Running a company involves a long list of risk exposures that vary by the nature of the industry. One of the most common risk factors across all industries is customers failing to pay their bills, which can impair cash flow and impact profitability.
The risk is so significant that establishing reserves for uncollectable accounts is a normal accounting practice. Because accounts receivable typically represents one of a company’s largest assets, maintaining large reserves often ties up a great deal of working capital.
That’s why an increasing number of companies are turning to an insurance product that provides a more affordable way to reduce the risk. What’s known as trade credit insurance protects companies from the inherent risks associated with extending credit.
How Trade Credit Insurance Works
In simple terms, trade credit insurance reimburses companies for lost receivables due to a customer’s bankruptcy or default. If a customer defaults on a receivable, the insurance company issues payment to the insured.
Policies can also be written to cover receivables that age past a certain amount of time. For example, if a customer has 30-day terms with your company, and your trade credit policy covers late accounts, the insurer would issue payment on day 31 and then pursue collection from the customer through legal channels.
With trade credit insurance, a company is guaranteed to receive payments for its receivables. In most cases, the cost of coverage is a small fraction of the amount companies currently keep in reserves, freeing up that capital for other purposes such as growing the business.
The insurance carriers offering this coverage have access to extensive global data resources that allow them to assess the risk associated with both public and private companies. Given a list of your company’s customers, they determine how much coverage they’re willing to issue—much as a bank studies your personal finances before deciding whether to approach your mortgage or car loan. That gives you guidance as to how much credit you can extend to those customers.
This coverage performs optimally for companies doing $2 million or more in annual revenue. Companies dealing with low margins, high volumes, commodities, custom-made products or large customer portfolios are most likely to benefit from this insurance.
Besides covering a company’s current receivables, trade credit insurance makes it easier for companies to expand their customer base into new business sectors or across international borders. Without coverage, a manufacturer might be hesitant to sell machinery in South America, as an example, because of risks associated with currency and political issues. By addressing those risk factors, the coverage allows that manufacturer to pursue South American sales with confidence.
Given that trade credit insurance is a new concept for many business leaders, it’s important to work with a broker that has extensive experience with this product—both to ensure that the coverage addresses the company’s unique situations and to verify that the pricing properly reflects the risks. A knowledgeable broker will see to it that your company receives the greatest value possible from this proven, practical type of coverage.
If you would like to learn more, contact your Hylant service team member or your local Hylant office.
The above information does not constitute advice. Always contact your insurance broker or trusted adviser for insurance-related questions.