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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
    • Europe
      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
    • North America
      • USA
      • Canada
    • Australasia
      • Australia
      • New Zealand
  • Hi-Tech
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    • UK Fintech
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      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
  • Legal
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    • Articles
      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
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      • Economic News for 2022
      • Financial Crisis or Not?
      • Credit Suisse Bailout
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      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
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      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
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Home Credit Insurance

Credit Insurance in Trade Receivables Financing

John Goodden by John Goodden
January 31, 2023
in Credit Insurance
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Download file | Play in new window | Duration: 8:42 | Recorded on November 28, 2022

Trade receivables refers to unpaid invoices for goods or services provided. Until an invoice is paid, it is classified as a trade receivable. There is always a time lag between delivering a product or service to another company and getting paid. This time lag can cause problems, and it is for this reason that trade receivables financing is common practice. It is also the reason why credit insurance is so important. This post will take a closer look at credit insurance.

Risks

While a company waits for its customer to pay an invoice a lot could change in the world. The currency stipulated for paying an invoice could change drastically in value. The customer could go into insolvency. And, as we have seen recently, a country you trade with could become an international pariah, making receiving payment a process fraught with political attention and possible sanctions. In this context of risks, it is therefore wise to use credit insurance to mitigate against potential pitfalls.

The Benefits of Credit Insurance for Companies

There are specialised insurance policies for trade receivables. They have 3 main benefits:

  1. Supporting Sales Growth. A company can enter foreign markets with less trepidation that a debtor will default on the payment of an invoice if they have credit insurance. And a company will have less fear that the country they are trading with might go into a period of political and economic turmoil. Moreover, with credit insurance a company can offer longer payment terms to customers. This makes a company more competitive.
  2. Improving Credit Controls. In order to qualify for credit insurance on trade receivables a company must conform to certain credit control requirements. This is beneficial for a company as going forward it will have better credit controls in place.
  3. Better Financing Options. A company that uses credit insurance for its trade receivables has better financing options. The trade receivables can be used for factoring in order to generate cash needed for working capital. In certain instances, it can facilitate securitising trade receivables which again releases money tied up in unpaid invoices.

The Benefits of Insurance for Invoice Financiers

For banks and companies offering invoice finance services obtaining insurance has important benefits:

  1. A factoring company will have internal limits on the amount of money it has to buy trade receivables from any one client or from any one country. Having insurance on trade receivables can often allow these limits to be extended.
  2. Obtaining Capital Relief. A bank has to maintain certain levels of reserves of cash. These levels can be reduced if it enters into a credit protection arrangement such as a credit insurance policy.

The Cost of Credit Insurance

The cost for insuring trade receivables varies depending on the perceived risk of a non-payment of an invoice. The risk level is reflected in the premium paid for an insurance policy. There may also be legal fees involved to set up an insurance policy. There may also be broker commissions to pay. These fees increase the cost of trading. From the perspective of invoice finance companies, the cost of obtaining insurance will be included in the fees for providing factoring services.

There are also costs involved in maintaining a credit insurance policy. The credit insurance provider will stipulate a set of administration tasks for the holder of the policy. This will include putting in place credit control procedures and ongoing reporting of financial transactions. In the event of an insurance claim being made, the credit insurer may insist that it take control of the recoveries process. This might impact a company’s relationship with its customer.

The Role of the Insurance Broker

An insurance broker is a person who sets up and administers an insurance policy for an insurance company. The broker is the go-between for an insurance company and a company seeking insurance cover. As such the insurance broker has specialist expertise that can advise on financial matters.

A factoring company will use an insurance broker to make sure it has the correct insurance policy and to help with the legal wording on contracts.

Insurance brokers often specialise in certain sectors and certain types of insurance policies. This knowledge can be utilised by their customers.

In technical terms the broker acts on behalf of the insured. He or she will make an insurance contract legally binding by getting the insurers to stamp the policy. The broker will answer any queries that arise during the term of the insurance policy. They will also be the conduit for any negotiations regarding amending insurance cover.

Benefits of Credit Insurance

When a credit insurance policy is taken out for a seller using a factoring facility, the invoice financier in charge of the factoring facility is named in the document as the loss payee. This means that if an insurance claim is successfully made it is the invoice financier who receives the insurance pay out. This is because it is the invoice financier who has taken over the seller’s book of trade receivables, and if there is a missed payment on an unpaid invoice it is the invoice financier who is set to lose money.

