Is Credit Insurance the “Silver Bullet”? – Michael Dennis, CBF

The SIlver Bullet
The SIlver Bullet

In response to a recent blog in which I suggested that companies not reporting bad debt losses are not taking enough credit risk, I received an email suggesting that I had overlooked an important option which would allow B2B creditors to offer credit to less creditworthy companies with little or no credit risk.  His comment was essentially this:  Credit insurance is a “silver bullet.”  Bad debts are the problem and credit insurance is the solution.

Of the 25 years I have worked in credit and collections, I spent at least ten years with companies that purchased credit insurance including my present employer.  In each of those ten years, my company experienced bad debt losses, and in only one of the ten years were the costs associated with credit insurance offset by the recoveries we received.  How can this be true?  The answer is that there are a variety of factors, including these:

  1. My company [and most applicant companies] cannot not get credit insurance on every account for which coverage is requested.  Unfortunately, it is often these higher risk accounts (the zero credit coverage accounts) that fail
  2. Credit insurance is never first dollar coverage.  Insurance policies have (a) an annual deductible, (b) a per loss deductible and (c) a minimum dollar loss threshold below which losses were not insurable.  Put these together with the annual credit insurance premium and it is relatively easy to see how hard it could be to receive more than you put in.
  3. Each credit insurance policy issued had an annual dollar cap on payments.  If and when the cap on payments is reached, all bad debt write offs above the dollar cap are not covered by insurance and are bad debt losses.

In my opinion, credit insurance is not the silver bullet solution to bad debts.  However, I have a slightly different perspective on a statement I made previously that “bad debt losses are inevitable for companies offering open account terms”  which is this:

Michael Dennis, MBA, CBF, LCM
Michael Dennis, MBA, CBF, LCM

“Bad debt losses are inevitable for companies offering open account terms… unless the company’s credit department refuses to accept appropriate credit risks.”

That’s my opinion.  What is yours?

Michael Dennis’ Covering Credit Commentary. Michael’s website is  www.coveringcredit.com

The opinions presented are those of the author.  The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors.  Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.

12 Replies to “Is Credit Insurance the “Silver Bullet”? – Michael Dennis, CBF”

  1. I absolutly agree, I had carried Receivables insurance for 6 years. It was great before the “great recession” and paid off. However, after 2008 the annual fees increased, the accounts covered decreased and the risk I was taking without insurance increased on “good long term customers”. I found that if I had stopped doing business with the customers the insurance company dropped we could have lost a huge amount of revenue from those customers who by the way are still in business. I also found that I recovered more from independent collection agencies I used. I also found that unless a company had liquidated or filed BK a collection claim had to be submitted first. I found that the collection agency at the insurance company was not aggressive and did not recover one cent. Until those avenues had been exhausted the insurance claim could not be made. When a claim was made you had to be within compliance of all requirements of your contract and if you were not – regardless you claim would not be paid unless the account filed BK as long as it was still covered. No Insurance IS not the silver bullet.

  2. Right on Dennis and Anne. Add to everything you said the fact that you have many admistrative requirements to fulfill with most policies and carriers. At an Int’l Credit Conference I attended a few years back, a panel of Carriers addressed complaints from the attendees that legitimate claims are too often turned down. The number 1 reason cited by the panelists was that policy holders failed to fulfill one or more policy requirements. In other words, an “i” was not dotted or a “t” was not crossed. A lot of your attention is diverted to dotting all “i’s” and crossing all “t’s” to make sure your policy is truly valid.

  3. My company is trying to find a way to do more business with high risk startup companies in various tech industries. What I’m putting together is a risk mitigation strategy that includes credit insurance as a backstop to limit our maximum loss per year. Let’s assume policy requirements are met and admin issues are not going to prevent a payment.

    He is the idea. Let’s say we have 25 customers in a startup pool of AR that is given to the insurers to quote. These 25 customers have combined credit limits of $50M. We are willing to take smaller losses, but if the economy tanks, we don’t want to lose “too much”. Let’s assume the insurers are willing to insure the 25 customers 80% of the individual limits. We want a low priced policy that has a $5M aggregate deductible per year, thus limiting our bad debt to $5M for this pool of customers.$5M is 10% of the credit risk for this group. I’d like to hear anyones thoughts on this plan which we plan to implement in the next 2-3 months.

