Mohan Ramaswamy
When India announced a complete lockdown in 2020 at the beginning of the COVID-19 pandemic, it was unprecedented for India Inc. Economic conditions were extremely tough. Some companies even recorded zero sales during this period. Among them was Shree Steel Wire Ropes, a microcap firm engaged in manufacturing wire rope allied and railway overhead equipment products.
At the end of May 2020, its management admitted in a BSE filing that the company had not earned a single penny since the beginning of the lockdown. At the same time, its accounts receivable from government departments were also delayed, with no communication or update on when the payments would be released. Of course, there was no worry of default in this case, as the government was the customer.
However, many companies were in a similar situation, albeit with a big difference – their vendors were private entities, and there was no assurance that outstanding dues would be cleared.
Atradius, a global firm specialising in trade credit insurance, surety, and debt collections, published its India country report in August 2020. This report stated that in H1 2020, extended supply disruptions from China due to the coronavirus outbreak hurt import-dependent Indian industries, such as consumer durables, electronic manufacturing, and pharmaceuticals.
This disruption, combined with a steep drop in demand, resulted in a sharp increase in the quantum of delayed payments in Q2 2020. Many Indian companies were utterly taken by surprise and had almost no plans in place for such contingencies. However, many of them could have avoided the bloodbath with an important risk management tool—Trade Credit Insurance.
What is Trade Credit Insurance?
Trade Credit Insurance (TCI) is an insurance policy that safeguards manufacturers, exporters, traders, and service providers against losses incurred due to non-payment of commercial trade debt.
If a buyer delays payment indefinitely, or even defaults on the payment, often due to bankruptcy or insolvency, the TCI policy will compensate the seller depending on the agreed terms of payment.
Such a risk management tool is critical, as it helps companies manage credit and continue with their business plans despite setbacks due to delinquent invoices. Moreover, TCI helps manage unforeseen commercial and political risks of trade that are beyond a company’s control.
The essence of a TCI policy is directly related to a basic trade transaction—the delivery either of goods or services. For the credit cover to exist, this trade transaction must be fulfilled correctly, and the contract terms should meet satisfactorily. A claim is generally made when the extended credit period offered by the creditor has lapsed and when all means of recovery have failed.
What are the Benefits of Trade Credit Insurance?
Some of the benefits of purchasing a TCI policy include:
- Coverage of wilful default by a debtor
- Coverage of a debtor’s insolvency
- Protection of the company’s financials by protecting profitability and cash flow
- Accounting for political risks when doing business in a foreign country (exports); this could include cancellation of import license, government moratorium, war, natural disaster, and currency inconvertibility.
To summarise, TCI helps companies ascertain good buyers and monitor them while protecting them from unpaid debts.
Who Should Buy Trade Credit Insurance?
Any company that deals with customers and has receivables on its balance sheet should use TCI as a risk management tool because it will be exposed to potential loss from the inability of a customer to pay.
Further, any company involved in exports, especially to politically sensitive countries, should consider buying TCI to mitigate risks from sudden changes in the political environment. For instance, the military coup in Myanmar on February 1, 2021, created uncertainty among almost 100 Indian companies with investments to the tune of USD 1.2 billion in the country.
The protests across Myanmar brought the economy to a standstill; there are concerns about international sanctions being imposed once again. Purchasing a TCI policy helps protect against such risks.
Hence, any company involved in domestic trade or export goods and services can purchase trade credit insurance.
How do Insurance Companies Decide Premiums for TCI?
TCI premium is expressed in terms of the percentage of the insured turnover. Credit insurance companies decide the premium taking into account the following factors of the risk:
- Extent of the coverage sought
- Risk scores of the business sectors and buyers
- Countries where the buyers are located
- Track record of the supplier
- Insured turnover
- Trade losses of the insured
What is the Scenario in India?
Most general insurance companies in India have credit insurance product in their portfolio. Except for the Export Credit Guarantee Corporation (ECGC Ltd), insurers in India issue only ‘whole turnover’ trade credit insurance policies. These are TCI policies that cover all trade credit receivables from all buyers of a seller.
ECGC Ltd is a Government of India owned credit insurance company focused on export credit insurance. The government created ECGC in 1957 to protect Indian exporters who face risks such as non-acceptance of the export documents by a foreign buyer and non-payment due to protracted default or insolvency of the foreign buyer.
Apart from all companies’ commercial risks, exporters are also vulnerable to political and geopolitical turmoil. Export invoices could remain unpaid because of sanctions, the short supply of foreign exchange, and political conflicts.
In April 2021, the Insurance Regulatory & Development Authority of India (IRDAI) issued draft guidelines for general insurance companies to develop trade credit insurance products with customised covers for Small and Medium Enterprises (SMEs) and Micro, Small, and Medium Enterprises (MSMEs).
In the present form, TCI covers are not available to banks and financial institutions. However, once in effect, the latest draft guidelines are expected to enable TCI covers to licensed banks and other financial institutions.
The new guidelines also propose that insurers offer an indemnity of up to 90% of the trade receivables from each buyer for all policyholders other than banks, financial institutions, and factoring companies. For MSMEs, the policy can cover up to 95% in case of political risks.
The Indian Trade Credit Insurance industry as a whole had a premium income of INR 1,395.25 crore (USD 188.2 million as per the average exchange rate in 2020) in FY 2021-21. INR 236.44 crore (USD 31.9 million) was the premium income of private players—Bajaj Allianz, Bharti AXA General Insurance, Cholamandalam MS, HDFC Ergo, ICICI Lombard, Iffco Tokio, Raheja QBE, Tata AIG, Universal Sompo, and SBI General Insurance.
The New India Assurance Co Ltd was the only PSU insurer in the mix and had a premium income of INR 96.55 crore (USD 13 million) from the trade credit insurance segment. However, the most significant chunk of premium income in this segment was earned by ECGC, which had a premium income of INR 1,062.27 crore (USD 143.3 million).
For the credit insurance industry, which has been growing at around 20% by some estimates, FY 2020-21 was forgettable. The total premium income grew by only 0.54%, mainly due to the 56% growth in business for New India Assurance. Private insurance players’ premium for TCI contracted by 5.57% during the year. Lower premium income and higher claim payouts caused by COVID-led trade disruption have resulted in a double blow to the TCI industry.
As a result, it is no surprise that insurance companies are more cautious while offering TCI policies. The risk management guidelines of the insurer may change in terms of assessing the credit risk on the buyer and providing and monitoring credit limits.
Compared with other insurance policies, a policyholder cannot simply purchase a TCI policy and forget about it until it is time to lodge a claim. Scrutiny of the coverage terms is required right at the beginning, and the policyholder must be proactive and diligent in understanding the exact scope of the coverage. Periodic updates are necessary to address any changes in credit risk and protect the interests of the business.
Insurance advisors and brokers play a crucial role by bridging the gap between the insurers and policyholders and ensuring that the policyholders’ processes are compliant and thorough to support any potential claims.
Trade credit insurance companies need to understand and assess the credit risks posed by their policyholder’s customers in India and overseas. This means that the end customers’ risk profile has to be scrutinised very carefully. This includes a detailed assessment of their identity, statutory compliance, financial performance, litigation, management experience, operations, and media information, which is a complex task.
We believe that trade credit insurance has a critical role in mitigating trade credit risk, especially when global supply chains continue to remain disrupted by the pandemic. For international trade to return to normalcy, the friction caused by credit defaults and uncertainty needs to be minimised.
The trade-credit insurance industry, albeit adversely impacted in the past year, is resilient and shall rise to the challenge. Businesses can and must continue to rely on trade credit insurance for risk management purposes.
