Beyond Insurance: The Case for Trade Credit Assurance
Trade credit is a pivotal component of business relationships, allowing borrowers to manage cash flow and customer lenders to strengthen partnerships. However, a quick search on trade credit often leads us to a plethora of information about trade credit insurance. This is a product designed to protect sellers from the risk of non-payment by their buyers.
But what is driving the overwhelming focus on trade-credit insurance, and is it enough?
In the report titled “Global Trade Credit Insurance Market Report and Forecast 2022-2027” by Expert Market Research (EMR), the trade credit insurance market was valued at over USD 10.2 billion in 2021. The market is projected to expand at a compound annual growth rate (CAGR) of 8.6% during the forecast period from 2022 to 2027, reaching upwards of USD 16.70 billion by the end of 2027. Trade credit insurance safeguards businesses from the risk of non-payment, significantly mitigating the risk associated with credit transactions. The comprehensive coverage provided by trade credit insurance, which includes commercial risks like buyer insolvency and political risks such as war or terrorism, along with protections against currency inconvertibility and regulatory changes in international trade, is driving the market’s growth (EMR, 2022).
While the market’s projected growth suggests robust confidence in the protective measures of trade credit insurance, it also prompts a deeper inquiry into the motivations behind this reliance and whether such mechanisms are sufficient in addressing the core vulnerabilities faced by businesses in credit transactions.
The surge in demand for trade credit insurance signals a deeper underlying issue. A lack of assurance in the credit relationship.
This trend hints at businesses’ increasing apprehension about the financial stability of their trading partners. It’s akin to treating the symptoms rather than addressing the root cause. So, what is the cause?
- Understanding Beyond Credit Ratings: It’s one thing to know your customer’s credit rating, quite another to truly understand who they are. Credit ratings are essential, but they’re just a snapshot, a glimpse into a company’s financial reliability at a given moment. They don’t tell the whole story. The ‘actor’ your customer embodies in the business drama is as crucial as their credit score.
- The Evolving Credit Landscape: Trade credit is not a static moment but a dynamic relationship that unfolds over time. At the point of credit application, a business may be in excellent financial health. But what about six months down the line? Changes in creditworthiness can occur rapidly due to various reasons, such as market volatility, managerial decisions, ill health, or even ‘phoenixing’—where a troubled company is closed only to resurface as a new entity, often leaving creditors in the lurch. Traditional credit insurance may cover some of these instances, but the lack of ongoing assurance remains a vulnerability.
Trade credit assurance, on the other hand, is about building a more profound, informed understanding of your trading partners. It involves continuous monitoring and a relationship-based approach to credit management. It’s about knowing your customer’s business practices, their industry standing, and having mechanisms in place to detect and respond to changes that could affect their creditworthiness.
The distinction between trade credit insurance and assurance is clear.
Insurance offers a safety net, providing financial compensation in case of default. Assurance, however, is proactive. It’s about customer relationships, risk management and prevention, understanding the complexities of your customers, and evolving with them. Assurance could involve regular financial health check-ups, industry analysis, and even fostering open lines of communication with clients to gauge any potential risks before they become liabilities.
Trade credit insurance is a valuable tool for mitigating financial risks. But the future of credit management leans towards a comprehensive assurance approach.
It’s about being proactive rather than reactive. Ensure that you are as informed as possible about the businesses you partner with. In the end, the most successful companies will be those that not only insure but assure their trade credit practices. This will foster stronger, more resilient business relationships.