Avoiding disputes, risk with domestic trade credit insurance

Due to its marked financial attributes, short-term domestic trade credit insurance has played an active protective role in domestic trade, particularly commodities trading, in recent years. However, due to the slowdown in the Chinese economy, credit insurance has become one of the types of insurance with a relatively high risk probability in the past two years. In this period, Wintell & Co’s insurance law practice group has been involved in a number of credit insurance disputes, and the author will share some experiences with respect to the special features of this type of insurance and our handling of related disputes.

Underwriting conditions

In terms of the subject matter of insurance, underwriting conditions, risk sharing, and claim conditions, credit insurance has certain features that distinguish it from general property insurance.

Subject matter. The subject matter of credit insurance is the claims of the insured (the seller) against its debtor (the buyer), namely, in the instance where the buyer in domestic trade is late in payment of accounts payable, the insurer assumes the responsibility for paying to the insured the amounts specified in the trade contract.

Underwriting conditions. The financing and financial attributes of credit insurance determine that the insured is required to conduct a review of the creditworthiness and approve the limit of the insured’s transaction counterparty, i.e. the buyer, when its writes the policy. A condition precedent of the insured assuming the insurance liabilities is the approved limit, the insurer assuming insurance liability only for the insured’s buyer’s outstanding accounts payable that fall within such limit.

Sharing of risks. In contrast to general property insurance or liability insurance that achieves the sharing of risks through a deductible or franchise, credit insurance always requires the bearing of the risk of default on the claim jointly with the insured; the insurer will typically bear 85-90% of the approved limit of the credit insurance, with the insured bearing the remaining risk. In this way, moral hazard can be avoided on the one hand, and on the other, when an insured event occurs, the insured will be obliged to co-ordinate with the insurance company in recovery against the debtor to safeguard the joint rights and interests of both parties.

Claim conditions. The failure by the buyer under a trade contract to punctually settle its accounts payable will not immediately trigger insurance settlement liability. Credit insurance sets a three- to six-month claim waiting period. In practice, a significant portion of claims are recovered during the waiting period through joint collection efforts or the assertion of claims by the insurer and insured, avoiding complex loss assessment and claim procedures and reducing the costs of each party.

Keys to risk control

The distinctive nature of the credit insurance underwriting model has also gradually given rise to marked regularity in the risk control measures, such as the avoidance of potential credit insurance risk and handling disputes, once insured events have occurred.

Prudent revision of credit limits. Similar to the effect of a bank calling a loan early, the revision by the insurer of the credit limit of the insured’s buyer, particularly a reduction of the limit, will often affect the buyer’s repayment capacity. Accordingly, the revision of a credit limit should be done in a prudent manner and the notification obligation should be performed in strict accordance with the insurance contract. Injudicious revisions and inappropriate notifications are important reasons that have led to many buyers being unable to continue performing their payment obligations under trade contracts within a short period of time.

Strict review of the genuineness of underlying transactions. The genuineness of the underlying domestic trade transaction has, in many cases, become an important stage in the investigation by the insurer and a precondition to the insurer ultimately determining whether to bear the insurance liabilities. The author has seen many cases where, after the seller purchased credit insurance in a domestic trade transaction that was originally being performed normally, the probability of default by the buyer increased markedly. Among these, there were instances of fraudulent transactions between the insured and its affiliates, transfers of risks and insurance fraud.

Insurance companies should enhance their reviews of the genuineness of the method of performance of the underlying transaction, the shipping of the goods or the transport documents, and verify the financial figures on the relevant transaction invoices and payment movement records. Dedicated financial audits and the gathering of criminal evidence have become common survey and loss assessment means used by insurers.

Co-ordinating relationship with the reinsurer. Credit insurance will usually involve a reinsurer and a good understanding between the insurer and the reinsurer on their claim philosophy, and the degree of co-operation will usually affect claim progress and recovery efficiency. Such insurance has been available in China for a relatively short period of time and domestic insurance companies lack experience in the handling of claims. Additionally, a difference with the way of thinking of the foreign reinsurer, and differences over the meanings of terms after translation of the insurance terms, can lead to misunderstandings between the insurer and the reinsurer with respect to a legal relationship or legal concept, resulting in a difference of opinion between the parties and glitches in the handling of the case.

New development trends

With the rise of peer-to-peer (P2P) and other such internet finance business, and the rapid development of financial leasing and other such innovative business in recent years, credit insurance is also welcoming new development opportunities. The focus of credit insurance is no longer restricted to traditional export credit insurance or credit insurance. Due to the close connection between credit sale insurance, loan credit insurance, etc. and innovation in financial products, there is hope that they will make significant progress in future development.

The dispersal of the risks of an investor, lender or lessor through the purchase of credit insurance has now become the pre-eminent option of numerous new financial products. However, the reviews of the genuineness and compliance of the underlying transaction relationships by insurers will become a principal factor in deciding whether to underwrite such insurance and ultimately bear the insurance liabilities. The author is confident that, thanks to the establishment of a sounder credit regime and the advice of professional legal personnel, the development and improvement of the credit insurance market are achievable objectives.