Credit insurance originated in Europe in the middle of the nineteenth century. The shipment of goods to
faraway places such as Australia, New Zealand and India created a need for this kind of cover.
After the First World War, when there was unease about exporting to countries of former adversaries,
credit insurance services were set up by governments and used as a means of encouraging exports to countries considered too risky for open account trading. The concept was taken up by many countries that used it as a means of promoting their exports, where traders needed assurance that the risk of non-payment would not
threaten their viability.
Now most developing and developed countries use Export Credit Insurance schemes to give their exports a competitive advantage.
HOW IT WORKSCommercial risks take the form of buyer insolvencies (e.g. bankruptcy) or protracted defaults (slow payment).
These problems could occur for many reasons, such as fluctuations in demand or general economic conditions in your customer's country. Political risks are varied and include contract frustration risks such as changes in import
or export regulations as well as currency inconvertibility and exchange transfer risks and also incorporate confiscation, expropriation, nationalization and deprivation of assets.
All of your export receivables can be insured under one multi-buyer policy, or in some cases you can purchase key-buyer or single-buyer coverage. Export sales of all types of products may be covered, regardless of content or where the products are manufactured. Any kind of exporter can apply for receivables insurance, including service exporters, manufacturers, distributors, dealers, etc. Your foreign customers don't need to be huge corporations or government agencies; any buyers can be considered as long as they are creditworthy, as determined by financial information or, in some cases, simply your company's own ledger experience.
CREDIT INSURANCE SERVES THREE PURPOSES:
1. It ensures you get payment for the exported goods or services should your buyer become insolvent or default on payment.
2. It ensures you payment when political upheaval causes a default in payment being transacted in the normal commercial way.
3. Credit insurance is often taken as security with your bank for investment funding in expanding your business through increased cash flow. Export credit insurance is very customer friendly, in that your customer is not required to do anything, in order to set it up. In fact, it is generally considered best practice not to advise your customer that you have insured the sales contract. As far as the customer is concerned, you are treating them as a valued customer on ‘’openaccount’’ with the same credit terms as a domestic customer.
By comparison, letter of credit cover for your sales receivables must be put in place by the customer, and costs them normally between 1% and 8% of the purchase value of their order. This restricts your customer’s cash flow and puts you at a distinct disadvantage in comparison to exporters who offer open account terms.
TYPES OF RISK COVEREDThere are two basic types of export credit risk which can be insured:
1.COMMERCIAL OR BUYER RISK
Commercial risk cover is normally restricted to the actions by the foreign buyer and may be listed as follows:
• Buyer refuses to accept shipment (repudiation);
• Buyer refuses to pay for goods delivered at the due date for payment as stated in the sales contract;
• The Buyer’s bank defaults on the payment security document;
• The Buyer becomes insolvent. This may be indicated by different terms in different countries but normally covers bankruptcy, liquidation and receivership.
2. POLITICAL RISK OR NON-BUYER RISK
Political risk cover is normally associated with the actions of foreign governments, which prevents normal commercial transactions such as:
• Civil disturbance/riots
• Insurrection/guerrilla activities
However, it also applies to the less obvious risks such as:
• Acts of foreign governments preventing funds being transferred back to exporters (sellers) country
• Prevention by foreign government of goods arriving at their final destination
• Central bank of foreign government runs out of foreign currency.
TYPES OF CREDIT INSURANCE POLICY AVAILABLEThere are a range of different policies available from credit insurance companies and their brokers. They may be short-term, medium-term or long-term policies:
Short-term policies are the most popular and account for 80% of all export credit insurance policies and are used for fast-moving consumer goods (FMCG), food and agri-products, and production consumable goods. Short-term policies usually cover a stipulated period of between 30 out to 180 days plus.
Medium-term contracts cover 270 days to 3 years and are used primarily for capital goods.
Long–term policies are over 3 years, and are normally used for major infrastructural projects
Selected Market -policies are used where the exporter only wants cover in particular markets
Whole Turnover policies are common and cover the full sales ledger inclusive of home and export sales invoicing
Named Buyer policies are used for individual customers, where the exporter may have a large proportion of their sales concentrated
Pre-Shipment Risk cover also known as Pre-Credit Risk caters for the situation where for example goods are made “ to order.’’ The period where you are manufacturing but have not shipped to your customer can be covered in an export credit policy. If a problem arises during this period, whereby your customer goes bust, or a political risk occurs, and you cannot deliver, you would have a work in progress loss. It is to cover these risks that a pre-shipment or pre-credit insurance is put in place.
There are also variations on the latter policy, such as Post-Shipment Risk policies, and Consignment Stock Risk Policies. Please refer to the Glossary for further clarification of these terms.