Business Credit Insurance: When It Makes Sense, It Pays for Itself
In two previous articles, Credit and Collections – Tough Times Require Tough Measures, and Abbreviated Survival Guide for Extending Business Credit, I touched upon using credit insurance to provide protection against insolvency of a customer or multiple customers. In this article I am going to explain more about credit insurance.
Credit Insurance is sold to businesses selling to other businesses (B2B) to insure against the insolvency or inability of your customer to pay your invoices. In the credit insurance world your customer is called a “debtor.” On first blush one might think this type of insurance a luxury, but closer examination reveals that there are a number of very good financial reasons why a company should consider it.
The biggest reason why credit insurance might make sense is if your business has one or two very large customers which might cause your company’s demise if they are unable to pay for your goods and services. If your customer fails to pay because of insolvency or the inability to pay, the credit insurer pays you for your loss less a deductible and co-insurance. Deductibles and co-insurance amounts vary greatly, but my experience is that you can find a balance of cost vs. the amount of deductible and co-insurance.
Another reason to consider credit insurance is if bad A/R write-off as a percentage of outstanding A/R is fairly high. Credit insurers become your back end credit department. In my 15 years of experience in lending, I have found a great deal of respect for the credit review functions these insurers provide. The major insurers have very large databases of credit information on companies and stay on top of changing circumstances on a day to day basis. If you have credit insurance and your insurer doesn’t want to insure a particular company, I would find some other way to sell to them other than trade credit. Perhaps cash in advance, or COD.
If your company extends credit to foreign companies, credit insurance is a very good idea. Credit insurance covers political risk and several other types of risks inherent in foreign trade. All of the major credit insurers will insure both foreign and domestic accounts receivable.
Lastly, if working capital lender is excluding some of your A/R because of concentration of credit or because it is foreign, you can often persuade your lender to add these excluded accounts to your borrowing base because they are insured.
I have had quite a bit of experience with two of the three large credit insurers. My experience was that of a lender trying to give a customer a large line of credit based on A/R. In several cases, because my customer chose to have credit insurance, I was able to raise the advance rate and drop my costs to a point where they were lower than the cost of the insurance. Everyone won.
Unlike automobile or general liability insurance policies which are fairly standard from carrier to carrier and state to state, the terms and costs of credit insurance policies vary significantly from insurance carrier to carrier. My recommendation is that you get quotes from the top three credit insurers, Atradeius Credit Insurance, CoFace USA, and Euler Hermes ACI. Many business insurance brokers can help you navigate the marketplace.
My personal experience with Atradeius is they tend to be most competitive when you are considering insuring only one or a small number of customers. Their policy is very flexible and they tend to have the best overall program for larger customers. CoFace USA tends to shine when it comes to writing small policies. In my experience, neither of the other two carriers can write policies with minimum premiums as low as CoFace. CoFace also has a very well-respected collection division that provides collection services separate from their insurance.
The bottom line is when credit insurance makes sense it nearly always pays for itself, either though reduced costs of borrowing, mitigating losses, or providing credit services during these tough times.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
You may contact Sam directly at: sam@lesliethacker.com
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EXTRA: If you have questions for Sam regarding business financing, the credit market, and similar issues, please send an e-mail. Your questions will be recorded and Sam will answer the best ones in his podcast show.
