Credit insurance, which has been around for many years, is a custom financial tool that protects a business from losses due to insolvency or past due/slow pay from their customers.
This problem of insolvency or past due/slow pay from customers isn’t expected to stop any time soon, either. U.S. corporate default rates are expected to rise this year, as marginal companies that already refinanced debt in the last few years stumble because they didn’t reduce debt and just pushed out payment schedules, according to a USA Today article.
“This insurance product can be a cost-effective device for transferring risk — premiums are tax deductible while reductions in bad debt reserves are not,” says Cliff Baseler, vice president, Best Hoovler Insurance Services, Inc., a SeibertKeck company.
Smart Business spoke with Baseler about why the value of this insurance is consistently being demonstrated during economic financial crisis time and time again.
How does credit insurance coverage work most effectively?
If your company does business in which it extends a line of credit for merchandise orders or other accounts payable, then this insurance protects you against losses because when you extend credit to a business your own financial solvency gets tied in with that account. Coverage can apply to a single debtor or a greater spread of risk by including all of your unquestioned buyers in excess of a certain dollar amount. Annual sales of at least $1 million can make the program more cost effective.
Why should employers look into buying this type of coverage?
Business owners must be more attentive regarding the management of their accounts receivable in the face of this global economic climate. There are more business failures both domestically and internationally. This was borne out by increased worldwide demand for credit insurance across all geographies in the first quarter of 2012, according to the Global Insurance Market Quarterly Briefing. The United States saw a modest increase in demand of less than 10 percent, with the largest demand increase in Asia.
Credit insurance provides catastrophic loss protection that can be used by businesses of all sizes and by all business sectors. There are many benefits as to why a business owner will purchase this coverage. Some include:
- Increasing credit to your existing customer base and extending credit to new customers.
- Improving cash flow.
- Enhancing bank financing by increasing borrowing capacity. Banks will lend more against insured receivables.
- Reducing bad debt reserves and freeing up cash.
- Utilizing it as a risk management tool to improve business planning by elimination of unknown risk.
How does credit insurance protect you better than just looking at a customer’s payment history?
Unfortunately, payment history is not a valid predictor of default. Close to 50 percent of all payment defaults rise from stable and long-term customers. One sudden loss could have a devastating impact on you and your business. Consider that your receivables are a concentration of all your cost and profit, and in many cases, you create them based on a customer’s promise to pay. Therefore, there is a tremendous amount of risk facing your business. Credit insurance is a great tool to remove this disastrous risk from a balance sheet.
What do business owners need to know about purchasing this insurance?
The level of indemnity ranges from 80 to 100 percent depending on your credit management experience, accounts receivable portfolio and premium target. Policies are designed to fit a business owner’s need for coverage. Risk retention comes in the form of co-insurance and deductibles and helps in lowering the premium. Co-insurance is a percentage of the loss you retain on each insured account.
There are only a small handful of carriers that specialize in this type of coverage. Each will have their own risk appetite, underwriting philosophy, and method to how they structure and administer their policies.
Underwriters will research, approve and monitor the accounts you want to insure. They also will approve coverage limits on the customers you want to insure. You will want to provide underwriters with a balanced spread of risk that will offer best pricing and terms. It’s important to clarify with the underwriter your maximum terms of sale, lead times for customer orders and note any special circumstances that might require additional coverage.
You can insure the entire accounts receivable portfolio or a select number of accounts. The premium will be based on your loss history, customer credit quality, spread of risk, and deductible and co-insurance levels in the policy. Usually the premium is less than half of one percent of insured sales.
Your customers’ payment history is not a valid evaluator of their failure to pay. Having a carrier watching over your covered accounts and helping evaluate credit limits is a great advantage to a business owner’s risk management plan. Nonpayment and slow pay by your customers will weaken a company. Credit insurance can help protect a company’s biggest asset — your own business credit.
Cliff Baseler is vice president of Best Hoovler Insurance Services, Inc., a SeibertKeck company. Reach him at (330) 867-3140 or [email protected]
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