Trade credit insurance has been long touted as a useful tool for businesses to protect themselves against non-payment of commercial debt. Under such policies, a policyholder is generally indemnified against financial losses suffered following the default of a contractual counterparty on its obligation to pay.
Given the current economic and geopolitical climate, trade credit insurance will no doubt continue to play an important role in businesses’ risk management programmes for corporates and financiers alike.
Here are some key points to consider.
The basics of trade credit insurance
The primary benefit of trade credit insurance (in its most traditional sense) is that it empowers insureds to do business with new customers without fear of not being paid. For instance, an exporter or trader may take out a multi-buyer policy that insures payments (typically shorter-term trade debts) from certain approved buyers within certain defined credit limits.
Trade credit insurance can also be used to support supply chain finance (SCF), a financing technique in which receivables (i.e. sums due from a buyer to a seller under a contract) are sold to financiers at a discounted value to reflect the delay in payment, thus providing an alternative to traditional bank funding. SCF programmes are frequently insured, allowing financiers to protect themselves against the risk of non-payment by customers in respect of the receivables. However, it is vital that policyholders carry out adequate due diligence on the creditworthiness and business practices of their customers prior to entering such arrangements, otherwise they run the risk of being left without cover. For instance, financing should never be extended on the basis of future (i.e. hypothetical) invoices where no goods have been produced in connection with the financing.
Trade credit insurance can also be harnessed by banks and other financiers to finance trade. Comprehensive non-payment insurance (NPI) policies, which fall within the umbrella of credit insurance, typically protect against both credit risk and political risk and are a good option for lenders looking to insure against the risk that a borrower will not meet their repayment obligations. As a general rule, NPI policies are bespoke to a particular transaction (often longer-term debt instruments such as term loans or revolving credit facilities) and only require an insured to prove that non-payment has occurred, although the trigger for such loss must be clearly set out in the policy. Furthermore, a well-drafted NPI policy can also be used by financiers to reduce their capital requirements (credit risk mitigation).
It is worth mentioning that the description of an insurance policy should not be relied upon as being definitive of the scope of cover. A policy generically described as “trade credit insurance” might actually be an NPI policy, which is an issue that might come into play during a subsequent coverage dispute with insurers and have implications on what the policyholder is required to demonstrate.
Key policy terms
No matter their insurance needs, it is vital that policyholders read policy wordings carefully to understand the full extent of proposed coverage and insurers’ rights as to cancellation and non-renewal. Ultimately, the appropriateness of a particular type of trade credit insurance policy (and there are many!) will depend on a policyholder’s particular circumstances.
In particular, we always recommend paying particular attention to the following key terms, which often form the battleground for coverage disputes:
- Exclusions – these clauses set out what losses are excluded, e.g. those caused by the insured’s fraud or illegality or nuclear losses;
- Conditions precedent – these can either be precedent to the inception of risk or to the insurer’s liability, e.g. a condition that insurers be promptly notified of a loss event. Whereas non-compliance with the former shall result in the risk not attaching until it is satisfied, non-compliance with the latter will allow the insurer to deny liability and decline payment of a claim;
- Warranties – these are essentially promises by the policyholder to the insurer, e.g. requiring that the underlying goods be stored in a secured warehouse, the non-compliance of which will result in the insurer not being liable under the policy unless the breach has either been remedied or certain exceptions apply;[1]
- Fair presentation of the risk – this clause sets out the scope of a policyholder’s duty to make a fair presentation of the risk to be insured (e.g. are the trades being insured plain “vanilla” trades or structured “circle/string” trades) to insurers, which arises whenever a policy is taken out or renewed. Although this duty is governed by Part 2 of the Insurance Act 2015, it is not uncommon for the scope of such duty to be amended in credit insurance policies—therefore, policyholders should always consider whether they can ensure compliance. Otherwise, an insurer may be able to “avoid” the policy, i.e. treat it as never having existed.
These are of course just a few things to bear in mind.
For more information, please contact Amanda Montano.
Fladgate LLP’s Insurance Policyholder Team specialise in representing policyholders to help recover payments from insurers under their insurance policies or to advise on policy terms. If you need assistance with your insurance claim, get in touch with Garbhan Shanks, Head of Insurance.
[1] See ss.10(2) and (3) of the Insurance Act 2015.
