The photographs of the charred remnants of the Woodland Caribou, a resort on Puntzt Lake, B.C., that was recently consumed by fire, should convince the most ardent skeptic to regularly revisit their insurance requirements. An annual re-assessment of fire insurance, flood insurance (if available), earthquake insurance and coverage for other insurable risks is an essential part of owning and operating a small or medium-sized business. Add to the list automobile insurance, disability insurance, key man life insurance and insurance-funded buybacks of a deceased shareholder shares.
But there's another form of insurance which you might not be aware of, but which you might want to explore further, especially in light of the insolvency of Target Canada earlier this year. Many suppliers of Target were financially ruined by Canada's biggest deadbeat debtor. Maybe they should have taken out accounts receivable insurance (sometimes called credit insurance). Let me explain.
Other than restaurants, retail and other "cash and carry" businesses, if you're supplying goods or services to third parties, you're usually extending credit terms, and you'll always have some level of accounts receivable with your customers. If they're paying immediately or within 30 days, they're great customers. If they're over 90 days, maybe they aren't so great. Some businesses will obtain a security interest against a debtor under a general security agreement (GSA) and register that interest with the provincial personal property security registry. The security interest will create a charge on the goods of the debtor (like a mortgage). Theoretically, the charge should provide the secured party with security on the assets of the debtor, and if the debtor fails to pay, then the secured party can realize on the debtor's assets to the amount of the goods sold or services provided.
But more often than not, suppliers will rank behind banks and other finance companies (but not as low in priority as an unsecured creditor). Thus, even if a supplier has a registered security against the debtor for, say, $50,000 worth of goods, the supplier may never see that money repaid if there's not enough money left after a bankruptcy, receivership or insolvency because the bank has a priority position that ranks higher than yours (and there's no money left to pay you).
That's where accounts receivable insurance comes into play. Businesses may insure themselves against all sorts of risks like fires and floods, but their biggest risk may be their accounts receivable. It's estimated that 40 per cent of a company's assets are its accounts receivable and that on average, 1 in 10 invoices are bad enough to have to send to collection or sue on. Accounts receivable insurance is a financial tool that can manage the commercial and political risks of bad debts, and can "pay out" a percentage of the loss ( i.e. 90 per cent) like other forms of insurance.
In short, if you have accounts receivable of more than $2-million, you should be investigating accounts receivable insurance. Making a claim under insurance could conceivably put you in a better position than you would be as a secured creditor in second or third position to a bank, and won't necessarily involve hiring lawyers or collection agents. It's standard in the credit insurance industry that there is 10 per cent co-insurance, meaning that the client will be responsible for the first 10 per cent of any claim or loss, but that may be better peace of mind than losing 50 per cent or more of the debt.
Some businesses may choose to insure only one of their customers because they've done the math and that's all they need. Others may choose to insure only their top 10 customers because those customers account for 80 per cent of their sales. And others (typically with thin margins) will want the peace of mind that they'll get paid for everything they sell and will insure all their customers.
Premiums are a function of a number of factors. For example, some industries are inherently "riskier" than others. Furniture retailers and clothing retailers may well be riskier than food processing and commodities supply. Selling to certain companies is less risky than others (for example, selling to Walmart, Costco Google or Apple is less risky than selling to Sears). Those providing accounts receivable insurance regularly assess the risk factor associated with selling to various corporations.
The country where one's selling into is also factor in risk assessment for insurability and premiums. If an international customer has problems paying due to political embargoes or hard currency restrictions, this will affect insurability and premiums (in Russia, for example). Other countries may simply be uninsurable because the risk is too high. But if you're selling products or services into a low-risk country like France or the Germany, and the customer doesn't pay owing to insolvency or other factors, it may be more cost effective to make an insurance claim than hiring lawyers in those countries to navigate through debtor/creditor and bankruptcy laws under different legal system and in a different language.
In terms of accounts receivable insurance in Canada, premiums depend on the risk factor assessed by the insurer. If the risk factor is 0.25 per cent for $100 in receivables, then ensuring $5-million in receivables for the year would result in a premium of $12,500. If the risk factor is 0.35 per cent, then ensuring $5-million in receivables results in a premium of $17,500 per year.
"When investigating credit insurance and comparing it to other options, businesses would be wise to consider what amount of unrecoverable accounts receivable would seriously impact your company's financial stability or annual profit," says Pascale Hansen, in the Vancouver office of Euler Hermes. She adds that you should calculate how much new revenue would be needed to break even, "if you suffered an unrecoverable debt of $50,000 or even $100,000."
That's why you should at least consider accounts receivable insurance to protect one of your business's most valuable assets. I'm sure many of Target Canada's unpaid suppliers (referenced here) wished they had investigated this form of insurance before supplying to the retail chain.
Tony Wilson is a franchising, licensing and intellectual property lawyer at Boughton Law Corp. in Vancouver, he is an adjunct professor at Simon Fraser University (SFU), and he is the author of two books: Manage Your Online Reputation, and Buying a Franchise in Canada. His opinions do not reflect those of the Law Society of British Columbia, SFU or any other organization.
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Tony Wilson