insurers for longer term credits has been growing.
As selling companies usually do not want to wait that long before receiving payment, banks are financing these transactions by providing a loan to the buyer. The selling company is paid out of this loan during the manufacturing period or at the latest at delivery. These loans are known as buyer credits. In this case the bank is the insured for the credit risk.
The typical insurance form for MLT business is single transaction insurance.
Ancillary risks and products
Financial risk of trade transactions is not only characterised by (pre-)credit risk. There are several other risks credit insurers can provide cover for, including:
- Bond cover: The seller sometimes must provide bank bonds (such a for an advance payment). Insurers can cover the risk that the buyer wrongfully calls these bonds. This cover frees up financing capacity with the seller’s bank
- Currency risk cover: In the case of export transactions, sometimes the buyer pays in a different currency than the currency in which the seller has made manufacturing costs. This currency risk can often be covered in addition to credit risk cover.