Trade credit insurance helps businesses improve performance

In any language, the word ‘insurance’ carries the meaning of security, confidence, and protection. And that is exactly what insurance sets out to do – provide security.

I. Insurance throughout history

The first written mention of insurance appears in the Babylonian Code of Hammurabi, which required indemnification in the event of theft. The Roman Empire, the cradle of European jurisprudence, also offers examples of transactions which in effect constituted insurance. Ancient Romans could set up associations that insured or provided security for property, as well as those that paid out sums of money in the event of death, and as such were precursors of life insurance.

Unlike other European countries, Serbia was fairly late in embracing insurance. Even though the code of laws promulgated by Serbian Tsar Dušan in 1349 recognised rudimentary insurance transactions, such as collective liability for damage, insurance in its modern sense appeared only in the latter half of the 19th century. The first transactions were handled by foreign insurance firms, with the first Serbian insurers emerging in the 1900s.  

The development of insurance markets has paralleled that of societies and economies. New types of insurance have been created to address new risks. One such arrangement is trade credit insurance, which is relatively new to the Serbian market but has nevertheless been attracting a great deal of interest recently. This article will explore trade credit insurance, as well as the closely related retail credit insurance option.

II. The fundamental importance of trade credit insurance to modern-day business

Today’s cross-border commerce poses many challenges and risks for companies. To enter new markets and attract clients, firms have to offer deferred payment terms. On the other hand, businesses have to be certain they will be able to collect their accounts receivable from sales both at home and abroad to be able to operate, plan, and achieve sustainable growth. In recent years, companies have been successful in balancing between these two considerations by insuring their trade credit.

The covid pandemic brought about a dramatic upsurge in interest in trade credit insurance from businesses, especially in the Serbian market, as the country was the last in the region to introduce this type of insurance in the region. Trade credit insurance is commonly used by pharmaceuticals and tech companies and in the energy and metal industries, as well as by all consumer goods firms that seek security and certainty in collection.

Trade credit insurance generally covers accounts receivable owed to sellers by Serbian and foreign buyers of goods and services. These accounts receivable must arise and be reported during the term of the insurance agreement and must be subject to invoices issued by the insured person (in this case the seller) to buyers that stipulate deferred payment terms.

Although exact practices vary by insurer, a trade credit insurance policy will usually cover the amount owed by the buyer to the seller, any associated procurement costs, and any costs payable by the seller (such as the cost of attempting to collect the sum insured or recover products or sell those products if and when recovered).

Conversely, these policies generally do not cover any interest or additional costs associated with delayed payment, advance payments, contractual or judicial penalties, invoices that are contested or subject to customer complaints due to latent defects or patent defects reported by the buyer, and similar costs.

The insurance policies always cover commercial risk, such as the risk of the buyer becoming insolvent (including undergoing compulsory liquidation) and extended default risk (deferred payment). Insurers also offer coverage of non-commercial risks, which includes political developments, war, moratoriums, transfer and exchange bans, and other specifically defined circumstances.

Even though the state of the local market is such that only a few insurers currently offer these policies, the growth of interest in trade credit insurance is expected to drive demand up, since companies that insure their accounts receivable can be more competitive and profitable. Offering deferred payment terms to suppliers also improves companies’ cash flows.

III. Retail credit insurance as a subset of trade credit insurance

Alongside loans, banks now commonly offer insurance products that ensure those loans are paid back in the event of unforeseen circumstances, such as losing one’s job, lasting disability (in excess of 50 percent), or death.

This retail credit insurance has become increasingly widespread in the banking market. In this arrangement, the lender bank contracts insurance that allows it to recover any outstanding loan amount from the insurer if it is unable to collect the debt from the borrower.

The bank enters into the insurance agreement, pays the premiums, and, as the insured person, is able to seek reimbursement in the event an insured event occurs. The insurance policy covers the risk of borrower delinquency, and the sum insured is equal to the principal and any interest.

This business model is highly profitable, since the insurer, once it has paid the sum insured to the bank, will assume the bank’s rights and liabilities with regard to the borrower, and will be able to seek recovery using any collateral posted by the borrower when entering into the loan agreement.

IV. Conclusion

Today’s business practices bear out the saying of ancient Roman statesman Cicero, that money should be a servant rather than the master. Comprehensive planning and stable and sustainable cash flows underpin the performance of a business, and insurance, whose primary purpose is to provide security, helps support operations. Given its relative novelty, trade credit insurance is yet to demonstrate its full development potential and benefits for Serbian firms.