If you run
a business that has a large number of customers, the thought of one or two of
them missing a payment probably doesn’t keep you up at night. But for firms
that rely on a small number of very large buyers, even a single skipped invoice
can be catastrophic.
Credit
insurance, also known as receivables insurance, has become a popular way to
mitigate that risk. In the event that a client covered under the policy goes
bankrupt or otherwise neglects to pay for goods purchased in advance, your
company is reimbursed. Here is a brief, closer look at this type of insurance.
How
It Works, What It Costs
Some
insurance firms provide blanket policies that will cover all your accounts.
Under this arrangement, the carrier will sometimes apply a credit limit for
each customer that your business can’t exceed. But because these plans don’t
come cheap, a lot of businesses instead carve out narrower policies that only
apply to their largest clients.
The cost
of credit insurance varies based on a variety of factors, including the
creditworthiness of your buyers and your company’s prior collection history. In
the case of foreign clients, underwriters also factor in the risk of doing business
in that particular country. That said, a lot of businesses end up taking out
coverage for less than 1% of their receivables amount.
Doing so
tends to be less expensive than relying on “factors,” financial intermediaries
that essentially buy your receivables at a discounted rate. Traditionally,
these firms have been a fairly common way to limit credit risk. The problem is
that they can be incredibly pricey – many charge 2% or more of a company’s
credit accounts.
Additional
Benefits
The
primary reason for taking out receivables insurance is to get reimbursed if
customers fall behind on their bills. However, there are other key advantages
to these policies.
One
tangential benefit is the ability to increase the amount you can borrow from
your bank. Businesses will often use their accounts receivable as a form of
collateral for loans. But unless those amounts are insured, lenders see this as
an unsecured asset.
When you
take out credit insurance, though, these assets become a much safer bet. That
means, hypothetically, a bank that otherwise offers an advance rate equal to
75% of your receivables might increase that amount to 90%. For a company that
has $1 million of outstanding invoices, that would increase its credit facility
by $150,000.
It can
help with cash flow in another way, too. Businesses that take out insurance are
able to reduce the amount of money they have to keep in reserve for bad debt,
thus freeing up additional capital for their operations.
Another
reason to consider this type of coverage: Policyholders gain access to the
extensive data that insurers keep on businesses around the globe. That can make
a big difference if you’re deciding whether to work with a new client and don’t
know much about its credit history. It can also help businesses decide whether
to extend more credit to existing customers.
This type
of information can be especially valuable for companies that are looking to
expand overseas, in which case the reputation of their clients isn’t as well
known. Larger insurers record data on literally millions of firms worldwide,
which you may be able to leverage when deciding to extend credit.