Credit risk insurance is rapidly becoming a preferred financial tool for companies facing a wide range of problems and opportunities. In this article, we’ll explore how credit risk insurance can be of value in your business and outline the best approach to shopping for this unique and highly valuable coverage.

Determining Why You Want to Buy Credit Risk Insurance

Before actually going to the market for quotes, you would be best served by clearly identifying what your interest in credit insurance is and how you think it will benefit your company. As a custom tailored financial tool, there are many practical benefits to having this type of coverage in place. That said, there are also some common misconceptions about what this type of coverage can be used for.

At the most basic level, credit risk insurance is designed to protect you from unexpected losses due to the insolvency or past due default on the part of your insured customers. The limited number of underwriters who specialize in this unique coverage will in most cases, conduct credit evaluations on the accounts you wish to insure and approve them for specific credit limits based on your requests and the results of their research. Given this active credit evaluation on the part of the insurer, credit insurance should not be approached as a tool you can use to grant credit to companies that don’t merit it. Likewise, it should not be sought when you have an imminent loss that you are looking to shelter.

Credit risk insurance is a proactive management tool that best helps you in the following specific areas:

Catastrophic loss protection: Across most industries and companies of all sizes, it is generally true that the top 20% of accounts represent about 80% of the company’s revenue. In some cases, the concentration of credit exposure among a few or even one key customer is even greater. Just one sudden, unexpected loss could have a devastating impact on the business. If you consider that your receivables are a concentration of all of your cost and your profit, and that, in many cases, you create them based on nothing more than a customer’s promise to pay; you can see that there is a tremendous amount of risk facing your business. Even with customers you believe are “good as gold”, the risk of unexpected default persists. Credit insurance is a great tool to remove this catastrophic risk from your balance sheet and cap your company’s exposure.

Safe sales expansion: It is not uncommon for customers to request more credit than you are comfortable giving them, or to have new customers you aren’t familiar with seek meaningful amounts of credit from you. While you may invest in a professional credit practice to review these requests and manage the exposures, if you are limiting sales as a result of concern over the risk, credit insurance is an ideal answer. Many companies use credit insurance to be able to expand on existing credit limits without having to put themselves at additional risk. It is also helpful in covering open credit sales to new accounts where you might have limited information and sales history. It is worth pointing out that using your credit insurance policy to support additional sales you would not have made otherwise will not only allow you to recapture the premium, it will help you drop additional profit to your bottom line.

Credit decision support: As mentioned earlier, in just about every case, the underwriters on your credit insurance policy are going to actively research, approve and monitor the accounts you wish to insure. Having an industry specific financial analyst doing this work for you as part of your credit risk insurance program adds a lot of expertise to your credit practice, or provides you, to a certain degree, with an outsourced credit department. This allows you to focus your internal resources more on cash flow management and collections work. If you consider the cost of amassing the information resources, many by costly subscription only, and hiring the additional expert financial analysts, this decision support alone is worth the typical annual premium. Most companies operate on the general rule that as long as the customer is paying timely credit management efforts can be focused elsewhere. Unfortunately, payment history is not a valid predictor of default. Many companies are current on their bills at the time they file for bankruptcy protection or are forced into default. Having the carrier watching your covered accounts and helping you evaluate credit limits on new risks is a great advantage to the program.

Borrowing enhancement: If the company borrows against its receivables, credit risk insurance can provide additional protection to the lender so they may be able to enhance the borrowing arrangements. They do this by increasing the percentage they will advance against insured accounts, and/or roping more accounts into the borrowing base- large concentrations, slow payers, export customers, etc. This allows you to maximize the amount of working capital available from the same pool of receivables. If you’re in a high growth mode and find yourself in need of more working capital, credit insurance is a great way to resolve the problem. Exporting on open credit: With more companies sourcing customers outside their own borders, the risk of granting credit terms has to be balanced against maintaining competitive terms against other sellers. Export credit risk insurance is one tool you can use to offer competitive open credit terms without the additional risk.

Before you talk to a specialist in this field, you should take a look at your business- the customer base, credit practices, risk appetites, etc. and think about how you want the policy to go to work for you and where it can bring value. With this accomplished, you’ll be better prepared to have a productive dialog with a specialist who can help you find the ideal solution.

For more on this article, go to our How To Buy Credit Risk Insurance Section

Review a Related Case Scenario: Catastrophic Loss | Sales Expansion