How credit insurance works: a plain-English guide

If you sell to other businesses on credit terms, you are lending them money. You deliver the goods or do the work, send an invoice, and wait 30, 60 or 90 days to be paid. Until then, the money sits on your customer's balance sheet, not yours.

Trade credit insurance protects that money. If an insured customer becomes insolvent, or simply does not pay, the insurer pays you most of what you were owed.

That is the one-sentence version. The rest of this guide explains how it actually works, what it does not do, and how to tell whether it is worth having.

The short version

• You insure the invoices you raise to business customers.
• The insurer agrees a credit limit for each customer: the most it will cover on that customer at any one time.
• If a covered customer goes bust or fails to pay, you claim, and the insurer pays a set share of the loss, usually around 90%.
• You pay a premium, normally worked out from the turnover you insure.

What it covers

A credit insurance policy pays out on two kinds of event.

Insolvency. Your customer enters administration, liquidation, receivership or a similar formal process, and your invoice is stuck in the queue of unsecured creditors. In practice, ordinary suppliers rarely get much of their money back from that queue. The policy pays you instead.

Protracted default. Your customer is still trading but has not paid. If the debt is still unpaid a set period after it fell due, the policy treats it as a loss even though no insolvency has happened. That period is called the waiting period and is written into the policy. This matters more than people expect, because many losses come from customers who drift rather than collapse.

Some policies also cover political risk on export sales: a government blocking payments leaving the country, for example, or a war or import ban stopping a contract.

What it does not cover

Credit insurance is not a guarantee that every invoice will be paid. The main exclusions are much the same from one insurer to the next.

• Disputes. If your customer refuses to pay because they say the goods were faulty or the work was not done, the insurer will not pay until the dispute is settled in your favour.
• Customers you already knew were in trouble. Cover depends on telling the insurer about problems as soon as you know about them.
• Sales above the credit limit. If the insurer covers a customer for £100,000 and they owe you £150,000, the extra £50,000 is yours to carry.
• Connected companies. Sales to businesses you own or control are normally excluded.
• Missed policy conditions. Most policies require you to report overdue accounts by a set deadline. Miss it and a claim can fail.

That last point is where many claims go wrong. A policy is a set of obligations as well as a promise, and the wording matters.

Credit limits: the part most people overlook

The credit limit is the heart of the policy. Before you trade with a customer on insured terms, the insurer looks at that customer and decides how much it is prepared to cover.

Insurers hold data on millions of companies, often including payment experience from other policyholders that you will never see in a credit report. So a credit limit is a view from someone with far more information than you, who stands to lose money if they get it wrong.

Three things follow from that.

First, a reduced or declined limit is useful information. If the insurer will not cover a customer, it is worth asking why before you extend more credit yourself.

Second, limits can change. If an insurer sees a customer weakening, it can reduce or withdraw the limit. That applies to new deliveries, not goods already shipped under the old limit, which stay covered. Being told early is often worth more than the claim you avoid.

Third, you are not limited to what the insurer volunteers. Limits can be appealed with better information, such as recent management accounts or your own payment history with the customer. Most policies also include a discretionary limit, which lets you cover smaller customers up to a set amount on your own evidence, without a separate application.

How a claim works

When a customer stops paying, the steps usually run like this.

1. The invoice goes overdue. You chase it as normal.
2. If it is still unpaid by the deadline in your policy, you report it to the insurer. From then on you will usually need the insurer's agreement before supplying that customer again.
3. The insurer, or its collections team, often tries to recover the money first. Many overdue debts are paid at this stage.
4. If the customer becomes insolvent, or the waiting period runs out, you submit a claim with the invoices and proof of delivery.
5. The insurer pays the insured share of the loss. Anything recovered later is shared in the same proportions.

Good records make claims straightforward. Most claims that fail do so because a deadline was missed or a document was missing, not because the risk was uninsured.

How the policy is shaped

There is no single standard policy. The common structures are:

• Whole turnover: all your eligible business customers under one policy. The most common choice for trading businesses.
• Key buyer: cover on the handful of customers whose failure would really hurt.
• Excess of loss: you carry everyday losses and the insurer takes the large ones above an agreed level. This suits larger firms with strong credit control.
• Single situation: one customer, one contract or one country, insured on its own terms.

How the premium is worked out

The premium is normally a rate applied to the turnover you insure, often with a minimum premium for the year and an adjustment once the actual turnover is known. The rate depends on your sector, the quality and spread of your customers, your loss history, how well you run credit control, and how much risk you choose to keep through the indemnity level and any excess.

Because so much depends on your own book, the only reliable way to know the cost is to have the risk properly presented to the market.

What it does besides paying claims

Most policyholders get more value from the policy in years without a claim than from the claim itself.

• Better lending. Banks and invoice finance providers will often lend more, at better rates, against insured debts. The lender can be named on the policy.
• Bigger customers on better terms. You can offer open credit to large buyers that an uninsured competitor would hesitate over.
• Credit discipline. Insurer limits give your sales team an outside reference point, which takes the awkwardness out of saying no.

Is it worth having?

Credit insurance tends to make sense if:

• a large share of your revenue comes from a small number of customers;
• one bad debt would wipe out a meaningful slice of the year's profit;
• you want to grow with larger customers or overseas; or
• you rely on invoice finance or bank lending secured on your debtors.

It makes less sense if you sell mainly to consumers, take payment upfront, or have a very wide spread of small customers where any single failure would barely register.

Where a broker fits

You can buy credit insurance directly from an insurer. A specialist broker works for you, not the insurer: comparing what the main insurers will offer on your actual customers, negotiating the wording, appealing declined limits, and handling claims with you when they come.

That is what we do at Assured Trade. If you want a feel for how an insurer might view one of your customers, try our free Buyer Assessment tool. If you would rather talk it through, get in touch. And if insurance is not worth buying for your book, we will tell you.

This article is a general explanation of how trade credit insurance works. It is not advice on your own cover, and every policy wording differs.