Corporate Risk Solution
How It Works
Accounts Receivable insurance provides coverage to a business when one of its customers fails to make payment on its debt. When obtaining a policy, a company will name the customers to the policy with a coverage amount necessary. If a business has specific customers it has concerns about, the business can choose to insure only these specific customers. Generally, a business can also choose how late a payment must be before the insurer will pay and what percentage of the payment that the insurer will cover.
What It Covers
Though a business can often purchase a custom accounts receivable insurance policy to meet its unique needs, accounts receivable insurance generally covers defaulted payments due to the customer going out to business, changing ownership, becoming insolvent, filing bankruptcy or simply due to nonpayment. Most accounts receivable insurance policies also cover defaulted payments due to economic downturns, seasonal business cycles, natural disasters and geopolitical events. A business can purchase accounts receivable insurance that covers both domestic and international clients.
The premium cost of an accounts receivable insurance policy will vary depending on a number of factors including the credit standing and industry of the business. The amount of coverage a business chooses to purchase will also affect the premium cost. However, for coverage of domestic business the cost of coverage will generally equals a small fraction of 1% of Gross annual sales. For international business, the cost of coverage is generally a bit more.
As an added advantage of having accounts receivable insurance, the insurance company will generally monitor the companies that your policy covers. If one of the companies begins to show signs of financial problems, the insurance company will notify you of these problems. If the insurer notifies you a potential problem with one of your customers, you can take action to protect your interests.
Alternatives to Trade Credit Insurance
There are other ways to hedge receivables, including letters of credits, which can be quite expensive. There is a Receivable Put which is for single high risk buyers and is quite expensive. Self-insurance is another option, but it involves setting aside reserves to cover any losses from customers’ failure to pay. However, reserves eat into margins and do not protect against catastrophic, unexpected losses. Self-insurance also requires an investment in systems, credit risk monitoring and analysis expertise, the quality and scope of which often cannot compare to that offered by a trade credit insurance provider.
Another alternative, factoring, involves selling receivables to a factoring firm, which often requires accepting a discount to face value of between 1 and 10 percent. In addition, factoring firms may not agree to take all the credit risk in the event of non-payment. In an environment of narrow business margins and high levels of competition, the factoring discount can be a significant burden. Also, the company loses the client relationship benefit that owning the receivables helps to sustain.
There are many business benefits to trade credit insurance, both in growth and uncertain market environments. It mitigates risk very cost-effectively, while giving companies the confidence to expand their sales to new customers and markets. A firm may also be able to sell more on open account terms. In addition, trade credit insurance can help free up capital for other programs and projects. While serving as a tactical risk-mitigation tool, trade credit insurance can offer companies a strategic and competitive advantage.