Trade credit insurance protects the debtor book, at home and across the border.

What trade credit insurance actually insures

Trade credit is a licensed class of non-life insurance business in South Africa in its own right. It is not a sub-class of something else, and it is not the same thing as a guarantee, although the two are often confused because both respond to somebody failing to pay.

The distinction matters commercially. Under a guarantee the insurer stands behind an obligation owed by the insured's counterparty and pays the beneficiary. Under trade credit insurance the insurer indemnifies the supplier itself for a loss on its own debtor book. The policyholder is the party that is out of pocket, not the party that owes the money.

The insured event is loss on an approved receivable. In practice that means the buyer becoming insolvent, or simply failing to pay within an agreed period after the due date, which the market calls protracted default.

Source: Insurance Act 18 of 2017, Schedule 2 read with Table 2 (Classes and Sub-Classes of Insurance Business - Non-Life Insurance), Class 12 TRADE CREDIT: "Covers loss resulting from the provision of export credit or agricultural credit or any other trade credit as a result of insolvency or any other event". Class 12 has no sub-classes. Guarantee business is a separate class, Class 13.

The two halves of the market

South African insurers write trade credit in two distinct books. The split is not merely geographic labelling. The underwriting information, the pricing, the maximum credit periods and the events that trigger a claim all differ between the two.

A business that sells only within South Africa needs the domestic side. A business that exports needs the international side, and usually needs the domestic side as well, because very few exporters sell nothing at home. Where both are placed, they are normally written under one policy with separate limits and separate terms for each book.

How the two books differ

• Domestic covers sales within South Africa and, in most policies, the Common Monetary Area comprising Lesotho, Namibia and Eswatini
• International covers export sales to buyers outside that area and adds country risk to buyer risk
• Domestic credit periods are typically 30 to 90 days; export credit periods are often longer to allow for shipping and clearing
• Domestic claims turn on South African insolvency and business rescue processes; export claims may turn on a foreign insolvency regime the supplier has no visibility of
• Export cover can extend to events that have nothing to do with the buyer's solvency, such as an inability to transfer currency out of the buyer's country
• Export policies commonly offer pre-shipment cover for the period between order and despatch, which has no direct domestic equivalent

Domestic trade credit insurance

Domestic trade credit insurance protects sales made on credit terms to customers inside South Africa and, under most policies, the wider Common Monetary Area. It is the cover most South African manufacturers, wholesalers and distributors need first, because that is where the bulk of the debtor book sits.

The commercial case is not primarily about catastrophe. It is about being able to extend credit at all. A supplier that is unsure of a prospective customer either declines the business, demands cash up front and loses the order to a competitor, or takes the risk and hopes. Insurance replaces that guesswork with an underwritten credit limit on each account, set by an insurer that sees payment behaviour across the whole market rather than only its own ledger.

That information advantage is a large part of what is being bought. A credit insurer maintains a live view of how a buyer is paying its other suppliers. A reduction in an insurer's limit on a customer is frequently the earliest warning a supplier receives that something is wrong, and it arrives well before the account itself goes into arrears.

What domestic cover is typically used for

• Protecting the receivables ledger against customer insolvency and prolonged non-payment
• Supporting a decision to grant credit, or a higher limit, to a customer the supplier does not know well
• Removing the concentration risk created by a small number of very large accounts
• Making the debtor book acceptable as security to a bank or invoice discounter
• Reducing the doubtful debt provision and the earnings volatility that comes with it
• Giving a sales team a defensible basis on which to open new accounts quickly

What triggers a domestic claim

There are ordinarily two triggers. The first is a formal insolvency event affecting the buyer: liquidation, whether provisional or final, or the commencement of business rescue proceedings under Chapter 6 of the Companies Act. The second is protracted default, which arises when the debt remains unpaid for a stated number of days past due even though no formal insolvency step has been taken.

Protracted default matters more than it first appears. Many South African failures never reach a court order at all, because the business simply stops trading and is never wound up. Without a protracted default trigger, a supplier could hold a policy, lose the money, and still have no claim because no insolvency event was ever formally recorded.

Business rescue is worth understanding specifically. Once proceedings begin, a general moratorium applies and no legal proceeding, including enforcement action, may be commenced or continued against the company except with the practitioner's written consent, with leave of the court or in a small number of listed situations. In other words the supplier's normal collection remedies are frozen precisely when it most wants to use them. A trade credit policy responds in that period; a letter of demand does not.

