While business owners routinely insure their buildings, inventory, equipment and vehicles against catastrophic loss, they often overlook protection for an asset that may be more crucial to their business: their Accounts Receivable. The inability to collect a large receivable can be devastating to a business by jeopardizing the cash flow that is critical to its survival. As a matter of actuarial fact, it is 50 times more likely you'll suffer a Major bad debt loss than your building burning down. Both of these events would have the same devastating effect on your business. What many business owners don't realize is that they can protect their company from such a loss through credit insurance.

DOMESTIC CREDIT INSURANCE

Credit Insurance is an insurance product designed to protect a company's commercial accounts receivable from the effects of a loss caused by the insolvency or slow payment of one or more of its key customers.

Credit insurance can provide a number of benefits:

1. It works as a financial tool by facilitating the financing of accounts receivable.
2. It is axiomatic that the value of a borrower's collateral is vital to the accounts receivable financer's decision on credit matters.
3. Lenders recognize that credit insurance significantly reduces the risk that a borrower's key customer's insolvency will jeopardize repayment of its loan, and may very likely grant more favorable lending terms as a result.

Credit insurance also works as a collection tool.

Because it can reduce the overall risk of exposure to non-payment, credit insurance can give a business the confidence to sell more goods by liberalizing credit policies and enabling more customers to qualify for credit. It may also enable the business to take advantage of peak and cyclical selling periods and to expand into new product lines or new territories.

Another advantage of credit insurance is that you can make the lender the loss payee on the policy.

If an account goes bad, the lender gets paid directly. Now, the lender has peace of mind. If, around renewal time of your financing agreement, your receivables are performing well and the insurance policy is in place, and especially if you are profitable, you may ask the lender to lower your interest rate. In essence, this reduction in interest rate can, in most cases, cover the cost of the policy.

The cost of credit insurance will depend on several factors (the number and quality of accounts to be covered, the annual sales, the nature of the industry, the size of the face amount of the policy, risk sharing and loss experience.) However, the estimated cost is likely to be between 2/10 and 4/10 of 1% of annual sales to be covered .

In some cases, there may not be a onetime deductible because the insurance company will write a policy with co-insurance. An example of this co-insurance format is as follows:

Company A has insurance on a debtor for $100k with an 80/20 split. This means if the debtor is insolvent, the insurance company will pay $80k to Company A. All future losses on any customers will be split on an 80/20 basis.

In a straight deductible policy, the initial deductible could be $100k before a claim is paid. Once the company reaches their $100k deductible, all claims are typically paid 100 cents on the dollar up to the face amount of the policy.

In the scenario of co-insurance, Company A was able to collect their $80k, immediately. (Because there are several different companies that underwrite credit insurance, the rules and regulations may vary from one to another.)

The most obvious benefit of credit insurance is as an insurance product. Credit insurance policies work as follows:

1. The insurance company will conduct credit evaluations on each account that the insured submits for coverage.
2. Once an account is underwritten, it is endorsed into the policy, along with its approved credit limit.
3. The insured can submit either only its largest, key accounts or its entire portfolio, as desired.
4. A blanket provision is available which provides coverage on all accounts, up to an agreed maximum.

The credit insurance policy covers many loss situations, ranging from bankruptcy to un-collectible accounts (slow pay), including the absconding or death of a debtor, receivership, sale of goods under Bulk Sales Act, writ of attachment, etc.

By utilizing credit insurance as a financial tool, a sales product and as an insurance product, your company will be protected against catastrophic or excessive loss on your receivables. This is yet one more strategy that can be used to ensure success in the Game of Credit.

Footnote: Remember, credit insurance limits the risk but does not improve cash flow.

Therefore, you do not purchase credit insurance with the intention of replacing your credit department. Good, sound business decisions still need to be made. The granting of credit should be done on a personal level of understanding. The Credit Insurance accountability of another business' performance is most important. If you plan to do business with that company on a continued basis (which should be a stated goal at the start of the game), then make sure that customer gets all the attention necessary to please them. Replacing a credit department with credit insurance would tend to depersonalize a business and cause you to lose touch with your customers.

