Credit Insurance- Protect Your A/R
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.
Credit risk insurance normally covers two kinds of risk: commercial risk and political risk.
Commercial risk
Note: Credit risk insurance will not usually cover nonpayment due to contractual or legal disputes between the company and customer.
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.
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.
When managing risk consider insurance
Though most people don’t consider how risky everyday life can be, most companies and organizations understand that risk exists around every corner. The trouble is that some companies still do not take adequate steps to properly manage risk. Consider the recent incident of the executive who died via a treadmill accident when he hit his head. Though the accident was a freak accident- nonetheless it happened. If you drill down a little closer, you will find out that fatalities related to exercise and sports are not that uncommon. Perhaps they are more common than we would like to believe. Everyday life, whether business related or not, carries a certain amount of risk. Though companies may use insurance to manage risk, the problem arises when the insurance program in place doesn’t really address the potential risks the company faces. That is the problem many companies dont realize until it is too late- say after that catastrophe that wiped out the stock or assets of the company.
It should be noted that companies use insurance as a risk mitigation or transfer tool and that they manage insurance programs differently than the average consumer. However, when developing a risk assessment of insurance considerations, data is extremely important when considering a probability or a risk-related event. The collection of relevant data will determine what kind of insurance policies can be obtained, the price, and even the availability of certain insurance programs. How far back a company can go historically to obtain data determines the potential risks a company faces and, therefore, what insurance program and insurance provider is available as well as the costs involved.
When looking at risk insurance programs, the first question that should be asked by the company is whether it has accurate data. Does it have a good risk management information system in place? If not, does its insurance broker or provider have one? Or maybe the insurance broker or provider can help develop one.
Accurate data leads to the right risk management strategy and the right insurance program. Lack of data makes it harder to have an accurate picture as to the risks involved and, therefore, harder to develop the appropriate insurance strategy and program. It is necessary to obtain accurate historical data if at all possible.
The main reason that companies make extensive use of insurance coverage is to diversify and shift risk through use of business-related insurance. Insurance, if properly used and maintained can be a major risk management tool.
A major issue facing companies when trying to insure legal risk is the insurability of the risk. In essence, the cost of insuring the risk may be too great to justify the particular form of risk insurance. So when a risk assessment identifies a business risk, not only does the company need to determine if insurance coverage exists to cover the risk, but whether the cost of such insurance justifies its acquisition. Many manufacturing companies will not purchase product recall insurance or similar insurance because of its expense. Some manufacturing companies or organizations will not even purchase credit insurance because of its expense. Therefore, a company or corporation must pay attention to costs and consider methods to reduce the cost of insurance.
Questions you should ask yourself when considering insurance:
As with anything, asking the right questions is half of the battle.
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