Non-paying or late paying customers are a common cause of bankruptcies. In the Netherlands it is estimated that this occurs in 25% of bankruptcies. That is why credit management is important. You can never completely rule out bankruptcy and credit insurances exists for those situations. In this article we take a look at what a credit insurance is, how it works and for whom it is interesting.
What is a credit insurance?
A Credit insurance is an insurance that offers protection against default or inability to pay. The credit insurer pays the invoice if the customer has not paid invoices after X days or when it goes bankrupt. With a credit insurance, you therefore ensure that goods and services are paid, even when the customer defaults.
Why take a credit insurance?
It seems obvious why you want credit insurance, but it is not that straight forward. For some it is more interesting than for others, or maybe not at all. For example, if your target audience is consumers, a credit insurance is not relevant. See also what a credit insurance covers link to include section.
If you have sufficient financial reserves, you do not necessarily need a credit insurance. If you do not have those reserves, a credit insurance is a good instrument for the continuity of the company. This also applies when you depend on a few large customers or deals that have a major impact on the cash flow.
How does a credit insurance work?
In day-to-day operations, there are two important processes regarding a credit insurance. These are, getting a credit limit and the steps you take if a customer does not pay.
Determining the credit limit
A credit insurance works with a credit limit per customer. The standard method is that you request a limit from the credit insurer before you sign a deal with a customer. The credit limit issued by the insurer is the maximum insured amount. It is valid for a limited time and the insurer can withdraw the limit at any time. If the insurer withdraws a credit limit, future deliveries are no longer covered by the credit insurance.
There is another way to obtain a credit limit, and that is self-assessment. This is based on:
- a credit report from an information provider recognized by the insurer;
- customer payment behavior over the past 12 months.
In the case of self-assessment, you must hand over the credit report or demonstrate payment behavior with a claim.
The steps if a customer does not pay
If a customer does not pay, you have to go through a number of steps before the credit insurer pays out a claim. This process contains four key moments:
- A credit insurance policy works with an overdue period. This starts after the due date of an invoice. The insurance states that you must make an effort to get an invoice paid. Think of sending a reminder and contacting the customer.
- Cover for a customer ends 60 days after the due date. If you still deliver goods and services to the customer after that day, the insurance will not cover them. Any loss is at your own risk.
- 90 days after the due date, you must submit an invoice or invoices to the credit insurer. You usually have to start a collection process with a collection agency or bailiff.
- If an invoice is unpaid 120 days after the due date, you can file a claim with the credit insurer.
What does a credit insurance cover?
The credit insurance cover applies to customers for whom a credit limit has been issued. Either by the insurer or by self-assessment. If you meet the conditions, the insurer will pay out in the event of a claim.
The following are not covered by insurance:
- Invoices to customers who have already been declared bankrupt at the time of delivery.
- Invoices to consumers, government institutions and sibling and parent companies.
- Invoices that are disputed.
- Cases of fraud.
Automate the process
As with other parts of credit management, you can also automate credit insurance processes.
For example, you automate the determination of overdue periods. Assessing it for customers with one invoice is easy. That is not the case if you have 2,000 customers with 20 or more invoices per month. The insurer does not only look at the due date of an invoice, but also at the last payment date of a customer. Manually, this is a labour-intensive and error-prone process.
Software monitors that you go through the required steps of the credit insurance in a timely manner. And that you do them correctly. With credit management software, you not only work more efficiently, it also ensures that you meet the conditions for paying out claims.
What does credit insurance cost?
As with other insurance policies, you pay a fee for a credit insurance. This is a percentage of your turnover. In the Netherlands that is about 0.1% – 0.5%. That seems like a lot, but one bankruptcy can already make up for the costs. A higher turnover often leads to a lower premium, and many claims lead to a higher premium.
To calculate the fee, you periodically submit the turnover figures to the insurer.
Most contracts have a duration of 1 or 2 years and often. Depending on the agreements, (larger) claims can lead to a significantly higher fee.
Getting a credit insurance
If you decide that you want a credit insurance, it is best to request quotes from several insurers. You will get insight into both the different fees and the conditions.
You can get a credit insurance directly with an insurer. As with other insurance policies, you can also use a broker. In practice, this can be useful because a broker knows the market and can regularly negotiate better conditions or rates.
Credit insurance vs factoring
We want to mention factoring as a side note. It is a different product but can also cover the risk of default. An important difference with a credit insurance is that factoring is a form of financing. A Credit insurance only pays out in the event of default and does not provide financing. With factoring, you get paid almost immediately after sending the invoice. No matter if a customer defaults or not.
If you are looking for financing and also want to cover the risk of default, it is worth looking into factoring.
The credit insurance: tl;dr
Credit insurance is an instrument that protects you against the risk of unpaid invoices. It is a means that contributes to business continuity. When entering into a contract, familiarize yourself with the conditions for paying out a claim. If you do not do this, there is a chance that the credit insurer will not reimburse damage.
Continue reading about credit risk management: [What is credit risk management and how can you manage it?