Trade credit insurance: if a buyer who took goods on credit goes bankrupt, who covers the receivable?

Property insurance protects a building from fire. But for many trading companies the largest asset is not the building, it is what buyers owe them. From the day goods are handed over on credit, the seller has in effect given the buyer an interest-free loan. Trade credit insurance protects exactly that debt.

Key rules

• What is covered. The seller's unpaid debt is covered when the buyer is declared insolvent or when the buyer still has not paid long after the contract deadline. For the second case the policy usually has a waiting period: until it ends, no indemnity is paid
• A limit for each buyer. The insurer assesses each buyer itself and sets a credit limit for it. Credit given above the limit is not protected, and credit given to a buyer with no limit is not protected at all
• Own share. The indemnity is usually not the full amount of the loss: the contract states a share that stays with the seller. This encourages the seller to be careful in choosing buyers
• The premium is calculated from sales. In many policies the premium is set as a share of the volume of insured credit sales, not from the amount of a single debt
• The insurer monitors buyers. If a buyer's financial position worsens, the insurer may reduce or cancel the limit for further shipments. This warning is also a useful signal for the seller
• Read the policy terms. Whether a debt disputed over the quality of the goods is covered, within what period the seller must report a loss, what documents are required: all of this is written in the policy
• Insurance does not cancel the allowance. Under NAS No. 21, the allowance for doubtful debts is determined separately for each debt by assessing the debtor's ability to pay and the likelihood of repayment (paragraph 218). How the part of the debt expected to come back from insurance is taken into account when calculating the allowance is set in the accounting policy

Example: "Shirin Bulut" and "Mega Savdo"

The confectionery wholesaler "Shirin Bulut" sells 6 000 million soum of goods on credit in a year. Hypothetical policy terms: premium 0.2 percent of insured sales, that is, 12 million soum a year; limit for the "Mega Savdo" supermarket chain 400 million; seller's own share 10%.

"Mega Savdo" became insolvent, owing 500 million.

Let us measure the loss from another angle. "Shirin Bulut" keeps a hypothetical 10 soum of profit from every 100 soum of sales. To cover a 500 million loss it needs an additional 500 / 0.10 = 5 000 million of sales, almost a whole year of credit sales. With insurance, 140 / 0.10 = 1 400 million of sales is enough.

The lesson comes from the same example: with a limit of 400, giving the buyer 500 of credit left 100 million uninsured. The seller should have asked in advance for the limit to be raised or sold the part above the limit against prepayment.

In the accounts: the premium, as an accrued insurance payment, is recorded to the debit of an expense account and the credit of 6510 "Insurance payments", and when paid as Dr 6510, Cr 5110 "Settlement account" (NAS No. 21, paragraph 280, lines 2 and 3). If an allowance was created for the "Mega Savdo" debt, it was recorded as Dr 9430 "Other operating expenses", Cr 4910 "Allowance for doubtful debts", and writing the debt off against the allowance is recorded as Dr 4910, Cr 4010 "Receivables from buyers and customers" (paragraph 221, lines 1 and 2). The NAS No. 21 tables have a line for payments received from insurance companies only in respect of property insurance (paragraph 405, line 12); there is no separate line for an indemnity receivable under trade credit insurance: the account on which it is shown is set in the accounting policy.