Why trade credit insurance matters

South Africa is currently experiencing challenging political and economic conditions, which has a direct impact on the financial and trading performance of businesses. Vulnerabilities to external shocks have also converged at the worst possible time in our post-pandemic economy, with the impact rapidly manifesting in financing becoming more difficult to secure, more expensive and dwindling foreign direct investment. The way we do business has also fundamentally changed, with the pandemic acting as a major catalyst to shift all business into the digital and e-commerce realm, which brings with it exposure to new credit risks. As operating costs spiral to unsustainable levels and trading conditions become strained, so too is the incidence of debtors defaulting on payments.

According to Maria Teixeira, Trade Credit Specialist at Aon South Africa, businesses are faced with a slew of challenges in terms of driving profit margins and managing liquidity. “Comprehensive and consistent credit management of your debtors’ book is a critical building block in your organisation’s success and sustainability. Perhaps the single most important asset of a company is its debtors’ book. The last few months have seen a rapid and steep increase in bad debt losses as liquidations and business rescue cases climb.”

– According to Statistics SA’s (StatsSA) Liquidations Report for the year to August 2022 showed that liquidations soared by 44.8%.[1]

– The value of e-commerce transactions in South Africa is expected to surge 150% to R225bn by 2025.[2]

While the economy remains a sombre rollercoaster ride, it is crucial for organisations to make better decisions when it comes to providing goods and services on credit and protecting themselves from defaulting debtors. Trade credit insurance indemnifies a seller against losses from non-payment of trade debt arising from slow payment, insolvency and political risk in the event of a cross border transaction. Coverage is designed to prevent disruptive losses, reduce the risk of key account concentration levels and provide risk transfer of bad debt scenarios.

“Trade credit insurance answers an important question: Whether you are dealing with a potential bad debtor or not. Isn’t that worth knowing?” – Maria Teixeira, Trade Credit Specialist at Aon South Africa.

A common misconception is that credit insurance is expensive and complicated, and many companies never venture into the credit insurance space to their detriment, particularly small and medium sized businesses. “In the face of soaring liquidation numbers, it is important to note that when a company is placed under business rescue, payments to suppliers and creditors are put on hold, usually for months until a plan is approved by all stakeholders. When this is coupled with a lack of payment or delayed payments from any other debtors, it creates a serious cash flow problem for any organisation navigating a volatile business landscape,” warns Maria.

Some of the benefits trade credit insurance include:

Business Rescue and Liquidations are increasing – Business rescue applications are increasing across all sectors with the vast majority of business rescues ending in liquidations. If your business has debtors on its book that are going into either of these proceedings, there could be a protracted delay in payment, with the prospect of only receiving a percentage of the debt owed, or even none at all. And do not assume that big companies do not falter. With trade credit insurance in place, the insured will have the support of the insurer at business rescue or liquidation-related meetings, in addition to you proving that the company in question owes you money for goods or services delivered. As an added extra, legal fees and legal processes that are typically associated with these proceedings are shared with the insurer, freeing up your time, saving you from the added expenses and allowing you to focus on your business. If no payment is forthcoming, your trade credit insurance will indemnify your claim.

Trading Pressure – It is becoming a buyers’ market across many industries where clients play suppliers off against each other leading to lower margins, in addition to demanding credit facilities in very short timeframes. Do not fall into the trap of giving an unknown client a credit line when they have not been properly vetted or in the absence of trade credit insurance. Trade credit insurance will provide credit investigation of insured buyers and advice on appropriate credit limits that are within a debtor’s means. If a debtor defaults on payment, your trade credit policy will also provide for debt collection on your behalf. A trade credit insurer deals with these matters on a daily basis, so they have access to extensive debtor information and credit records on a quick turnaround, which is particularly handy when potential clients are putting you under pressure for credit terms.

Trading in Africa – Africa offers an avenue of investment, with many multinationals investing in countries such as Zambia, Kenya, Nigeria and many other African countries. But in the face of economic, political and regulatory uncertainty across the continent, it can be very difficult to recoup losses in unfamiliar territories. A professional trade credit insurer is able to assist clients in vetting potential clients or buyers in cross-border transactions, set credit limits and provide debt collection services if needed, significantly mitigating the potential risks on foreign soil.

Small Business – There’s a misconception that trade credit insurance is only suited to large corporate companies and that it is expensive. The reality is that even small businesses can insure from as little as R4 000 and up. You furthermore have the option of insuring a single debtor or your debtors’ book for a percentage of the loss, meaning that if you insure your debtors for 80% of the loss, you agree to carry 20% of the loss if anything goes wrong. These options make trade credit insurance flexible and affordable even for smaller companies. Small and medium businesses are certainly at greater risk if a major debtor defaults as their balance sheets usually cannot carry them through a major default. It would also be foolhardy to believe that large businesses don’t default on payments as recent corporate failures have shown. The question to ask is whether you are prepared to deal with a potential bad debtor and not know about it?

The rising risk of fraud
Maria says the incidence of fraud is ever increasing. “Companies are desperate for orders and could just be a little too eager to approve that credit limit on a buyer, especially one that they have dealt with before,” she warns.

Having credit insurance mitigates the risk up to a certain point in the sense that your credit insurer will review the applicants credit record and stability before placing cover. “Insurers will typically credit assess the debtor and will decide whether to insure the debt or not. However it is important to point out that trade credit insurance does not cover you for acts of fraud. When a prospective client applies for credit – even if it is a well-known debtor – it is crucial to carefully vet the application received for credit by checking phone numbers and delivery addresses, confirming you are dealing with the company that placed the order and that it’s not a fraudulent application. Make sure that you have a completed credit application and that the buyer agrees to your terms and conditions. Include surety on your credit application and ensure that it’s signed by a valid signatory,” Maria recommends.

Speak to the experts
There is no one-size-fits-all approach when it comes to managing the liquidity of your business, as each business has its own unique levels of exposure. Consulting with a professional broker who can provide you with valuable insights into business risks that may have a major impact on your business will help you to make better decisions when it comes to protecting your bottom line from the risk of defaulting debtors.