Difference Between a Letter of Credit and Export Credit Insurance

August 28, 2019

Difference Between a Letter of Credit and Export Credit Insurance | Niche Trade Credit Sydney

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.

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