It’s not always wise to base coverage solely on clients’ balance sheets

Less than one-quarter of Canadian businesses have trade credit insurance, which protects their receivables against buyer default and bankruptcies, but Intact Insurance predicts that market penetration is likely to change as the pace and size of interest rate hikes could drive advanced economies like Canada into a recession.

“There are no official numbers, but I assume the market penetration in Canada is about 20% to 25%, roughly,” Intact vice president of trace credit Jay Rampersad told Canadian Underwriter. “We are expecting to see a lot more demand.

“We’re getting more questions from brokers about trade credit. They want to be in front of the risk and protect their client [from] what’s coming.”

Rampersad noted most Canadian businesses will buy insurance to protect balance sheet assets against disaster. For example, they’ll insure their commercial buildings, operations, inventory and machinery. But what about their accounts receivable? Are they protected if a buyer teeters toward bankruptcy?

The question is especially relevant given Royal Bank of Canada’s July forecast for a short recession in 2023, according to various media reports. And, 68% of Canadians expect an economic downturn based on 40-year high inflation rates, labour shortages, and recent interest-rate hikes, said a June 2022 survey conducted by Yahoo Canada/Maru Public Opinion.

Brokers are meeting with commercial clients to talk about protection. But are they offering the fullest possible insurance package?

“Brokers are insuring on the [client’s] balance sheet,” Rampersad explained. “They’re insuring the inventory, the property, the plant, the equipment, the vehicle. But in a lot of cases, 40% of the asset on the [client’s] balance sheet is accounts receivable.

“So, it’s one question to ask your client: ‘Why is that asset not insured?’”

Trade credit insurance essentially pays out losses to businesses that don’t receive payments from their buyers. Perhaps the client’s buyers are late with their payments, or worse, don’t pay at all.

“In the event the business doesn’t get paid, then we are paying,” Rampersad said. “So, most of our underwriting is done on the counterparty risk — who they are, who they’re selling to.”

The product is flexible in terms of which accounts receivables a business can choose to cover, although the underwriter’s preference would be to protect the whole book of business. In fact, brokers may be leaving money on the table inadvertently because of a misunderstanding about the application of trade credit insurance.

“One common misconception is that trade credit is only available for export, for clients who are selling services and widgets internationally,” Rampersad said. “But it’s available for domestic trade as well…about 40% of our [trade credit] portfolio is domestic trigger.”

Trade credit insurance is designed to assuage the client’s fear of its buyers going bankrupt. Underwriters in this line of business want to provide that protection, but at the same time are alive to the danger of moral hazard — the possibility an insured will take greater risks (or not take any steps to mitigate risk), knowing they are protected by an insurer.

In the face of a global recession, business owners should know trade credit underwriters will be carefully distinguishing between high and low risks, with an appetite for the latter.