Accounts Receivable Insurance: How it Works, the Benefits and Costs

What is Accounts Receivable Insurance?

Accounts receivable insurance – sometimes called A/R insurance or trade credit insurance – provides companies with protection against customers that fail to pay what they owe by securing their accounts receivable.

Well known and widely used by European companies for decades, accounts receivable insurance is now becoming more commonplace among companies of varying sizes based in North America as well.

The reason for this growth is that, on average, accounts receivable typically make up 40% of a company’s assets. As a result, there is a greater chance that a business will experience a loss within its accounts receivable than any other asset, especially with past-due invoices and non-payment events being so common.

Accounts receivables are a critical component of your balance sheet — they directly affect your cash flow and profitability. Many companies in the U.S. are thorough when it comes to protecting against losses related to property damage, liability, and other unpredictable, high-exposure risks.

However, these same organizations often fail to view accounts receivable as one of the most valuable assets that can and should be secured – leaving themselves exposed to cash flow and revenue problems.  There is a safer way to do business.

Once implemented, accounts receivable (A/R) insurance coverage can help credit risk teams and other stakeholders manage the commercial and political risks that are beyond the organization’s control.  

What Does Accounts Receivable Insurance Cover?

Accounts receivable insurance is designed to protect your business from non-payment of commercial debt. That means that if a customer does not pay you because they go bankrupt or insolvent, or if they simply do not pay on time, an accounts receivable insurance policy will pay you up to the insured credit limit. Accounts receivable coverage helps you protect your capital, maintain your cash flow and secure your earnings while extending your competitive credit terms and helping you access more attractive financing.

There are four types of accounts receivable insurance:

• Whole Turnover – This type of accounts receivable coverage protects your business against non-payment of commercial debt from all customers. You can choose to have this coverage apply to all domestic sales, international sales or both.
• Key Accounts – With this type of insurance, you choose to insure your largest customers whose non-payment would pose the greatest risk to your business.
• Single Buyer – If most of your transactions are with one customer, you can choose accounts receivable coverage that insures against potential default from just that customer.
• Transactional – This form of accounts receivable insurance coverage protects against non-payment on a transaction-by-transaction basis and is best for companies with few sales or only one customer.

Benefits of Protecting Accounts Receivable Insurance

From the definition of accounts receivable insurance presented above, you know that this tool helps companies protect themselves against non-payment risks and maintain their balance sheets.

However, while your accounts receivable coverage policy is a shield, it can also act as a sword to help you grow sales and obtain better financing terms.

Expand Sales with Receivables Insurance

An accounts receivable insurance policy allows companies to feel secure in extending more credit to current customers, or to pursue new, larger customers that would have otherwise seemed too risky. The protection it provides allows a company to increase sales to grow their business.

Insured companies can sell on open account terms where they may have previously been restrictive or only sold on a secured basis.

 “Accounts receivable insurance has allowed us to take on customers and transactions we wouldn’t have felt comfortable taking on by ourselves,” commented Mike Libasci, President of International Fleet Sales, in our case study, Reducing Concentration Risk Helped Drive Growth. “It has not only allowed my company to take on larger deals, but be more liberal in terms, and the result has gone straight to our bottom line.”

Gain a Competitive Edge by Offering Better Terms

With access to extensive knowledge about the creditworthiness of new and existing customers, companies with accounts receivable insurance can prevent losses. Companies can improve their internal procedures, make credit decisions quickly, and gain a major competitive advantage by extending more attractive offers to customers and prospects. Overall, this allows companies to sell more in foreign markets which means more revenue opportunities.

“This is a fast-paced business, and companies want an answer quickly. If you wait days or weeks, a deal can be gone,” said Ori Ben-Amotz, Chief Financial Officer of Hadco in An Efficient Credit Management Process Accelerates Business Growth. “We were not able to make quality decisions, especially under pressure. We were over conservative and held back limits.

“With [accounts receivable] insurance, we don’t have to ask for cash up front or payment on delivery, which makes us much more competitive. This is the tool we needed to take more market share from our competitors.”

Get Better Financing with Accounts Receivable Coverage

Banks typically limit what you can borrow based on the perceived risk of international receivables, concentration of sales to large customers, or age of certain accounts.

When your domestic and international receivables are covered by an accounts receivable insurance policy, you may be able to borrow more — often at more favorable rates.

