How credit insurance can protect you in case of nonpayment

One of the key components of the recession has been the banking industry’s reluctance to extend credit to businesses across the country and around the world. This, obviously, has put a strain on many organizations.

Therefore, if businesses want to stay afloat in these tough economic times, they need to be able to collect the payments owed to them and, almost as important, collect them on time.

“More companies are turning to credit insurance to protect themselves during the economic downturn,” says Brian Slife, vice president and account executive for Aon Risk Services Inc. “Credit insurance protects against the risk of nonpayment of trade debt; that is, amounts owed to you arising from goods or services you have supplied.”

While standard credit insurance covers insolvency and nonpayment for domestic and/or export trade, companies can also add protection for political, pre-credit and work-in-progress risks.

Smart Business spoke to Slife about credit insurance and how it can help businesses in any economy.

What are some of the key benefits of credit insurance?

Credit insurance protects your profit and loss (P&L) statements and balance sheets by transferring payment risk to your insurers. It facilitates access to financing and helps you obtain improved terms from the banking market. And, it provides access to complementary debtor evaluation tools and expertise that underpin the credit decision.

A good credit insurance policy will enhance your credit management and help you comply with corporate governance ‘best practices.’ You’ll be able to increase sales through secure credit lines on your customer base, and you’ll be able to increase export revenue through competitive, but secure, credit terms.

Both small and medium-sized organizations enjoy the protection and outsourced credit evaluation provided by credit insurance. Not only that, there is a significant growth in the purchase of credit insurance by multinational organizations. These companies are looking to protect against large credit exposures while achieving a commonality of credit management across their national operations, so credit insurance is very attractive to them.

How does credit insurance help the bottom line?

Credit insurance can be used to enhance your receivable portfolio, which in turn allows competitive financing, improved ‘cost of funds,’ and the ability to negotiate advance rates. This can apply to the full spectrum of facilities, from invoice discounting to off-balance-sheet securitization.

Are there any additional benefits?

Credit insurers have developed sophisticated data analysis tools that can provide you with the latest intelligence on your company and the economy. They can provide a credit evaluation service, which will help their policyholders decide on the best level of credit for each of their customers, or provide the policyholders the ability to set their own insured credit limits.

How does credit insurance work?

A typical policy covers a total debtor portfolio or a selection of key customers. To activate the coverage, you establish credit lines on your customers, either internally or via the credit insurer’s in-house resources. Premiums can be charged on the credit line, on outstanding receivables or on turnover (sales). Claims are paid at 85 to 100 percent of the bad debt after an agreed grace/waiting period (e.g. 30 days for insolvency).

Why do companies need credit insurance?

Companies typically buy credit insurance to reduce or transfer the risk of nonpayment from their balance sheets to an insurance company, to increase their ability to borrow against receivables, to be more competitive by offering longer terms of sale or increased credit lines to their buyers, to be able to safely enter new markets, and to be able to safely offer terms to new buyers.

Has the need for credit insurance increased as international business has increased?

Yes. Credit insurance is very common in Europe. Because of this, European companies are more willing to offer payment terms when they export. Companies in the United States have found that they have to offer similar terms to be competitive. Many companies have turned to credit insurance as a way of mitigating the risk of offering credit terms when they export. Another reason for this is that the leading credit insurers have extensive databases of financial information that their insureds can tap into to help them make more informed credit decisions in foreign markets.

Do all companies need credit insurance?

As we are seeing today, any company can suddenly find itself having financial difficulties. I don’t think there are very many buyers of unquestionable credit quality remaining. I would say that unless a company derives all of its revenue from sales to the U.S. government, there is a reason to insure your receivables against a sudden financial meltdown.

What else should companies know about credit insurance?

Over the past couple of years, credit insurance has become a lot less expensive than it was in the past. Even though the market is beginning to change, rates are still relatively low and quality coverage is available.

Brian Slife is a vice president and account executive with Aon Risk Services Inc. (www.aon.com), a risk management, human capital and reinsurance consulting firm based in Cleveland. Reach him at (216) 623-4112 or [email protected].