FOREIGN CREDIT INSURANCE

For companies that sell goods and services overseas, the credit insurance product is invaluable.

It makes your now ineligible export a/r, with you lender, eligible. It also replaces Letters of Credit, which significantly increases your sales and saves you and your buyer the cost of the L/C.

Remember: No two companies are alike. Always check the pros and cons before making any decision, and above all, see if the program works within your stated goals. The rules and regulations in foreign credit insurance are different from those in domestic insurance.

Check with the banks you are looking to work with and see if they are familiar with credit insurance and how it works. In a borrowing situation, foreign insurance can improve cash flow by having a lender advance against a covered account.

RULE: When cutting expenses in your company, never release your credit manager (if he/she is doing a good job). It is the credit manager who affects cash flow more than anyone.

TIP: If your collateral is performing and your receivables are insured, as a negotiating technique, lenders should be willing to reduce your cost of funds, hopefully, by 1/4 percent. If they do, quite possibly, a majority, if not all, of the cost of the insurance policy could be saved by the reduced interest rate.

THE TWELVE (12) MOST F.A.Q.'S ABOUT CREDIT INSURANCE

1. What is Credit Insurance?
It is an insurance product designed to protect your company's commercial accounts receivable from the devastating effects of a loss caused by the insolvency or slow pay, of your key customers.

2. Why buy Credit Insurance?
If just one of your major customers fails, the damage can be devastating to your firm. Declaring bankruptcy is no longer the last resort it used to be. It has become an accepted business strategy! We don't have to look too far back to see major corporations filing a Chapter 11 to avoid class action law suits (Texaco, Johns Manville, etc.), get out of future lease obligations and of course Major fraud (Enron, Pharmor,etc.).

3. What can Credit Insurance do for my company?
Credit Insurance can provide three (3) benefits: as a financial tool, a sales product and as an insurance product.

4. How can Credit Insurance work as a financial tool for my company?
By facilitating the financing of accounts receivable, lenders recognize that the insolvency of a company's key customers may jeopardize repayment of a loan. Credit Insurance reduces this risk and may result in more favorable lending terms and ease any concentration rules your lender may be imposing on your largest buyers.

5. How does Credit Insurance work as a sales product?
By allowing increased sales, Credit Insurance will enable you to sell more goods on credit terms while substantially reducing the risk of exposure of non-payment. It may also enable you to take advantage of peak and cyclical selling periods and to safely expand into new product lines or territories.

6. How does Credit Insurance work as an insurance product?
By providing Catastrophic Loss Protection. Generally, it is recognized that 20% of a firm's buyers account for 80% of sales. Credit Insurance protects against the catastrophic loss resulting from the insolvency of those key accounts.

7. How does Credit Insurance work?
Once underwritten, a buyer is endorsed onto the Policy, along with its improved credit limit. There is no need to monitor account ratings or complete monthly reports. Coverage is agreed upon upfront.

8. Must all accounts be Credit Insured?
No! The Policy is flexible and can be tailored to your specific needs. It can cover your largest, key accounts...those which would cause catastrophic loss for your company if they became insolvent…or, you may choose to ensure your entire portfolio. You make the decision.

9. What types of losses are covered?
The Policy covers many loss situations, ranging from bankruptcy to un-collectible accounts.

10. Is there a deductible?
Risk sharing is part of every policy. This is either in the form of a deductible and/or co-insurance. Like any other insurance policy you own now, the expected, ordinary, losses are easily absorbed by your company. The Credit Insurance covers against the unexpected losses which can be devastating to you.

11. How much will it cost?
Premiums usually cost a small fraction of 1% of sales and are based on the type of business, annual sales and loss experience.

12. Why not continue to "Self- Insure" ?
Although some companies have chosen to self-insure in the past, doing so may now cost you more. Under the 1986 Tax Reform Act, businesses can no longer use the bad debt reserve method of accounting to determine tax deductions. On the other hand, Credit Insurance premiums are fully deductible, allowing you to put the cash you now have in reserves to better use and set up an actual cash reserve for bad debt.