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Keeping Your Balance

Insurance That Aids You When a Client Can't or Won't Pay


Question: What's wrong with getting 80% of your business from 20% of your customers?

Answer: If one of your big customers goes belly up, you may face a hole in your accounts receivable big enough to destroy your business.

Fortunately, a handful of U.S. insurers now sell coverage targeting business owners with just this problem. The insurance doesn't cost much and--perhaps more important--it does good things to your balance sheet and your working capital.

Common in Europe but not here, accounts-receivable insurance--also known as credit insurance--pays off when one of your customers stiffs you for any reason, including bankruptcy. The insurance is particularly appropriate for companies engaged in foreign trade, though the insurers now issuing the coverage in the U.S. target companies that do domestic business too. And you don't have to be big to need the coverage, or to afford it. In fact, the insurance is so new to the U.S. insurance market that the only problem you may encounter in buying it will be to find an insurance broker who knows about it.

In essence, the insurance:

* Relieves you of the worry of bad debts, not to mention the nightmare of trying to collect money from people who can't or won't pay what they owe you.

* Allows you to offer attractive terms to your credit-worthy customers, thus expanding sales because you no longer worry about unforeseen losses.

* Enhances your balance sheet by reducing your bad-debt reserves.

* Last but not least, it brings a smile to the face of your friendly local banker when you ask to borrow for working capital.

Only a handful of U.S. insurers sold accounts-receivable insurance until a year ago, and maybe 1% of U.S. businesses bought the coverage, said John Trocher, vice president of American Credit Indemnity of Baltimore, whose company markets the coverage to small businesses. In contrast, about 35% of European businesses carry the coverage.

How does the insurance work?

If your company is like most, your accounts receivables constitute a hefty portion of your assets. But even if you don't think twice before protecting your physical plant with fire insurance, you have probably never considered insuring your accounts receivable, which may present the bigger threat of loss.

Let's assume your annual sales total $10 million and your accounts receivable average $1 million. In any given year you expect bad debts to run $200,000--2% of sales. In practical terms, this means that you must put $200,000 aside in reserve, to cover the losses you expect.

You can't use this money for such things as working capital, of course. And, of course, your friendly local banker doesn't count the $200,000 when calculating how much to lend you in a working-capital loan secured by accounts receivable. What's worse, he or she won't look at accounts receivable reflecting foreign trade at all, since nothing scares a banker more than the thought of having to fly off to some foreign country to collect what people owe you.

Trocher says you can insure as much as 95% of your accounts receivable, including both domestic and foreign accounts, for a premium ranging between 0.5% and 0.6% of your accounts receivable--in other words, for a premium of $5,000 to $6,000 per year. That's cheap when you consider that you otherwise must reserve $200,000 for bad debts.

"It's not the 2% to 3% of expected losses that you worry about," Trocher says. "It's the big hit that may come once every four or five years when one of your big customers doesn't pay. Every company builds that 2% to 3% into its business plan. But if one of your big customers goes belly up, there's no plan."

Hence, accounts-receivable insurance.

Jackie Deane, who runs the San Francisco office of AIU North America, a unit of the insurance giant AIG, offers different numbers for a company engaged exclusively in exporting American-made goods. If sales run to $10 million and accounts receivable average $1.5 million, bad-debt reserves might run to $200,000, or 2% of sales. But credit insurance covering 90% to 95% of your receivables would cost between $25,000 and $50,000.

"This is all hand-knit [coverage] for each client," Deane says. "It's not cookie-cutter insurance."

If that seems high, consider what the insurance does for your business. In the first place, it frees up your bad-debt reserves, improving the look of your balance sheet. Second, it protects your accounts receivable against catastrophic loss. Third, it allows you to improve the credit terms you offer your best customers, thus giving you a competitive advantage. Lastly, it reassures your local banker that you stand to collect on every penny of accounts receivable covered by your insurance, thus making it much more likely that you can borrow what you need for working capital.

In short, the insurance makes sense for small to mid-size companies whose business affairs involve lots of accounts receivable from a handful of customers. And if your insurance broker gives you a blank look when you ask about the coverage, you can chalk it up to the fact that few insurers offer it, and far fewer businesses buy it--at the moment.

In addition to American Credit Indemnity and AIU, other insurers offering accounts-receivable coverage include Reliance Insurance Group, CNA, Maryland Netherlands Insurance and Exporter's Insurance of Bermuda. If demand for the coverage grows, other insurers will doubtless join the competition.


Juan Hovey writes frequently about insurance and financing. He lives in Thousand Oaks, and his e-mail address is

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