Trade credit insurance provides coverage for nonpayment risk on accounts receivables that can be attributed to protracted default, bankruptcies, or commercial or political risks, the latter being more of a concern when a foreign government could impose capital controls that won’t allow money to leave the country for the U.S.
“Accounts receivable is a big item on any company’s balance sheet,” says Jim Altman, middle market Pennsylvania Regional Executive at Huntington Bank. “It’s converted into cash that’s used to pay creditors and employees, which are among the most important functions of a business. But often it’s the one asset that’s not covered. Also, in terms of low rates, it’s hard to build a case for not doing it.”
Smart Business spoke with Altman about trade credit insurance, what it covers and how it can be used to grow a business.
In what situations does it make sense to have a trade credit insurance policy?
Any company that sells good or services could use this insurance. Companies with more than $5 million in sales are good candidates.
While some industries — mining, energy, metals and automotive, for example — are ideal candidates, given our current economy, for credit insurance, the type of business and sales volume are less relevant than a specific industry or buyer base. Companies in highly cyclical industries will find it prudent to insure their accounts receivable.
With respect to circumstance, highly leveraged companies with tighter cash flows should consider credit insurance as well. A general rule of thumb is companies that have receivables of a magnitude that nonpayment could impair their ability to service their debt or cover payroll should be insured. Also, if you’re dealing with a high degree of customer concentrations, look to insure.
It could be too late or too costly if a company waits for the industry to deteriorate before insuring. In those cases, it can be tough to get approved, or there will be higher-than-usual rates because of the inflated risk.
What policy provisions should businesses consider or be ready to discuss with their broker when negotiating credit insurance?
A good place to start would be with a company’s comfort level with risk. If a $100,000 bad debt expense can be afforded, then that’s a good place to set the policy deductible.
Pay specific attention to reps and warranties, exclusions and the length of the waiting periods. The insured will want the fewest reps and warranties and shortest claim times after a default occurs.
Be mindful of situations where there are exclusions, and reps and warranties the insured can’t control. For example, sanctioned language that says if the U.S. government slaps punitive sanctions on a country, then the policy may be canceled.
Generally, it’s important to understand credit insurance is a very niche business with just a few insurance companies that have expertise with this product. Businesses considering insuring their accounts receivable should expect their insurance broker to understand their business and not just have insurance product expertise. That’s why working with an experienced broker is so important. There is so much flexibility and many ways these policies can be set up that it takes someone who knows what they’re doing to put them together.
Why is credit insurance a good investment?
In addition to mitigating risks to accounts receivables, savvy companies have used credit insurance to grow their businesses. They use it to increase domestic credit lines, offer extended terms to clients and explore new geographies. In other words, they use it to proactively make their business larger and stronger in a manner consistent with their risk tolerances.
Consider one growth-minded Western Pennsylvania company that put this coverage in place. With help from the insurer identifying which prospects had the financial wherewithal to pay invoices, they generated enough incremental net sales to cover the policy premium within a month.
Companies considering this coverage shouldn’t wait for an issue to arise to buy insurance. Rather, they should be opportunistic and grow their business through strategic use of trade credit insurance.
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