These days, many companies are faced with numerous risks such as cyber security threats, government investigations, scandals, onerous litigation, etc. These threats and others of course pose a great risk to the long term viability of a company. Manufacturing companies as well as distributors face the added burden of dealers and retailers declaring insolvency or refusing to pay their debts as they become due for a number of reasons. Fortunately, commercial credit risk insurance, sometimes called “trade” credit risk insurance, can help a company protect its account receivables (A/R) from unexpected losses due to nonpayment or slow payment by the company’s buyers or debtors. It usually covers nonpayment because of a buyer’s insolvency but may also cover nonpayment due to political events that hinder payment or distributors on credit. A/R is the money owed to a company by its customer for products and services sold on credit. Normally, a sale is only treated as an account receivable after the customer has been invoiced for the product or service.
Depending on the industry and size of the company, it may or may not sell many or all of its products via credit. The risk, therefore, of nonpayment or slow payment (90 or 180 days after invoice, etc.) can be quite serious and expose the company to a potential crisis if the A/R is not paid. This is a major concern for any company selling product on credit.
In fact, on a number of occasions, I had to deal with bankruptcy issues because dealers and retailers of the company I worked for declared bankruptcy. Because we had a sound risk management program in place, one that also had credit insurance, we were not exposed to the extent of other creditors that had failed to obtain credit insurance. So even though the company I worked for was one of the major unsecured creditors, it exposure was primarily the deductible it had to pay as part of the insurance coverage.
Types of Credit Risks
Credit risk insurance normally covers two kinds of risk: commercial risk and political risk.
- Insolvency or bankruptcy
- Protracted nonpayment
- Default of customer
Note: Credit risk insurance will not usually cover nonpayment due to contractual or legal disputes between the company and customer.
- Political risk
- War, strikes or other potential civil disturbances
- Repatriation concerns: decision by the government not to allow repatriation or release of the funds
- Transfer risk: political events including wars or political disputes preventing transfer of payment
Benefits of Credit Insurance
There are numerous benefits for using credit insurance, if applicable. The most obvious benefits are:
Transfer or mitigation of risk. Credit insurance assures a company that its A/R will be paid if one of its customers declares bankruptcy or is unable to pay. This is subject to the terms and conditions of the insurance policy.
- Improved cash flow. A timely collection of A/R provides much-needed operating cash flow.
- By using credit insurance, a company is able to extend more credit to its primary customers, promoting increased sales. This can be cyclical, allowing increased turnover of products and, therefore, increased sales.
When a company initially sets up its risk management processes it should pay attention to credit insurance or trade insurance if that insurance is available in its industry and for the products its sells. It is another way of transferring risk when debtors are unable to pay outstanding A/R. Remember, insurance is a way of transferring risk. Use it.