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What Experts Think

Difference Between a Letter of Credit and Export Credit Insurance

In today’s competitive and unpredictable global economy, it’s now more important than ever for companies to protect themselves with robust trade credit insurance policies. Does your business export goods and services overseas? Then you may be wondering if your business should use a letter of credit, or export credit insurance to protect your accounts receivable.

While both export credit and a letter of credit can reduce problems with payment, cash flow issues, and reduce political risk, there are several notable differences between the two. No two businesses and their foreign risk profiles are the same, so it’s essential to choose a policy that will give your specific business the maximum coverage it needs. 

What is a Letter of Credit?

Also known as an export letter of credit, this type of insurance protects your cash flow and ensures that you get paid for any goods shipped. A bank in a foreign country issues an export letter of credit and an Australian bank confirms the policy.

A letter of credit is a promise made from the issuing bank to pay your company on behalf of a foreign buyer if they fail to pay for goods shipped. An export letter of credit is a very secure document and can offer you adequate protection from political risks if you conduct international trade. However, all terms of the export letter of credit must be met, so the insurance covers the failure of a foreign importer to pay. This could include conditions such as on-time delivery and the quality of the goods, which can get a little complicated.

What is export credit insurance?

Export credit insurance is often used in international trade scenarios. This insurance covers accounts receivable when a company extends trade credit to another entity.

Trade credit insurance covers invoices sent to customers and guarantees they will be paid if the customer goes bankrupt, is in protracted default, or otherwise fails to pay the invoice. It’s possible to use a policy that covers your entire accounts receivable, an individual customer, or for a single invoice.

Usually, a company will get between 85% and 100% of the value of the invoice from the policy. It protects your company’s cash flow from bad or missing clients. But, export trade insurance does have limits in place for the size of the transactions. Transactions that exceed these limits may need to be individually approved via a credit check on the creditworthiness of the buyer. 

Which type of insurance is right for your business?

It depends. For example, more significant transactions with new clients could be adequately protected with a letter of credit. This can help you build trust in a new business relationship and can also ensure that you get paid for your shipped goods. But the downside for letters of credit is the terms of the policy can be complicated, and they can also be expensive.

In emerging markets and developing countries, a letter of credit from an issuing bank may not be very reliable. Plus, letters of credit requiring the consent of another entity to be valid. Export credit insurance will cover your invoice if a customer defaults and you don’t need a buyer to be a part of the process for getting coverage. 

Contacting an insurance professional can help you narrow down your choices and make the right decision for your business coverage. Contact Niche Trade Credit and see why Australian businesses trust us with their credit insurance needs. Call us today 02 9416 0670.

*DISCLAIMER: No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publications sold on the terms and understanding that (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication; and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.

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What Experts Think

How Political Risk Insurance Protects Contractors

Political risk insurance protects businesses from contract frustration that arises due to unstable political events in foreign markets. While nearly all types of companies that conduct international trade can obtain coverage for political risk from reputable financial institutions, contractors need to understand how political risk insurance protects them specifically. Contractors who work in the construction, engineering, and other contracting firms are protected with a political risk insurance policy from political violence, losses due to political issues, and foreign government action. 

Why is political risk insurance important for contractors to have?

In today’s global economy, many contracting businesses are taking advantage of unique opportunities in emerging markets. While these opportunities can be a goldmine for businesses, they put the firm at long-term risk for political instability. By obtaining coverage through a political risk insurance policy, companies are protected from asset, income, and property losses due to government involvement, war, and terrorism. Investors, lenders, and the contracting firm itself are all protected from these losses with political risk insurance. 

How are investors and financial institutions protected?

Political upheaval can leave investors vulnerable to a range of liability issues in foreign markets. Without protection, investors can have their profits, dividends, loan payments, and fees repatriated. For contracting firms with physical assets held in a foreign country, they leave their items vulnerable to damage from political violence. Foreign government instability and interventions can significantly impact financial institutions that engage in cross-border trade. Political risk insurance can protect these organisations from those risks, making a contracting firms business overseas a more stable investment risk for investors and lenders. 

How are contractors protected?

  • Contractors are protected from non-payment risks that occur from government and state-owned organisations instability in emerging markets. 
  • Contractors with large equipment and other physical assets held in a foreign country are protected from having these items damaged or becoming inaccessible from political violence. 
  • Political risk insurance also protects contractors in the mining, energy, engineering, and construction industries with performance guarantees. 

What types of liability issues does political risk insurance protect against?

  • Currency inconvertibility and Exchange Transfer Risk
  • Expropriation, Confiscation, Nationalisation
  • Economic Crashes and Political Upheaval
  • War, Strikes, Riots, Rebellions
  • Acts of Terrorism
  • Permit Cancellations
  • Delayed Payments
  • Selective Discrimination
  • Forced Divestiture and Forced Abandonment
  • Arbitration Award Default
  • Contract Frustration from Political Events
  • Wrongful Calling 
  • Non-honoring of Sovereign Obligations

Socioeconomic issues and foreign government interventions can create environments unfavorable to investors, lenders, and exporters, preventing them from taking advantage of business opportunities that arise in emerging markets. For contractors and other businesses who engage in foreign trade, it’s impossible to predict if these issues will occur and how much they will impact them long-term.

Unfortunately, exposing a business to these risks leaves them vulnerable to losing their assets and income. For contracting firms, having political risk insurance coverage can make their business operations a more attractive investment for lending institutions, which can give them an advantage over their competitors. 

At Niche Trade Credit, we can address these specific risks for contractors and other businesses with political risk insurance policies designed to protect your business from foreign instabilities. Our advisors will perform an in-depth analysis for a single situation, medium and long-term exposure risks with reliable underwriting and in-house country-risk analysis and political risks analysis from experienced advisers. See why people trust us to protect their business. Reach out to us today on 02 9416 0670.

*DISCLAIMER: No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publications sold on the terms and understanding that (1) the authors, consultants and editors are not responsible for the results of any actions taken on the basis of information in this publication, nor for any error in or omission from this publication; and (2) the publisher is not engaged in rendering legal, accounting, professional or other advice or services. The publisher, and the authors, consultants and editors, expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this publication. Without limiting the generality of the above, no author, consultant or editor shall have any responsibility for any act or omission of any other author, consultant or editor.