What is Credit Insurance?

Credit insurance is an insurance policy that pays a seller if a buyer does not pay an invoice. In effect, the risk of incurring a bad debt is shifted from the seller to the insurer. The insurer should be willing to provide coverage against customer nonpayment if a proposed customer clears its internal review process.

Advantages of Credit Insurance

Credit insurance offers multiple benefits. First, a company may be able to increase the credit levels offered to its customers, thereby potentially increasing revenue. Second, an international sale might normally be delayed while the parties arrange a letter of credit, but can be completed faster with credit insurance. Third, the insurance can cover the shipment of custom-made products, in case customers cancel their orders prior to delivery. And finally, credit insurance essentially shifts risk away from a business, so it is especially beneficial in companies that have an understaffed credit department that cannot adequately keep track of customer credit levels.

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Disadvantages of Credit Insurance

The main disadvantage of credit insurance is its cost. The insurer has to build a profit into the insurance premiums that it offers to its customers, so you will incur a cost for this service that may exceed the bad debt losses that you would otherwise incur if you were to take on the risk of customer defaults yourself.

Credit Insurance Best Practices

It may be possible to offload the cost of credit insurance to customers by adding it to customer invoices. This is most likely to be acceptable for international deals, where a customer would otherwise be forced to obtain a letter of credit to pay for a purchase. In this case, the customer will incur a lower cost by paying for the credit insurance. As is the case with all insurance policies, be sure to examine the terms of a credit insurance agreement for exclusions, to see what the insurer will not cover.