How Trade Insurance Helps Your Business Prosper
Trade insurance can protect your company against the risk of your buyers not paying and sometimes even your suppliers not honoring their obligation.
Most businesses wouldn't dream of not insuring their buildings, machinery or employees, but the impact of payment default can be just as devastating. In fact, what makes trade credit insurance stand out from the others is that it can actually help your business prosper. This insurance can protect your company against the risk of your buyers not paying and sometimes even your suppliers not honoring their obligation (in the case of advance payment)– or even prevent you going bankrupt.
Here are three reasons you should seriously consider it.
1. Suppliers and customers go bust all the time
The risk of non-payment is a very real one. Let's say your business often pays for goods or services upfront but what happens if one of those companies then files for bankruptcy? UAE law means that it could be a long time before the creditors get around to you. UAE bankruptcy is set out in Book Five of the Commercial Transaction Law, also known as Law 18. This provides a ranking of creditors. Employees' wages come first, followed by government taxes and any public funds used to deal with the liquidation. Only then does attention turn to other creditors.
How trade credit insurance helps your company in uncertain times: With trade credit insurance, you would be covered for a whole host of eventualities including insolvency, protracted default, non-delivery of pre-paid goods and even political risks. Taking into account an excess, this means a typical recovery of around 90% of insured debt. Even if the bad credit risk from each of your customers is quite low, the impact can be high. This is because the volume of sales required to replace unpaid debt are far higher than the debt itself.
Here's an example: Let's say a customer has AED1 million in unpaid debt. It's easy for us to trick ourselves into thinking that is just AED1 million of extra sales required to make up the difference. But of course not all of a sale is profit. If the business is lucky enough to operate at a 10% profit margin, it would actually need a further AED10 million in sales to cover the default. Being able to claim back in such a situation can be hugely important for your business: It can mean the difference between continuing to trade or not.
Related: Need To Protect Your Business? Here's How Risk Engineering Can Help
2. Third party default has a knock-on effect
It's not just your direct clients or suppliers that pose a risk to your company. When one company defaults it can send a shockwave through an industry. There is a domino effect that means other companies start to struggle financially as well. The payment defaults will then trickle down to you. For example, maybe your company undertakes work with 50% of the payment due upon completion. But the same terms may apply to your customer's suppliers as well, and so on. It just takes one company to hit financial trouble and suddenly your customer has insufficient funds to pay you– a case of protracted default.
How trade credit insurance mitigates knock-on effects: By helping to recover the costs of this bad debt, trade credit insurance helps protect the balance sheet, revenue flow and bottom line. As such, it also allows you to actually do business even if the local or global market is suddenly quite volatile. With a plan in place, a business can continue trading or even take on new customers that may otherwise have been deemed too risky. This a big advantage when your competitors are getting cold feet. And a big advantage when approaching a bank because you're more likely to get better terms as your business carries less risk.
3. Political events, economic downturns and natural disasters can strike
The world is constantly changing and it's hard to predict what will happen next, so it's important to adapt. The World Economic Forum Global Risks Report 2018 has been rating risks since 2008 and illustrates this point perfectly. In 2008, the biggest risks were mainly economic and geopolitical– asset price collapse, political instability, and spiking gas and oil prices. Fast forward a decade and the top risks are now extreme weather events, natural disasters, cyberattacks and fraud. Although that's not to say political upheaval isn't still a major factor.
Frequent losses appear to come from changes to the exchange rate caused by political instability, according to the Willis Towers Watson 2018 Political Risk Survey Report. This survey collected responses from 40 companies around the world and found that 35% had suffered some kind of political loss. Staggeringly, 43% of these losses totaled US$100 million or more. Since 2008, Willis Towers Watson alone has been involved in helping businesses collect US$1.035 billion in credit and political risk claims. So, while the risk of war, selective discrimination, and volcanic eruptions may feel low, if they strike the financial consequences can be devastating. If you or your suppliers operate in other territories, you need to prepare for non-payment. A change of government, for example, could mean your investors or suppliers are suddenly deprived of investment through changing tax laws or even confiscation. The sudden imposition of sanctions on a particular country can also impact on any suppliers you have there.
How your company can navigate political uncertainty and natural disasters: With trade credit insurance you not only have peace of mind about political turmoil and sudden natural disasters, but also the chance to expand overseas. Trade credit policies will protect the business against the risks of importing from, or exporting into, other markets. More than this, you also gain access to a wealth of knowledge about trade and different countries. Policy providers hold access to an incredible amount of real-time intelligence on businesses all around the world. They have to if they are going to define the risk. And by taking out a policy you will gain access to this information.
Gain a competitive advantage
As ever with insurance, be sure to shop around. There are a whole host of different polices out there, with choices about the level of commercial and political cover, as well as for domestic or export trade. As polices go, trade credit insurance is one of my favorites– as you've seen, the benefits it brings are simply huge.