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Business Credit Insurance
by Steven P. Gan
Stellar Risk Management Services, Inc.

Credit Insurance is an indispensable insurance product that protects you from payment default or customer bankruptcy.

Pretend for a moment that you are a company that has been shipping products on credit to several customers located in the gulf coast area of the U.S. for the past several years. All of a sudden, here comes Hurricane Katrina and 90 percent of your customer base in this area has either been wiped out or damaged to the point that they are virtually bankrupt. What would be the impact on your company? Without question, your cash flow would take a dramatic dive downwards and you would probably have difficulties paying your own suppliers. In turn, your suppliers would also feel the cash flow pain resulting in a cash flow downgrade ripple effect throughout the entire economy.

How can a company avoid the impact of an excessive or catastrophic loss? One way is to simply take advantage of insuring your accounts receivables through credit insurance. Credit insurance is a before sales credit risk management product that insures commercial accounts receivable against nonpayment. In other words, even if your customer defaults on payment or goes bankrupt, you will be paid, subject to the terms and conditions of the policy, for the merchandise shipped or services rendered to your customer. By assuring payment, your company's stability and growth will be greatly supported.

Ok, let me back up and express to you some important ideas. As much as possible, most of us want to minimize the risk to our lives, our families, our jobs, and our society. In order to minimize a particular risk we will do things such as purchase life and health insurance to provide coverage for our families in case we become sick or disabled. We will purchase auto insurance to protect our car, and we will purchase fire insurance to protect our home. When it comes to our business, what do we do? We purchase property and casualty insurance to protect our office equipment, buildings, and inventory. We also normally have two or three back up computer systems (God forbid we can't use our email). We further purchase general liability insurance to protect us from those inevitable lawsuits. However, when it comes to our accounts receivables, for some reason, the connection still has not been made that they should also be insured against an excessive or catastrophic loss.

Do you feel that your accounts receivables are one of your company's most important assets? I'm sure you do but believe me when I tell you that some people don't feel so or can't understand so. When you sell your products on credit (by the way, the word "credit" comes from the Latin "credere" which means, 'to trust'), you are saying to your customer, "I trust you to pay me subsequent to your receipt of my goods and services". What this means is that when you sell on credit you are passing to your customer, on good faith, the control to pay you for your goods and services, as reflected by your accounts receivables. In other words, you are entrusting them with a certain control that can often represent a very high-risk situation. It's not necessarily a high-risk situation from the viewpoint that your very good customer for many years will not suddenly have the volition to pay you, but it could be that due to a particular situation beyond his control, he suddenly cannot pay you. These situations do not have to be as overwhelming as Hurricane Katrina but they could certainly be as hard as a major bankruptcy such as Enron, World Com, or K-Mart. In light of the unexpected, credit insurance is one of those risk-minimizing products that are indispensable for your business. It's not only for the basic recovery of a potentially lost accounts receivable, but also for the support your company will need during the recovery process by easing the cash flow crunch and allowing you time to locate the replacement business.

Well, in this article I am not here to ALARM you but merely to INFORM you about a product that has many benefits to minimize the risk of doing of business and to help to you to maintain your stability and growth. Let me tell you a few more benefits about credit insurance.

  • Credit insurance provides a safety net to enter new markets, whether domestic or overseas. Credit insurance will minimize the risk by paying you in the event your overseas customer (who is more difficult to contact and understand) defaults on payment or goes bankrupt. This safety net allows you to greatly expand your business to new markets not only because of the insurance coverage but also through the wealth of credit information about the country risk to where you would like to export, that is often provided by the credit insurance carriers.

  • Credit insurance greatly enhances your borrowing power. Many companies that try to use their accounts receivables as collateral to borrow from financial institutions will find that insured receivables is a great way to not only obtain funds quickly but also at a lower rate since the lending risk to the financial institutions will be reduced.

  • Credit insurance greatly assists in helping companies to establish a guide for effective credit risk management. In order to get covered under credit insurance, an insured has to show that there is an internal credit risk management system in place that will, at a minimum, attempt to show a level of due diligence and care in contracting with and selling to present and new customers. By helping companies who are interested in credit insurance to establish credit controls and guidelines, the credit insurance companies help to raise the overall internal control and security of the insured.

Let me tell you a little bit about the cost of credit insurance. Firstly, any commercial entity that is selling their product or services on a credit basis to another commercial entity (business to business) could be a candidate for credit insurance. The premium is generally 0.2% to 0.8% of the estimated annual sales and the insurance payment is between 50 percent and 90 percent of the defaulted amount. It all depends on how much the insured wishes to be covered, the industry, and past default history. A credit insurance policy can be customized to meet the needs of the insured. In general, if a company has approximately $10 million dollars in estimated annual sales, the premium will be between $20,000 and $80,000 dollars. If a customer defaults, say for $100,000, the reimbursement would be between $50,000 to $90,000. In view of the amount of the potential losses, the premium really is very cost effective.

I hope in this short article I have been able to enlighten you to at least explore the value of credit insurance in minimizing the loss of a payment default or bankruptcy of you customer. For those of you who have questions or would like to hear more, please feel free to contact me at Stellar Risk Management Services, Inc. Tel: 847-714-0121; Fax: 847-714-0104;

Steven Gan is the founder and president of Stellar Risk Management Services (SRMS), Inc. located in Northbrook, IL. SRMS is a credit risk management consultancy and brokerage whose goal is to source and systematize the products and services that will protect a company's accounts receivables and greatly strengthen its cash flow.

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