Source: Companies Act 71 of 2008, section 133(1) (general moratorium on legal proceedings against a company in business rescue, subject to the exceptions in section 133(1)(a) to (f)) and section 133(3) (suspension of time limits during business rescue proceedings). Policy triggers vary between insurers; the wording of the specific policy governs.

How credit limits are set and managed

Cover operates through credit limits. The insurer sets an approved amount for each buyer, and the supplier is insured up to that amount on that account. Sales above the approved limit are, as a rule, not insured at all, which makes limit discipline the single most important operational habit under this class of policy.

Limits are not permanent. An insurer can reduce or withdraw a limit for future deliveries, usually on notice, if the buyer's position deteriorates. Deliveries already made under a limit that was in force at the time normally remain covered, but the supplier must stop shipping on credit once the reduction takes effect or it carries the excess itself.

Most policies also give the supplier a discretionary limit: a modest amount, set in the policy schedule, up to which the supplier may extend credit to a buyer without applying for an individual limit, provided it has followed a stated credit check procedure. Used properly this keeps small accounts out of the administrative loop. Used carelessly it is a common reason claims are reduced.

The practical consequence is that the policy is only as good as the credit control function behind it. Insurers expect aged debtor listings to be maintained, overdue accounts to be chased and reported within the policy deadlines, and further supply on credit to be stopped once an account is materially in arrears.

International trade credit insurance

International trade credit insurance protects export sales against non-payment by foreign buyers. It carries the same core buyer risk as the domestic cover and adds a second layer that domestic cover does not have to price at all: the risk attaching to the buyer's country rather than to the buyer.

The information problem is what drives demand. A South African exporter assessing a buyer in Lagos, Nairobi or Sao Paulo cannot pull a local credit report, does not know how that buyer pays its other suppliers, and has no realistic prospect of enforcing a South African judgment in the buyer's home courts. An insurer with an international underwriting network can price that buyer where the exporter cannot assess it.

The second driver is growth. Exporters are routinely asked for open account terms by buyers who will not open a letter of credit, and a letter of credit ties up the buyer's banking facilities in a way that makes a competitor offering open account terms more attractive. Credit insurance lets an exporter offer those terms without carrying the full consequence of being wrong.

What international cover is typically used for

• Protecting export receivables against foreign buyer insolvency and default
• Assessing buyers in markets where the exporter has no reliable credit information
• Offering open account terms in place of a letter of credit to win business from competitors
• Entering a new market with a known maximum loss rather than an unknown one
• Obtaining or improving export finance, where the funder takes cession of the policy proceeds
• Covering the pre-shipment period on made-to-order goods that have no alternative buyer

Country risk, transfer risk and political events

On the export side a buyer can be entirely solvent, entirely willing to pay, and the exporter can still not receive the money. The funds may be blocked by exchange controls in the buyer's country, or the local currency may not be convertible, or a moratorium on external payments may be declared. These are transfer and convertibility risks and they sit with the country, not with the buyer.

Beyond that sit the political events proper: war, civil disturbance, expropriation, the cancellation of an import licence already granted, or a change in law that makes performance of the contract unlawful. Policies differ substantially in how far they extend into this territory, and cover for a given country is frequently restricted or withdrawn as conditions change.

This is the part of the arrangement most worth reading closely before an order is accepted. An exporter that assumes country cover is automatic, in a market where the insurer has quietly closed cover, is exposed on the whole shipment. Confirming that cover is open for the destination country before committing to a large order is a cheap discipline.

Where the private market stops and the export credit agency begins

Private trade credit insurers concentrate on short-term business, generally receivables falling due within a year, sold on repeating open account terms. That is the right answer for a manufacturer shipping goods month after month.

It is not the right answer for a South African contractor exporting capital goods or a large project into another African market on multi-year payment terms. For that the relevant institution is the Export Credit Insurance Corporation of South Africa SOC Ltd, the state-owned national export credit agency, which provides political and commercial risk insurance to South African exporters of goods and related services. Its product range extends beyond receivables cover to investment insurance, bond insurance and programmes for smaller transactions.

The two are complements, not substitutes. An exporter with a repeating short-term book and an occasional large project may well use a private insurer for the former and the export credit agency for the latter. Establishing which route applies before quoting on a large export contract avoids discovering, after the contract is signed, that no private insurer will look at the tenor.

Source: Export Credit Insurance Corporation of South Africa SOC Ltd, established in 2001 under the Export Credit and Foreign Investments Insurance Act 78 of 1957 as amended; a licensed non-life insurer and authorised Financial Services Provider (FSP 30656). Source: ecic.co.za.