However, in the event of needing to make an insurance claim, it is the company who is using factoring services NOT the factoring company that needs to apply to the insurer. Moreover, it is the company that needs to submit all the necessary documents in order to facilitate an insurance claim. If the company holding the insurance policy goes insolvent, the loss payee status of the invoice financier may not result in payment from the administrators involved in the insolvency as there might be third parties with a prior claim to the monies raised. To prevent such a scenario, a factoring firm can insert an assignment of proceeds clause into the insurance contract. This effectively puts the factoring company to the front of the queue for receiving money as a result of their client going bankrupt.

A factoring firm can be named in an assignment of proceeds as the beneficiary of any payments made arising from insurance claims. It is legally difficult to be assigned the insurance policy. However, with a co-assurance insurance policy both the factoring company and its client company are identified as the insured parties. There are effectively two insurance policies: one for the company using trade receivables finance and one for the factoring firm. However, in the event that a debtor cannot pay their invoice only one insurance claim can be made.

The main advantage of using co-assurance in an insurance policy is that the factoring firm has the power to make a claim independently of its client. This type of insurance policy structure will still leave the company, not the factoring firm, with the obligations of providing documentation and proof in order to make an insurance claim.

Another possible mitigation that a factoring company may place on a credit insurance policy, is to insert protective provisions in the factoring agreement. These provisions bind a company to comply with the terms of the insurance policy in a timely fashion.

If it is still deemed that there is a risk of a credit insurer not paying, then a factoring firm might take out its own insurance policy on the trade receivables it owns. This way it can make a direct claim in the event of a debtor defaulting on an unpaid invoice.

In Summary

Where there is risk, there is the need for insurance. While a factoring company will thoroughly research an unpaid invoice before it accepts the invoice for factoring, there is still the real possibility of an invoice going unpaid. This could be because of financial mismanagement, currency fluctuations, global financial disasters, wars etc.

The best way to mitigate against risk is to take out a credit insurance policy. In the case of insuring a factoring agreement, a policy broker is used. They work on behalf of the party seeking insurance, they will negotiate the details of the policy and make sure the ensuing insurance policy is legally enforceable.

If the factoring company is not able to recover the money due from an invoice that it has bought as a result of a factoring agreement then it can request that its client (in whose name the insurance policy is registered) make an insurance claim. The factoring company will be designated as the ‘loss payee’. To mitigate the possible situation of the company that takes out credit insurance on its unpaid invoices going insolvent, an assignment of proceeds clause or a co-assurance structure can be inserted into the insurance policy. Alternatively, the factoring firm might decide to take out separate insurance.

In many instances credit insurance is not deemed necessary for factoring. About 50% of factoring is done without insurance. This is to reduce costs where risk is considered as minimal (especially with non-recourse factoring). As noted above the costs of credit insurance have to be set against the benefits of using insurance – not only does it protect against non-payment of an invoice, it can also lead to an increase in credit limits and better credit control systems.

Tags: assignment of proceedsco-assurancecredit controlcredit insurancecredit protectioninsurance brokerloss payeepolicy feesprotective provisions
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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
    • Europe
      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
    • North America
      • USA
      • Canada
    • Australasia
      • Australia
      • New Zealand
  • Hi-Tech
    • Digital Platform/IT/Software Providers
    • UK Fintech
    • Articles
      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
  • Legal
    • Law Firms
    • Articles
      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
  • Rates
  • Economy
    • Economic Indicators
    • Articles
      • The Collapse of the Russian Rouble: An Historical Analysis and Current Implications
      • The Current State of the UK Economy
      • Economic Forecast for the UK in 2023
      • Economic News for 2022
      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
    • Credit Insurers
    • Articles
      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
      • What are Export Credits and Country Risk Classifications?
      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
  • Associations
  • ESG
    • ESG Articles
    • ESG Resources
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    • Ripple (XRP) Wins Latest Battle with SEC
    • UK Passes Financial Services and Markets Act 2023
    • Latest about the UK Regulatory Proposal for Crypto Assets
    • How will MiCA (Markets in Crypto Assets) Regulation Affect Trade Finance and the Banking System?
    • Markets in Crypto Act (MiCA) Becomes EU Law
    • An Introduction to EU’s Markets in Crypto-Assets (MiCA) Law 
    • Supply Chains and Blockchain Technology
    • The DeFi Revolution
    • How DeFi Fulfils the Functions of Finance
    • Taxonomy of Crypto Assets
    • Crypto Currencies
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    • Interview with Tradeshift
    • Interview with Kyriba
    • Interview with Orbian
    • Interview with Crossflow
    • Interview with Dancerace
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