Businesses and companies work on credit. The raw materials that they buy and the finished goods which are sold are sold in large quantities. Buyers seldom pay cash upfront for the goods bought from businesses. They buy the goods on credit and then repay their debt over a specified period. But what would happen if the buyer dies or becomes financially insolvent? Who would pay off the debts owed by the buyer?
In case of death or bankruptcy of buyers, businesses stand to face considerable financial losses as they are unable to generate revenue from their sales. These financial losses can weaken the financial position of the business and that is why credit insurance policies are available in the market. Let’s understand what these policies are and how they benefit businesses –
What is credit insurance?
A credit insurance policy is a policy which covers the credit risk faced by businesses. If businesses have debtors and the debtors are unable to clear their dues due to death, disability or insolvency, the credit insurance policy pays the outstanding dues and helps businesses generate revenue. These policies, therefore, protect businesses from bad debts having an adverse impact on their profitability.
Types of credit insurance policies
Credit insurance policies can be taken by businesses and well as by individuals availing a loan. can be of the following types –
- Credit life insurance
Under this policy, credit risk due to the death of the debtor is covered. If the debtor dies before paying off his debts, the policy would pay the outstanding debt.
- Credit disability insurance
If the debtor becomes disabled due to which repayment of the debts is not possible, the policy would cover the repayment.
- Credit involuntary employment insurance
If the debtor becomes unemployed and loses his source of income he might not be able to repay his liability. The policy would cover such contingencies and pay the debt on the debtor’s behalf.
- Credit property insurance
Under this policy, the property which is mortgaged against the debt is protected from theft, damage or any other type of loss.
- Trade credit insurance
This policy is specifically designed for businesses and protects businesses from bad debts due to non-repayment by debtors
Coverage under credit insurance plans
Credit insurance policies cover two main types of risks which are classified as commercial and political risks. Here’s what these risks include –
- Commercial risks
Commercial risks include insolvency or bankruptcy of the buyer as well as non-payment of dues by the buyer.
- Political risks
Political risks are risks faced due to political circumstances like the following –
- Cancelling of the import license
- War, riots, revolution, rebellion, etc.
- Any Government decision which prevents payment of dues
- A general moratorium (repayment holiday) granted by the Government of the debtor’s country
- Any type of political events which do not allow payment of dues
- Non-payment by the Government who is the buyer
- Non-payment because of natural calamities in the buyer’s city or country
What is not covered under credit insurance?
Credit insurance policies do not cover repayment defaults due to the following instances –
- Trade disputes
- Sale to an individual using the goods and services for non-professional work
- If payments have been received in advance
- Loss because of fluctuations in foreign currency exchange rates
- Nuclear perils
- Sales done under irrevocable Letter of Credit
- When the goods are not accepted by the buyer
How does credit insurance work?
In case of credit insurance, the organisation wanting to avail coverage for its credit risks would have to approach the insurance company for coverage. The company covers a percentage of the exposed risks. This means that the highest outstanding debt which the organisation has from a debtor can be covered up to a specified percentage which is usually 70% or 80%. The premium is then determined and paid by the organisation seeking insurance. Thereafter, in case of any payment default which is covered under the credit insurance policy, the insurance company would settle the bills on behalf of the defaulting buyer.
Making a claim under credit insurance
To make a claim under a credit insurance policy you should inform the insurance company immediately of the repayment default. The claim form would have to be filled providing details of the loss suffered and submitted to the insurance company. A police FIR might also be needed in certain cases. The insurance company would, then, verify the details of the claim form and check the documents. If everything is found in order, the claim would be settled.
Documents needed for credit insurance claims
For making a valid claim in your credit insurance policy the following documents would be required –
- Claim form
- Police FIR
- Books of accounts which show the debtor’s balance
- Bank account details of the policyholder
- ID proof
- Any other document that might be required
Benefits of buying credit insurance plans
Credit insurance policies provide definite benefits to businesses which face credit risks. These benefits include the following –
- By paying the dues owed by debtors, the policy ensures that businesses get the payment for the goods that they have sold
- Credit insurance policies limit the bad debts of businesses and help in maintaining the profitability
- Since businesses don’t suffer from repayment losses, their market value is also maintained
- The policy provides financial security to organisations which are in the business of selling goods and services on credit to individuals in India as well as abroad
Since credit insurance is beneficial, you should invest in a good policy for covering the credit risks faced by your business. Non-repayment of dues might cause a serious financial setback for your company and if you are in the initial stages such setbacks can result in a shutdown. A credit insurance policy comes in handy and takes care of repayment related risks thereby indemnifying your business in case of losses.
Frequently Asked Questions
- How does a credit insurance policy help in borrowing by businesses?
Businesses often avail loans based on their trade receivables. When the trade receivables are secured financial institutions can offer loans to businesses on attractive terms.
- What is the exchange rate fluctuation?
The currency rates change frequently and if rates become volatile due to some problems, the business faces risk. This risk is covered under credit insurance plans.