Policy structures available on both books

Trade credit insurance is not a single product. The structure chosen determines both the premium and the amount of routine administration the business takes on, and the cheapest structure on paper is frequently the wrong one.

Insurers resist purely selective structures for the same reason any insurer resists selection against it: a supplier allowed to insure only the accounts it is worried about will insure exactly those accounts. Whole turnover structures are therefore both the most common and, per rand of turnover, usually the cheapest.

Common structures

• Whole turnover: the entire eligible debtor book is declared and insured, giving the broadest cover and the lowest rate
• Key accounts: a named group of major buyers is insured, leaving the long tail of small accounts uninsured
• Single buyer or single contract: cover on one named relationship, usually where one account dominates the book
• Excess of loss: the business carries an aggregate first loss and the insurer responds above it, suited to businesses with strong internal credit management
• Pre-delivery or pre-shipment: covers costs incurred between order and despatch where the buyer fails before delivery
• Trade finance and funder-driven structures: arranged principally so that a bank or invoice discounter will advance against the insured book

What is not covered

The exclusions are consistent across the market and are the source of most declined claims. None of them are unreasonable, but each one describes a situation a supplier can walk into without noticing.

The most common cause of a reduced claim is not an exclusion at all. It is a sale made above the approved credit limit, or after the insurer had reduced it, or outside the maximum extension period. In each case the policy is working exactly as written and the supplier simply was not insured for that portion.

Typically excluded or not insured

• Amounts above the approved credit limit for that buyer, or sales made after a limit was reduced or withdrawn
• Debts that are genuinely disputed by the buyer, until the dispute is resolved in the supplier's favour
• Sales to related parties, associated companies or entities under common control
• Accounts already overdue beyond the stated period when the policy incepted, or when the limit was applied for
• The uninsured percentage or first loss that the supplier retains on every claim
• Sales in countries or currencies for which cover is not open under the schedule
• Interest, penalties and collection costs, unless the policy specifically extends to them
• Losses where the supplier failed to notify an overdue account or to stop supply within the policy deadlines

What the insurer expects from the business

This is an underwritten class in which the policyholder's own conduct materially affects the outcome. Insurers price on the quality of the credit management function, and a business with a disciplined process pays less than one without it.

The obligations are not onerous, but they are deadline driven. A missed notification date is a complete answer to a claim in a way that would be unusual in property or liability insurance, so the notification clauses deserve to be diarised rather than filed.

Standard policyholder obligations

• Declare turnover accurately and on time, since premium is usually adjusted on declared insurable turnover
• Apply for credit limits before extending credit above the discretionary limit
• Follow the stated credit checking procedure for buyers covered under the discretionary limit
• Maintain an aged debtor analysis and act on it
• Notify overdue accounts within the period stated in the policy, commonly measured in days past due
• Stop further supply on credit once an account is materially in arrears, unless the insurer agrees otherwise
• Observe the maximum extension period, which caps how far a due date may be extended without losing cover
• Hand the account over for collection when required, and cooperate with the insurer's recovery process

Cost, rating and the effect on funding

Premium is normally expressed as a rate per mille on insurable turnover, adjusted at the end of the period against actual declared turnover, with a minimum premium. Credit limit application fees are usually charged separately. Rating is driven by the spread and quality of the debtor book, the sector, the credit terms granted, the loss history and the size of the retained first loss.

A properly reasoned case for the cover is rarely made on premium alone. It is made on what the cover releases. An insured debtor book is acceptable security in a way an uninsured one is not, and banks and invoice discounters will normally advance a materially higher percentage against insured receivables, frequently taking cession of the policy proceeds as part of the facility.

There is an accounting dimension as well. Insured receivables generally support a lower doubtful debt provision, which improves reported earnings and reduces the volatility that a single large failure would otherwise introduce. For a business with concentrated exposures, that stability can matter more to a funder or a shareholder than the premium does.

Trade credit insurance compared with a guarantee

The two instruments are regularly confused, and the confusion is expensive when it results in the wrong one being arranged. A guarantee is arranged by the party that owes an obligation, in favour of the party it owes it to. Trade credit insurance is arranged by the party that is owed money, for its own protection.

So a fuel retailer that must give its supplier security before an account is opened needs a guarantee. The wholesaler on the other side of that account, worried about the retailers it supplies generally, needs trade credit insurance. The same commercial relationship produces two different products depending on which side of it you sit.

A business can quite properly need both at once: a guarantee in favour of its own suppliers, and trade credit insurance over its own debtor book.

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