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Abstract
Trade credit insurance (TCI) is a risk management tool commonly used by suppliers to guarantee against payment default by credit buyers. TCI contracts can be either cancelable (the insurer has the discretion to cancel this guarantee during the insured period) or non-cancelable (the terms cannot be renegotiated within the insured period). This paper identies two roles of TCI: The (cash ow) smoothing role (smoothing the supplier's cash ows), and the monitoring role (tracking the buyer's continued creditworthiness after contracting, which enables the supplier to make ecient operational decisions regarding whether to ship goods to the credit buyer). We further explore which contracts better facilitate these two roles of TCI by modeling the strategic interaction between the insurer and the supplier. Non-cancelable contracts rely on the deductible to implement both roles, which may result in a con ict: A high deductible inhibits the smoothing role, while a low deductible weakens the monitoring role. Under cancelable contracts, the insurer's cancelation action ensures that the information acquired is re ected in the supplier's shipping decision. Thus, the insurer has adequate incentives to perform his monitoring function without resorting to a high deductible. Despite this advantage, we nd that the insurer may exercise the cancelation option too aggressively; this thereby restores a preference for non-cancelable contracts, especially when the supplier's outside option is unattractive and the insurer's monitoring cost is low. Non-cancelable contracts are also relatively more attractive when the acquired information is veriable than when it is unveriable.