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Business credit insurance: How to protect yourself against clients who don't pay

business credit insurance Most small-business owners know the pain of unpaid invoices. When clients pay late or don't pay at all, a business can find itself without enough money to operate and may even have to close its doors.

While there's no way to predict whether a new client will turn into a deadbeat, business credit insurance can lower your risk of a financial hit.

Business credit insurance -- also known as trade insurance, accounts receivables insurance and bad debt insurance -- protects businesses in two basic situations:

  • If a client fails to pay an undisputed invoice within a certain period of time, the insurance could provide the policyholder with some or the entire invoice amount. The period of time varies depending upon the insurance provider and the policy.
  • If a client declares bankruptcy and is unable to pay at all, the insurance would kick in and cover some or all of the loss. 

Overdue balances are, unfortunately, not unusual. According to Euler Hermes, a provider of business credit insurance, 1 in 10 invoices is late, and more than 38,773 North American businesses closed shop in 2013.

If one or more of those companies declared bankruptcy while owing another business money, their financial problems were passed on to other firms.

How business credit insurance works

So how can business credit insurance save the day for small businesses?

"Credit insurance helps you limit your credit risk before there is a problem," says Michelle Dunn, author of the "Collecting Money" book series. Rather than waiting for late payments to pile up until they hinder cash flow, credit insurance gives business owners access to cash to cover the shortfall.

Credit insurance can be purchased to cover all of your clients or only your riskiest ones. A credit insurance provider will look at the fiscal health of your clients, as well as such factors as the industry you are in and whether your clients do international business.

Once the provider does its research, it will assign a credit limit for each client that is covered, which is the amount the provider is willing to pay you if the client defaults on a payment.

"We have a very large team of risk analysts whose specific job is to crunch numbers and look at financial data, payment trends and industry reports," says Carlo Carlini, vice president of Baltimore-based Atradius Trade Credit Insurance Inc, a provider of business credit insurance policies.

If a client fails to pay and you file a claim, the credit insurance provider would typically pay within 60 days, according to Euler Hermes. At that point, some credit insurance providers may try to go after your client to recoup the money that they paid out, Carlini says.

If your client paid after you'd filed and received payment for a claim, you would return the money from the client to the insurance company.

The cost of business credit insurance varies depending on the size of a company and how much business it does, so a policy could easily cost anywhere from $10,000 to several million dollars per year, Carlini says.

When policyholders file a claim, they generally are required to share in the risk by paying coinsurance, or a portion of the costs, which is typically set at 10 percent of the coverage limit, Carlini adds.

Other benefits of business credit insurance

While businesses of all sizes can benefit from credit insurance, small businesses may have more to gain since they typically have less money saved to handle late or default payments, Carlini says. Business credit insurance can also help business owners in other ways.

  • It can help a business secure financing from a lender because it protects the business from cash-flow risks.
  • Business credit insurance premiums are tax-deductible.
  • Business owners can learn more about the fiscal health of their clients because most credit insurance providers continue to watch for signs of financial trouble among a policyholder's clients even after the policy has gone into effect. If the financial health of a policyholder’s client changes, the insurance provider may lower or raise the limit on that particular client.
  • A business credit insurance policy frees a company to use its cash reserves for other things.

A business owner must look at how deeply late payments could hurt the company's ability to survive, then determine how much he or she is willing to pay for peace of mind.

"Depending on the dollar amounts of your past-due accounts and the monthly premium you pay, this could be good for your business," Dunn says.

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