Credit Insurance Vs Letters of Credit: What Gives?

A sale isn’t complete until the seller receives payment. Two common ways sellers secure payment for short-term sales are letters of credit and credit insurance. While both protect against non-payment, they differ in cost, flexibility, and risk management.

A letter of credit (LC) offers greater security for the seller, but it can limit sales due to added complexity and cost. Meanwhile, credit insurance allows sellers to extend credit, reducing risk while enhancing sales potential.

Let’s break down both options.

What Is a Letter of Credit?

A letter of credit (LC) is a bank-issued guarantee that ensures the seller receives payment. If the buyer defaults, the bank covers the payment. In global trade, where transactions involve longer transit times and unfamiliar buyers, LCs provide security.

Seller Advantages:

• Guaranteed Payment: The issuing bank ensures funds are transferred.
• Negotiated Terms: The LC specifies all sale conditions.
• Risk Reduction: Eliminates uncertainty in cross-border transactions.

Disadvantages:

• Complex Negotiation: Sellers must meet strict conditions.
• Risk of Errors: Any documentation mistake can delay or void payment.
• Cost for Buyer: LCs typically cost 0.75%–1.5% of the transaction, increasing expenses.
• Tied-Up Capital: The buyer must set aside funds, reducing cash flow and borrowing capacity.

When to Use an LC:

✅ High-value or international transactions.
✅ When the buyer lacks an established credit history.
✅ If securing bank-guaranteed payment is necessary.

Learn more about letters of credit at Investopedia.

What Is Credit Insurance?

Credit insurance protects sellers from non-payment risk while allowing them to extend open account terms to buyers. Instead of requiring a bank guarantee, the seller is insured against customer defaults, insolvency, or late payments.

Seller Advantages:

• Increased Sales: Extending credit makes it easier for buyers to purchase.
• Risk Protection: If a customer defaults, the seller can file a claim and recover losses.
• Stronger Credit Decisions: Insurers assess buyer creditworthiness and set appropriate limits.

Buyer Advantages:

• Lower Borrowing Costs: No need for a costly LC.
• Improved Working Capital: Buyers keep cash available for operations.

Credit Insurance vs. Letters of Credit: Key Differences

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How Credit Insurance Impacts Financing

Companies increasingly view credit insurance as a strategic tool. By protecting accounts receivable, businesses:
✅ Expand sales by offering competitive credit terms.
✅ Reduce financial risk without tying up buyer capital.
✅ Strengthen their balance sheet, securing better financing terms.

Balancing Cost and Risk

The chart below illustrates how credit insurance and LCs impact sales and financial risk:

Cash in Advance: High cost, low risk.
Letters of Credit: Secure but costly and restrictive.
Credit Insurance: Balances risk while promoting sales growth.

Conclusion

Credit insurance vs. letters of credit—what’s better? It depends on your priorities.

• If security is most important, an LC ensures guaranteed payment.
• If growth is the goal, credit insurance allows sellers to extend credit with confidence.

As businesses seek more flexible financing, credit insurance is becoming the preferred choice for managing payment risk while maximizing sales potential.

Since 2004, Securitas Global Risk Solutions, LLC (“Securitas”) has helped clients develop credit and political risk transfer solutions that provide value on numerous levels. As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring a complete understanding of policy wording and delivering excellent responsive service.