    1. Hello Paul,

      AU Group is a specialized credit insurance broker and we can certainly help you. The way you’re looking at it is exactly what we strive for, someone with a sound risk strategy that wants to support it with a taylor made trade credit insurance policy. Please contact me directly at 514 742 8868 or simard@credit-insurance.com. Whereever you are in the world, I’ll put you in contact with someone who will be able to help you. I look forward to discussing this with you. Kind regards, Roch Simard

  4. You hit the nail on the head, there are no silver bullets in credit. There are many methods used to protect your assets, but none that are a guaranteed solution.

  5. There are no silver bullets in life. And there are no silver bullets in credit management either. Credit management is the art of managing risk to maximize the return. The goal is that for the return to far exceed the risks, to keep things profitable and viable.

    Credit insurance is an instrument to manage risk; it does not eliminate it completely. Credit insurance is not a replacement for good credit management practices and due diligence; it supplements them.

  6. Ditto 🙂

    My employer had credit insurance for ten years. We never broke even… not once in ten years. Why? Because we either got NO insurance or a fraction of the amount we required for our high risk customers + the annual deductible, copayments, and premiums.

    Something else that has not been mentioned is that insurance companies want a lot of information. In our case, monthly reports on the status of the accounts of the insured customers/debtors.

  7. Michael, I completely agree with your conclusion that credit insurance is not a silver bullet – in fact, I don’t think very much of this credit tool at all. I think it’s about as good as any insurance product, which is to say that it is there to MITIGATE catastrophic loss.

    In most industries bad debt is unavoidable – so I agree with that too. I once wrote an article about 3 Traits of a Great Credit Manager, comparing “good” credit managers to “great” ones. Take a look at that article here:
    http://www.zlien.com/blog/three-traits-of-a-great-credit-manager/

    Good credit managers eliminate or reduce risk. Great credit managers find the balance between risk and revenue.

    However, my focus is primarily in the construction and building supply industries, and I actually think that parties CAN nearly eliminate bad debt and write offs in these industries – all while increasing revenue and being pretty apathetic to traditional risks. This can be done through mechanics lien and bond claim laws.

    There’s lots to talk about on this topic, and some people love these instruments and some people hate them. Most people simply don’t understand them. But I can guarantee almost any company that I consult with this: If they use them religiously, and correctly, they can kiss bad debt good-bye.

  8. I consistently hear these criticisms of whole-turnover, cancelable credit insurance policies. My company offers protection on a single-account, non-cancelable basis. We focus on the high-risk situations, rather than covering the accounts everyone knows will fair well. Please email or call with interest.

  9. There is no silver bullet on b2b credit exposures, period. Credit insurance can never be an alternative to sound risk management practice. Indeed, without adequate credit management processes a business wouldn’t be able to obtain credit insurance anyway. If controls are weak and credit management poor then this insurance is indeed not worth having because the problems referred to in the article about limit and terms restrictions would certainly come into play.
    However, in the hands of a competent risk manager, credit insurance can be an invaluable risk mitigating tool and a support to the credit management team. Identifying poor risks so they can be avoided or more closely managed, as well identifying the better risks within the portfolio so that sales opportunities can be exploited. Whether the purpose of the insurance is to smooth cash flow or to protect the balance sheet from catastrophic losses credit insurance clearly works very well for thousands of companies across the globe.
    There is a huge array of policy structures available today so it is possible to construct a tailor made solution for the vast majority of situations. From single buyer cover right up to a no-limits, hands-off pure Excess of Loss catastrophy cover and every variation in between. It is also true to say that there are many B2B portfolios where credit insurance has very little to offer, either because there neglible real risk or the opposite is true and the anticipated coverage would be so low. Not surprisingly, credit insurers can choose the risks they are prepared to cover and very weak buyer or countries will not make the grade. As an insured you not only have an investment grade balance sheet sitting behind your own, you also have access to the underwriters vast and current information database. Adverse payment trends which are not in the public domain as well as up to date management information received by the underwriter from buyers, is all there in the background supporting your business. Excellent credit management practice is about managing the poor risk and maximising opportunities with the better rated buyers. Intelligently utilised, credit insurance can provide that edge for credit managers.
    If it doesn’t work for some for any ot the reasons outlined in the article then I would suggest its not the tool that is at fault, its the person in control of it. I’ve never seem a bad credit insurance policy, but I’ve seen way too many cases where it is being poorly administered.

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