Many companies self-insure against bad debt losses. Accounts
receivable is often the only tangible asset on the balance sheet not
insured. Companies often have substantial bad debt reserves in recognition
of the fact that sooner or later one [or more] of their customers will
One alternative is to purchase credit insurance that covers the entire accounts
receivable portfolio. Once a credit insurance policy is in place, a company
may be able to reduce its bad debt reserve significantly. In effect, a credit
insurance policy can "cap" a company's exposure to unexpected and
catastrophic credit losses. Credit insurance eliminates risks by transferring
them to the insurer.
Even with a credit insurance policy in place, it is difficult to determine
how much of the company's bad debt reserves can be "drained." Some
of the limiting factors include these issues:
Coverage will be denied to some customers.
The company may elect only to purchase coverage
for a certain portion of its accounts receivable. [For example,
it is not uncommon for companies to insure only their foreign accounts
Some customers will not qualify for the dollar
amount of amount of coverage requested.
Insurance policies typically include an exclusion
for losses below a certain dollar amount - so not all accounts
and not all losses will be covered.
Amounts outstanding prior to the effective date
of the policy are not covered.
The fact that the debt must be undisputed to qualify
Policies come with an annual deductible and a per
loss co-payment or deductible - each of which must be factored
in when determining the appropriate bad debt reserve.
All of these factors make it difficult to know exactly
how much the bad debt reserve can be reduced. What is clear is that
some adjustment to the reserve must be made once a credit insurance
policy is in place --- so credit insurance can be used to lower [but
not eliminate] bad debt reserves.