Using credit insurance to manage risk

There is always a development of risk involved when a company decides to extend credit to its customers. Credit policies in place will help limit the risk of extending credit, but sometimes there are circumstances that may affect the timeframe of when your customers pay.

Many SMEs use credit insurance - also known as trade credit insurance or business credit insurance - to help manage the credit risk. Credit insurance limits the risk of extending credit to customers and acquiring bad debt because it insures them against the possibility that customers will default or become insolvent.

Credit insurance is easy enough to set up through a broker or insurance company. In Australia the biggest providers include; Coface, Atradius, QBE and Euler Hermes. The costs associated with credit insurance are usually charged monthly and are calculated as a percentage of your business sales or outstanding receivables.

Credit insurance not only protects you from risks of acquiring bad debt, it also helps you grow your company by extending more credit to existing customers or prospecting to potential customers that were too risky before. As well as this, you also have the opportunity to receive better financing terms because some banks will lend more capital against insured receivables.

There is no denying that credit insurance provides substantial benefits, but it is important to be careful and remain mindful of your credit management. Before a policy is developed, your insurer will first need to determine that you are capable of managing credit. It is possible the insurer will ask that you can provide evidence that your business meets minimum standard credit control. You can do this by providing proof of your trading terms, clearly defining the agreed terms between you and customers, as well as displaying credit applications from all your customers.

It's natural that your insurer will examine different aspects of your business to maintain that the risk threshold of your business is aligned with your own. The elements the insurer will examine include:

  • the annual turnover of the business
  • previous experience of bad debt losses
  • current length of credit given by the business
  • the status of buyers
  • the trade sector in which the business operates
  • the size of individual accounts and what percentage of turnover they make up.

The insurer will then define a credit limit for each of your buyers and the premium you pay will reflect the average credit risk of the insured portfolio of your buyers.

When aligned together, a good credit management policy and credit insurance policy can play a vital role in the overall growth of your business. In addition, a good combination of the two will ensure that any exposure to overdue debt is effectively managed and will protect your firm's revenue and bottom line. But it's important to understand the intent of a credit insurance policy is to share the risk of your credit with your insurer, so you will need to display sound credit management practices before your credit insurance policy is bound.

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