Don't wait to check your parachute until you're out of the plane

Does it do what it says on the tin? Credit insurance, that is

Business failure and insolvency are so rarely a cheery subject. But it's kinda funny how frequently companies hit by high-value losses almost immediately say "we had insurance", as if to say the loss will not be felt too hard.

It’s tempting to boast that your debt is insured when it isn’t: it makes the loss seem less troublesome or deflects attention. Even if it is insured, the level of recovery available, given the type of policy you hold, may still leave you picking up between 10 and 20 per cent of the loss value, and that’s if your claim is accepted by an insurer in the first place.

Insolvency is part of the risk of doing business on open credit and there is no shame in sustaining bad debt, so long as it’s within sensible bounds.

Four principal insurers are predominant in the IT sector, and service vendors, distributors and some larger resellers: those four are Euler Hermes, Atradius, Coface and QBE. They also serve small to medium-sized resellers, but often the costs and policies are not suitably geared for businesses below a certain level of annual revenue.

We insure most things in life that are precious: our life, homes, family, and of course our cars. A business insures its buildings, its employees and other valuable assets, so understandably the type and scope of cover held is vital.

Nobody likes paying for insurance, but the pain of losing something of great value with no return is generally too terrible to contemplate; as a consequence, we bite our lip, shop around for what appears to be the best deal and hope when the time comes to claim, we made the right choice.

For a business, the biggest asset by far is the value of its accounts receivable ledger; in other words the amount owed by clients on open credit terms. Depending on the nature of the business, this can be as high as 75 per cent of total assets and generally not lower than 40 per cent.

As a wholesaler or distributor, insuring your receivables while employing sound credit management practices and policies is important to maximise the level of borrowing you get from banks, particularly if you use invoice discounting to fund activities. Lower gross margins drive the need for insurance cover, but it is also nonetheless relevant for resellers as well.

Your track record in terms of managing credit and loss levels will drive the premium rate applied to your policy and it’s here that wholesalers and distributors operating on squeezed lower gross margins must tailor their policies, balancing premium cost to cover attainable.

The scope and range of policies and types of cover provided by insurers are ample but some will not sit comfortably with businesses primarily due to premium cost.

Management of the policy is often more critical than the policy itself

The most common policy held by wholesalers or distributors are generally whole turnover policies with an eye firmly fixed on premium cost and "catastrophe" cover in case a series of significant losses occurs in a year. To keep the premium cost low, they will set a level of non-qualifying loss, in other words they will select a debt level below which no claim will apply.

Claims on debts are subject to an audit to ensure the correct process was applied by the insured in setting the credit limit; indeed any major claim will be closely scrutinised to ensure total compliance and adherence to credit policy requirements.

If, for example, supply continued while aged unpaid debt was evident, or if monthly reporting to insurers was inaccurate, a claim may be declined. Management of the policy is often more critical than the policy itself.

The level of cover provided will, of course, vary but it is never more than 95 per cent of debt value, often ranging between 75 to 90 per cent depending on insolvency or protracted default, the latter meaning failure to pay on time.

Insurers and their risk teams are no mugs – they watch and analyse the sector closely and will provide cover only when it clearly makes sound sense to do so. Where they may provide cover on higher risk clients and markets the premium rate will naturally reflect the risk taken, and this is well beyond the scope of anyone operating on gross margins of less than six per cent. "Zombies", of course, may not qualify for cover no matter how high the premium.

Moaning about no cover, removal of cover or insufficient cover shows either a lack of understanding of what insurers provide and how they do it or complete ignorance of what credit risk is all about. Saying you’re covered when half the world suspects or knows you’re not is equally silly.

This reminds me of a story once when challenging the managing director of a completely failed business, at a creditors meeting, who had casually responded to critical questioning along the lines of: "Well, you were insured so what’s your problem?" I countered by suggesting therefore burglars and car thieves should be let off, because owners might be insured.

If as a business you sustain a loss and it’s inevitable you will, by all means try to minimise the effect but you can only achieve this through communication, the right policy for your business, contact, rational argument, gentle persuasion and demonstrated control through a successfully managed credit policy.

My experience tells me more than 50 per cent of businesses operate the wrong policy, fail to note the value of policy by region or, worse, incorrectly manage it.

Credit insurance remains relevant and provides greater leverage in seeking additional inward investment. Banks and principal suppliers still like to see it and for many, it still makes sense. ®