Giving Credit Where It's Due: Credit Insurance Explained
Credit insurance is designed to protect businesses from unexpected losses due to the insolvency of a customer or the failure to pay an undisputed invoice. This coverage can be purchased for either a specific client, referred to as named buyer, or for all business receivables, referred to as portfolio coverage. In either event, the business provides a list of all customers to the underwriter along with a requested limit of coverage. Specific customer underwriting decisions are dependent on variables, such as publically available financial information, the amount of credit coverage a particular insurance company already has extended to this particular customer, current market conditions, etc.
ScenariosThere are 2 scenarios where a Credit insurance policy will pay the policy owner:
- In the event of a customers bankruptcy, the policy will immediately pay the policyholder the amount of the uncollectible receivable up to limits on the policy and subject to policy deductibles.
- In the event that a customer simply fails to pay the outstanding receivable, the insurance company will first attempt to collect the outstanding receivable. If unsuccessful, they will pay the loss after a predetermined number of days typically 180.
Benefits of a Credit Policy
- The insurance company will actively research any new customers to determine their credit worthiness. Many times, this service is included in the cost of the policy or for a nominal fee. Having an industry expert assisting you with credit decisions may alone be worth the price of the policy itself.
- If you borrow against your receivables to fund payroll, having a Credit insurance policy can help reduce your borrowing costs. Banks and funding companies may lower your interest rate knowing that your receivables, which are used to collateralize the loan, are insured. The interest savings alone can be more than the cost of the policy.
- The policy will pay you in the event of a bankruptcy or protracted default of a customer.
Case StudyA staffing client purchased Credit insurance on all of their receivables. One of their largest customers decided to replace the agency and refused to pay an outstanding $985,000 receivable. The client tried collecting payment, but when that failed, the debt was reported to their insurance carrier. Since this bad debt was not a result of bankruptcy, the staffing client waited 180 days while the insurance company attempted to collect the outstanding receivable. Once the 180 days had lapsed and the debt was not paid by the former customer, the insurance company wrote a check to the staffing agency for $886,500 (outstanding receivable less 10% deductible).
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