Credit insurance: assessing risk versus mitigation

Apio’s Francis Kingston talks about why credit insurance is worth considering in an unpredictable economy, and the benefits it offers business owners with a debtor’s book.

Any business that sells on credit has a debtor’s book that could range between one and 10 000 debtors – clients who owe them money on a 30, 60, 90-day account or longer. Credit insurance is the protection against non-payment of a client’s debtor – in a nutshell, insurance against a bad debt.

On the face of it, it sounds like a no-brainer for companies with debtor’s books, but not every company will opt for this form of insurance. There are many factors influencing the decision to insure your debtor’s book, including what your risk appetite is. If you have a long-established client base who you’ve been doing business with for many years, and who have a solid payment history with you, you might not be inclined to insure against non-payment. On the other hand, if you are a new business trading with companies you know very little about, you might decide that credit insurance makes a lot of sense to ensure that non-payment is catered for.

Clients must consider their risk requirements and risk appetite. If you have a debtor’s book of 100, but each debtor only owes R5 000, do you really need to insure against bad debt? However, if the non-payment of just a single debtor could fundamentally damage, or even sink your business because of compromised cash flow, credit insurance makes more sense.

A complicating factor is the current economic environment. Anyone who reads the news will be aware that even so-called blue chip, JSE-listed companies are struggling, and in some cases entering business rescue or liquidation proceedings. This is symptomatic of a ‘hard economy’, and doesn’t affect just big businesses, but companies throughout the economy, from so-called blue chip to sole proprietors. The bad news is that if a company in business rescue or liquidation owes you money, the chances are high that, at best, you will only recover a small percentage of that money, and only after following due process that could stretch for months or even years.

You may decide that you only want to insure clients above a certain amount, for example, an amount owing of R1 million. Traditionally, insurers offering credit insurance insisted that you insure your whole book. However, in the past two years, a new product offering gives you the opportunity to pick and choose. If you have a debtor’s book of 100, you may opt to insure only five of those debtors, who would each be rated individually. However, on a stand-alone basis, this form of credit insurance is more expensive than if you were to insure your whole book.

The question to ask is, how well do you run your debtor’s book? A bigger company with a credit department dedicated to keeping a close eye on their clients, may have a tight grasp on their risk scenarios. However, a medium or small business will not necessarily have the expertise for such close attention. Here, credit insurance can play a big part, because the insurers essentially act as a first line of defence on the clients the company is dealing with. An insurer might decline to cover a client with a bad payment history and judgements against them, and armed with that feedback from the insurer, you can make a decision to carry on trading with the client, trade with them on a cash-only basis, or not at all.

For companies that require financing from a bank or other lenders, and who intend using their debtor’s book as collateral, a fundamental requirement for the loan may be credit insurance on that debit book. This not only makes your debtor’s book that much stronger as security for a loan, but may reduce the cost of borrowing because you’ve got better security to offer the lender.

When it comes to affordability, many factors influence cost, including the type of industry, and the nature of the company itself. For example, when dealing with a well-established organisation compared to a Moms-and-Pops store, the rate would be far lower for that established entity. Another significant influence is the level of risk you’re willing to take yourself. You may opt to insure only debtors above R100 000, or you may want to insure everything from R1 000 upwards.

Ultimately, the decision to opt for credit insurance rests with you, the business owner. You know your debtor’s book and you know what level of risk you’re willing to take on. In a challenging economic environment, with long-established companies showing signs of distress, it’s worthwhile testing different scenarios through detailed analysis and a conversation with your broker.