Trade credit insurance (also known as accounts receivable insurance or A/R insurance) is a type of insurance policy that businesses can purchase to cover any financial losses they might incur from unpaid debt. In other words, trade credit insurance can insure that you still get paid, even when your customers don’t.
Trade credit insurance can provide an added layer of protection for accounts receivable when customers are unable to pay on time or default on a loan altogether.
This is especially comforting considering that accounts receivable typically represents more than 40 percent of a company’s assets, according to insurer Euler Hermes. What’s more, if you have a relatively small customer base accounting for the vast majority of sales, losing just one account to default could have devastating consequences.
For example, if 20 percent of your customers make up 80 percent of total sales, it may be wise to have a credit insurance policy in place because the risk of loss from just one customer is so great, you might not be able to recover from it.
Credit insurance can also allow companies to take on more sales by reducing the risks associated with nonpayment.
Knowing Which Accounts to Insure
With most trade insurance providers, you have the option to insure all or a specific portion of your accounts receivable. Some companies may prefer to take out a customized policy that only covers certain accounts, such as high-dollar or high-risk accounts.
Others may choose to insure particular accounts that are deemed high-risk, either due to current financial conditions or geographic location. Some companies only insure their global customers.
In some cases, it may be more cost effective to insure the entire accounts receivable portfolio. It depends on a variety of factors, such as how your assets are spread out among your customers and the insurer’s pricing structure. Talking to an insurance agent can help you decide which option will provide the most protection for the least amount of money.
Trade Credit Insurance Policies and Pricing
According to the Credit Research Foundation, a policy on domestic receivables typically ranges between one tenth of one percent of sales to four-tenths of one percent of sales. For example, if your annual accounts receivable equals $10,000,000, and one percent of that amount is $100,000, you can expect to pay between $10,000 and $40,000 to insure those accounts. That may seem like a very small price to pay to cover such a large amount of sales.
Still, some companies prefer to purchase smaller policies tailored to a specific group of accounts. For example, some companies will purchase an export credit insurance policy to protect their international receivables against non-payment. This is especially helpful when you have customers based in countries that are experiencing civil unrest, riots, or war. It can also protect against trade sanctions, embargoes, and changes to import/export regulations.
The cost of customized policies varies on the insurance company, the number of accounts covered, and type of coverage needed. Most insurers will provide companies with a free quote online.
Is Trade Credit Insurance Right for My Business?
If, by now, you're thinking that trade credit insurance is a must-have for your business, there are a few things to note before deciding whether it’s right for you.
For one, most policies won’t allow you to file a claim if the invoice is disputed. In this case, you would have to wait until the dispute is resolved before the account can be declared unpaid. Once that happens, then you can file a claim to collect on nonpayment.
Second, if you do purchase an insurance policy, you shouldn't let your customers know if their accounts are insured. It’s best to keep that information confidential since it might tempt a customer to default, knowing that their debt is covered. It can also take leverage out of any collections issues you might have to face down the road. For a very minimal cost – often a fraction of one percent – you not only gain peace of mind, but also the ability to quickly make data-informed decisions about selling to new customers or extending additional credit to existing ones.
Lastly, not all companies qualify for trade credit insurance coverage. Many insurance companies use risk assessment data from companies like Dun & Bradstreet to help them make better informed decisions about who they’ll cover. If your company is just getting started or is not profitable, trade credit insurance might not be a cost-effective option for you.
Overall, trade credit insurance can be a great tool for minimizing credit risk and protecting your accounts receivable (and business) from any significant losses. Most companies provide policies for small, medium, and large companies, and policies can be customized to your specific needs. Either way, if you’re looking for ways to minimize bad debt, it’s definitely worth looking into.