How to insure against credit risk in account receivables

How would your company be affected if your customers could not pay their bills or went bankrupt? The resulting loss of income can range from a minor setback to a devastating financial loss for your company. In fact, most companies' largest assets are their accounts receivables. So, how much of your money do you want to risk?

In today's business environment the greatest perils are no longer just theft, fire or flood but rather credit risk the risk of non-payment by your customers due to insolvency or serious late payment of monies due. According to the American Bankruptcy Institute, there have been more than 200,000 U.S. businesses filing for bankruptcy since 2008. Despite this very real risk, it is estimated that only 10 percent of U.S. companies, both small and large, buy credit insurance.

You may have thought you have this type of protection, but with a standard commercial insurance policy you do not. Credit insurance can be obtained to protect a company's commercial accounts receivable from unexpected and catastrophic losses resulting from protracted default slow or extremely late pay, insolvency and from political events that obstruct payment. Credit insurance also protects your risk of non-pay by foreign buyers due to currency issues and political unrest with additional variations to protect you as required by your needs.

For the purpose of this article I use the term "credit insurance." However there are other names, such as "trade credit insurance" and "accounts receivable insurance" for this type of commercial coverage. The term "credit insurance" should never be confused with personal credit insurance, credit life, or credit disability insurance, as they are not the same.

Many companies' risk exposure to larger accounts-receivable losses has increased significantly from factors such as fewer and larger clients, selling to national wholesalers and distributors and an increase in export business. While all of these factors may provide for positive business growth, they can also increase your risk exposure by having a majority of your company's sales being generated from a smaller number of customers. You now have fewer accounts with larger receivable amounts, and a single loss can put a severe financial strain on your company. If the loss is large enough. or you have multiple companies defaulting at or near the same time, this type of loss exposure can put you out of business.

Each credit insurance policy can be customized for you to cover the specific risk you wish to mitigate. With credit insurance coverage, you can choose to have protection for some or all of your accounts receivable. You may only be concerned with catastrophic losses over a certain dollar figure. As an example, you might want to insure against any losses over $10,000 or $25,000 because this amount of loss would put a significant financial strain on your company. Of course, this amount varies with your company's needs. Again, you can have a policy designed for your needs and cover all, or part, of your accounts receivable balances.

This is just one example of how credit Insurance works for you. As each of these policies is designed specifically for your company needs, variables for coverage and deductibles will be specific to your policy. The carrier who has written your credit insurance policy takes the burden of collecting your overdue accounts receivable, or defaulted payments. In this example, the trigger for the policy to react is 120 days past due. You have $25,000 owed your company which is now 121 days out. The carrier issues a check to your company, which is a percentage of the amount due you. Let's say it's 95 percent. The 5 percent charge is equivalent to a deductible. You receive a check for $23,750 and the carrier has the burden of collecting the $25,000 payment. You win because you have the vast majority of your money, and your outstanding accounts receivable is cleared off of your books.

Credit insurance can also enable you to increase credit lines to existing customers, extend credit confidently to new customers, or protect you when you enter new markets with your products and services. If you are utilizing asset-based borrowing, your accounts receivables can be at the very core of your line of credit. Your company can use credit insurance coverage to help bolster your borrowing capacity with your bank. If you export, credit insurance can help you to compete more effectively by enabling you to offer open-account terms to your foreign customers rather than insisting upon a letter of credit or other types of secure payment. Credit insurance also covers your company for the repudiation of an exported shipment. When a buyer fails, or refuses, to take delivery of goods your credit Insurance will step-in with coverage for this loss of revenue.

Imagine the impact on your company if one of your largest and best clients turns into your worst nightmare! Credit insurance offers you a buffer between profitability and a financial catastrophe.

Tim Kane is an independent insurance broker with L/P Insurance Services in Reno. Contact him at 996-6045 or tim.kane@lpins.net.