Businesses must remain vigilant as uptake of trade credit insurance also raises risk of fraud

In response to an increasingly volatile economic landscape, South African businesses are turning to trade credit insurance as a strategic tool to safeguard their operations against the risk of non-payment and insolvency.

This surge in uptake reflects a growing recognition of trade credit insurance’s critical role in enhancing cash flow management, reducing credit risk and enabling companies to expand their market reach locally and internationally.

This is according to Gareth Joubert, Managing Director—Trade Credit Insurance at Hollard Insurance, who notes that many local businesses are experiencing severe challenges due to delayed or defaulted payments.

Beware of fraud

“These payment issues often result in cash flow problems, which can disrupt operations, stifle growth and, in some cases, lead to permanent closures. This highlights the importance of trade credit insurance as a crucial safety net for businesses that ensures stability and mitigates risks in an unpredictable market,” says Joubert.

However, he warns that the uptake of trading on credit has also led to an increase in fraudulent activities, particularly company impersonations and scams involving fake businesses, which necessitate heightened vigilance.

“Company impersonations occur when individuals or entities present themselves as legitimate, creditworthy companies. They often use forged documentation to place orders with suppliers, requesting deliveries to alternative addresses or arranging to collect the goods themselves. Once the goods have left, the individuals disappear, leaving the supplier with unpaid invoices,” says Joubert.

“However, trade credit insurance will not pay out when it comes to sophisticated impersonation fraud, where the true identity of the client is misrepresented to the policyholder and, by extension, the insurer.”

The debt must be undisputed

He explains that trade credit insurance does not cover this type of fraud because insurers underwrite and insure identified clients of the policyholder. If the goods were delivered to someone pretending to be the identified client, then the insured client will dispute the debt as they did not purchase it. Since trade credit insurance is a credit policy, insurers only pay if the debt is undisputed. Consequently, when a client denies the debt due to impersonation, the insurer cannot honour the claim.

On the other hand, says Joubert, fake companies are set up by fraudsters to appear as legitimate businesses. These companies may trade with policyholders over some time to build trust, only to place large orders and then vanish with the goods. Fraudsters may also acquire dormant companies with good reputations to use as fronts for their schemes. This type of fraud ends up being covered as the vanishing business is the actual business that is insured under the policy.

Unlike traditional insurance, where misrepresentation by the policyholder can affect claims, trade credit insurance deals with the risk of the buyer. Misrepresentation by the buyer is more difficult to detect and address. However, fraud is a significant concern, with impersonation risk being particularly relevant.

“Some measures to mitigate fraud include verifying contact details and company URLs, and ensuring deliveries are made to the correct premises. However, the type of fraud that involves fake businesses with real registration numbers and directors makes detection difficult. These businesses can provide false trade references and financial statements, leading to claims that must be paid if a court confirms the debt,” says Joubert.

Authentification is essential

To combat fraud, robust underwriting processes and document authentication are essential. This includes biometric scans and verification by relevant authorities. Despite these measures, time constraints often challenge fraud prevention efforts.

Quantifying trade credit fraud annually can be challenging due to the complexity and scope of fraudulent activities. While specific statistics on trade credit fraud in South Africa are not readily available, financial crime, including fraud, has resulted in significant losses. For example, South Africa lost almost R3.3 billion in 2023 due to various forms of financial crime.