How to buy Credit Risk Insurance
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.
This article is broken down into 6 key sections, with the intent of helping you understand the process of determining your credit risk insurance needs and then how to buy it.
Determine Why You Want to Buy Credit Risk Insurance - summary of benefits of credit risk insurance
Locate the Right Credit Risk Specialist to Assist You - why this is important, what to look for
Designing a Credit Insurance Program to Fit Your Needs - budget considerations, risk retention, establishing coverage limits
The Application Process - what to expect, turn around time, selecting carriers to solicit
Evaluating Credit Insurance Offers - apples and oranges, how your specialist can help, key points to compare for credit risk insurance
Implementing and Managing the Program - getting started, ongoing management items, how your credit risk specialist can assist
Designing a Program to Fit Your Needs
Once you have given careful thought to where credit insurance fits into your business, and you have your specialist ready to help you, before marching off to underwriters with an application, it is best to work with your broker to map out how you want the policy to look.
Your broker can assist you in understanding the underwriter's perspective so that together, you can design a policy that meets your needs and represents a fair opportunity for the carrier as well. First, we'll examine a few basic policy parameters, then look at some more detailed items you'll want to consider prior to submitting an application.
Premium. Always the first item of interest, the policy premium is a logical first parameter to examine. Because the policies are custom tailored and there are numerous factors that affect the premium, providing you with estimates in an article of this nature would be misleading. Suffice it to say, for a small fraction of a percent of covered annual sales, an amount easily recaptured through any of the proactive benefits of the policy, you can insure your portfolio or any meaningful segment of it. The ultimate premium that the carrier charges will be priced based on a number of factors including: default rates in your industry, your loss history, customer credit quality, the spread of risk and the deductible and coinsurance levels in the policy.
Risk retention: These come most commonly, in the form of deductibles and coinsurance. Carriers use either or both to allow for risk sharing. This risk retention assures them you have a vested interest in continuing to manage your exposure, while also allowing you to minimize your premium. Deductibles are typically a one-time per annum first loss position you have to satisfy before claims payments start. Coinsurance is a percentage of the loss that you retain on each account, and typically ranges between 10% and 20%.
One general rule in designing your policy is to use a coinsurance level less than or equal to your gross margin. This allows you to be sure you are covering your cost while avoiding paying additional premium to insure your profit. A deductible can be used to lever down the premium to a certain point. You can maintain a small reserve to cover the deductible or take it out of your cash flow at the time of the first loss.
Coverage limits: Your underwriter will review and approve specific coverage limits on the customers you wish to insure. While you can always request limit increases or submit new accounts as often as you need to throughout the policy term, you will need to start off with that initial list of accounts you want to insure at the present time. In selecting the accounts, it is important to not try to guess which accounts should be insured and which do not pose any default risk. The policy is designed to protect against unexpected losses and as such, you should only be looking at the size of the exposure, not the perceived credit quality of the account. It is often the accounts that appear "good as gold" that carry the largest balances and can hurt you the most if an unexpected default occurs. Additionally, you want to provide the underwriters with a balanced spread of risk that will allow them to give you their best pricing and terms.
With these three key items addressed, your specialist broker may recommend additional coverage endorsements based on the nature of your business. These should be discussed and itemized in the quotes that you receive. You will also want to clarify items like your maximum terms of sale, lead times in filling customer orders and note any specially purchased materials or custom work that might require additional coverage.
Once you and your broker have a better picture of how the policy will look, it is simply a matter of completing the application. Your broker will submit it to the appropriate markets for you.