How Does Accounts Receivable Insurance Coverage Work

Once your partnership begins, the insurance provider analyzes the creditworthiness and financial stability of your insurable customers.

In the case of Allianz Trade, buyer and country risk evaluations are aggregated into a proprietary risk grade. This risk grade is informed by data from more than 85 million companies monitored in our database, the local insights from our presence in 52 countries, and the nearly $1 trillion in trade transactions we cover globally.

With this information, our underwriters are able to forecast the probability of default and assign specific credit limits to your customers.

Throughout the life of the policy, the A/R insurance policyholder may request additional coverage on a specific buyer should that need arise.

The insurer will investigate the risk of increasing the coverage and will either approve the additional coverage, or provide a detailed explanation about why the existing limit must be maintained. Similarly, policyholders may request coverage on a new buyer with which they’d like to do business. Allianz Trade receives over 20,000 credit limit requests every day and processes 85% of them in less than 48 hours.

Accounts Receivable Risks: Monitoring & Advisement

Customers’ creditworthiness can change throughout the year, so the insurer must consistently monitor policyholders’ buyers.

At Allianz Trade, we invest heavily in the development of proprietary credit and financial information, and employ risk analysts as well as industry- and country-based underwriters in many geographic locations in order to have a close physical presence to our customers’ buyers.

Our team analyzes payment information about policyholders’ buyers to identify early signs of financial trouble to ensure early intervention is initiated.

This allows the companies we insure to make more informed decisions about how much credit to extend to their customers. More importantly, it enables companies to avoid accounts receivable losses through the close monitoring of their customers.

With accounts receivable insurance coverage, the policyholder’s credit management team can be enhanced by the thousands of professionals associated with these carriers; your credit insurer essentially becomes an extension of your team.

Accounts Receivable Insurance Policy Management

Insurance providers have many approaches to account management and service.

With Allianz Trade, our policyholders are assigned their own service team and have a primary point of contact on that team empowered to resolve almost any issue related to a policy – from new credit limits to claims.

In our experience, this provides the highest satisfaction possible as the service team learns the individualized needs of your business and can customize their approach accordingly.

Allianz Trade customers also get instant, secure online access to accounts receivable coverage policy information – including the ability to obtain coverage decisions in real-time. The ATO platform enables policyholders to:

• Fulfill new orders without delay by getting requests for coverage answered quickly
• Access your current policy coverage and decisions report
• Submit credit limit requests and monitor their status in real-time
• Submit claims online and access updates on claims activity at any time
• View buyer information and collection files in progress
• Create reports to monitor and optimize your accounts receivable

Accounts Receivable Insurance Claims

In the event an insured buyer fails to pay, the policyholder will enter a claim to request reimbursement and collections action by the insurer.

The amount the insurer pays when you make a claim is called the indemnity.

The level of indemnity on Allianz Trade policies ranges from 80% to 100% of the amount of the debt. The variation depends on:

• Which policy you select
• How you manage credit terms
• The state of your accounts receivable portfolio
• Your premium target

At Allianz Trade, our claims department handles all pre-claim activity, and is dedicated to providing world-class customer service. The claims team also provides special assistance to all first-time filers to ensure a smooth transaction.

As mentioned in the previous section, Allianz Trade customers can also make a new claim and monitor progress on current claims online 24/7 with the Allianz-Trade Online (ATO) management system.

Those evaluating insurance for accounts receivable will want to make sure they’re selecting an insurer with a strong track record for paying claims when necessary.

“We know that Allianz Trade will stand behind us in the event of a loss,” said Jeff Green, CFO at Johnstone Supply. “And I know from experience that that isn’t always the case with other insurers.”

Is Accounts Receivable Insurance Worth the Cost?

The cost of the policy will be different for each business because it’s calculated based on a variety of factors, including:

• The coverage you choose
• The sector and geographies you work in
• Losses experienced in the past
• Customers you trade with and their creditworthiness
• Your internal credit procedures
• And many others

As a guideline though to pricing, we can say that the accounts receivable insurance premium is based on a percentage of the company’s sales – usually a fraction of one percent on average. Sometimes the rate will be higher or lower depending on variables like those mentioned above.

However, the question of cost then leads to ROI evaluation.

The cost to a business of non-payment can be considerable. Suppose you have a 5% profit margin and suffer a $100,000 debt. In that scenario, you would need to win new sales of $2 million to make up for the lost profits.

Plus, your financial position can be weakened by bad debts in other ways, such as:

• Reduced cash flow
• Diminished capacity for investment
• Poor morale among employees worried about the business’ stability

Avoiding these negative outcomes, combined with the prospect of increasing sales safely thanks to reliable creditworthiness data, often justifies the cost of receivables insurance and enables businesses to turn this solution into a growth-driver.

 “Local distributors will call us inquiring about accounts receivable insurance,” said Cathy Jimenez, Del Campo’s Credit Manager, in Proactively Mitigate Risk and Grow Your Top Line. “I tell them there is a cost, but it’s easily offset by what you get. When you think about the benefits and what you could lose if a customer went bankrupt or just failed to pay, the cost of credit insurance balances out. I strongly recommend it.”

Protect Your Business with Accounts Receivable Insurance

In summary, when you insure your accounts receivable, you can count on being paid for what you sell, even if one of your covered accounts suddenly faces insolvency or is otherwise unable to pay. 

For a very minimal cost – often a fraction of one percent – you not only gain peace of mind, but also the ability to quickly make data-informed decisions about selling to new customers or extending additional credit to existing ones.

Accounts receivable insurance is a great way to make sure you don't leave money on the table as a result of an overly conservative risk posture.

What is Accounts Receivable Factoring?

Factoring accounts receivable insurance for receivables is an agreement with a third party company to purchase accounts receivables at a reduced amount of the face value of the invoices. The factor provides a cash advance ranging from 70% to 90% of the invoice’s value. When the invoice is collected, the factor returns the balance of the invoice minus their fee. These costs may range from 1% to 10%, based upon a variety of components. Some AR factoring services will assume the risk of non-payment  of the invoices they purchase, while others do not.

Is factoring receivables a good idea?

AR factoring can be a good idea if your company is having cash flow issues and needs to collect on receivables quickly. Receivables factoring allows your company to apply the receivable funds toward future projects, payroll or other operating expenses without having to wait for payment of invoices.

However, while receivables factoring can be beneficial in the short-term, there are long-term costs to consider. You pay fees ranging from 1% to 5% for the service, even if the receivable is paid in full within 60-90 days. The longer the receivable remains unpaid, the higher the fees. Payment guarantees aren’t always available, and if they are, they can double factoring fees to as high as 10%. For small businesses with smaller receivables, this may not seem like a lot. For larger companies, there is the potential to lose between $10,000 to $100,000 for every $1 million in factored receivables.

In addition, accounts receivables factoring poses risks to your long-term customer relationships:

• You lose control of your customer relationships in a factoring agreement.
• The factor that owns accounts receivable manages all credit matters involving those customer relationships.
• You have to go through the factor in order to contact a customer.

How Does Factoring Accounts Trade Receivables Work?

Business accounts receivable factoring starts when you’ve successfully provided the goods and services to a customer and invoiced them. You can then sell your invoice to a factoring company. Here’s how AR factoring works:

• You sell the invoice to the factoring company.
• The factor funds your company with an advance ranging from 70% to 90% of the invoice amount.
• When the customer pays the invoice, your company gets the remaining balance of the invoice, minus the factoring fee.

The business accounts receivables factoring process has its advantages, but it also comes with a cost.

Recourse vs Non-Recourse Factoring

There are two types of invoice factoring: recourse and non-recourse. Before you choose to do business with a factoring company, it is important to know the difference between the two options.

Recourse Factoring

Recourse factoring is the most commonly used form of AR factoring. With recourse factoring, if a customer fails to pay, you are responsible for buying back the invoice from the factoring company. The factor tries to offset the risk of non-payment by assessing the customer’s creditworthiness and applying collection calls between 40–90 days after the invoice was sent. If the factor is unable to collect on the invoice within 90 days, the factor may “recourse” the invoice back to you. You may then need to use a collection agency to collect on the invoice. In the meantime, you’ll need to pay the factor back.

Non-Recourse Factoring

Non-recourse factoring carries a higher risk and is generally used less frequently. With non-recourse factoring, the factor takes responsibility for the invoice, even if they are unable to collect. Often, non-recourse factoring is only applied if the invoiced company files bankruptcy. In addition, fees for non-recourse factoring are much higher than those for non-recourse factoring.

For companies looking to avoid the risks of recourse factoring and the higher costs of non-recourse factoring, trade credit insurance provides an attractive alternative.