Credit insurance
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Rycroft Associates

Jargon & Myths put to rest

FIRST LOSSES EXPLAINED - please follow this link
We also look at Discretionary Limits. Trading Experience. Status reports. Salvage. Salvage Pro-Rata and Due Care and Prudence.

Discretionary Limit - the limit you are allowed to go up to without reference to the insurer, however, it is unfortunately called the "DISCRETIONARY" limit, but it is anything but, whilst you have the discretion to grant credit, it must be based on some factual information (such as trading history or bank report or status report) and whatever system you have used to "justify" the credit given must be provided in order to get a claim paid - in simple terms - you must in the event of a claim be able to "justify" why you gave credit in the first place - ideally using third party information (a status report) or have "satisfactory" trading experience (i.e. the experience must justify the credit allowed).

Trading Experience - each insurer differs as to what is acceptable experience - however, an account that has only a small volume of payments is not going to "justify" any significant credit limit - e.g. a payment of £200 will not justify anything above £300 let alone £1,000. The main issue with trading experience is monitoring the account - once a payment reaches 12 months old (and less with some policies) it is deemed too old to be able to be used as "Experience". It's not the regular accounts that catch you out it's those that just turn up maybe once or twice a year and don't, on reflection, actually hold/attain any history of substance.

Status/Bank Reports - one of the benefits of obtaining a status report is the fact that the accounts have been professionally assessed and a credit opinion formed, CCJ information is also checked on a daily basis and the report has the bonus of being acceptable as "justification" for the next 12 months (with most insurance policies), the only danger therefore is that the report becomes out of date before you replace it with an up to date report. The actual thinking here is that you would get a report, which would then be eventually overidden by trading experience. Clearly, how you operate your Discretionary limit needs some consideration or some professional input (from say, a credit insurance broker).

The obvious way round this would be to take on board one of the status agencies monitoring systems, however, the insurers do not currently accept the monitoring system fully - e.g. if you get a report and it is good for say £5,000 and the report does not change for 2 years plus, you will be in a position where you do not have an up to date report (we are currently trying to overturn this as it doesn't make any sense that you have a live system - i.e. you get new reports straight away rather than a yearly report, but you may be penalised for acting prudently in the monitoring and granting of credit). The problem with only taking yearly reports is that, if you get a report today and it doesn't recommend credit, tomorrow it may do or vice versa, it does today, but then tomorrow something happens with your customer - surely you want to know about?

Salvage - is the money (cash, cheques, credit notes, etc) received after the account has been frozen due to it's age or due to known problems with your customer. The issue you need to be aware of is that (and again each insurer is different) if you do not have a sufficient credit limit to cover the debt, you may find that the salvage monies are split "Pro-Rata" between you and the insurer, (see further down for an example).

Where did the Salvage clause come from? -
Salvage came from a court case in the 1930's when a timber yard went up in flames - or rather half of it. They were under-insured and only had the equavalent of half the yard covered. The argument put forward by the timber company was that the insurance company should pay out the full policy entitlement (timber worth £60k, policy worth £30k fire damaged £30k therefore they were covered), however, the insurer refused to pay on the basis that they were covering £30k of timber and he still had £30k of timber - in a nutshell - whose is to say what went up in smoke - the insured timber or the uninsured timber and how do you differentiate? The judge therefore concluded that the timber that was left should be split between the two parties 50/50 - "PRO RATA" (had the timber yard had £45k of cover then it would have been 75/25 in favour of the timber co) and the salvage clause was born. - side note: this is the uk view for salvage and relates to travel insurance, fire insurance, etc. However, there is one credit insurance company that takes a different view, they offset any salvage monies received to the oldest part of the debt, this does (99 percent of the time) work in your favour.

Pro-Rata example - debt £30k Credit limit £25k monies recovered £10k - you work out what proportion of the debt was covered and then apply that percentage to any money recovered so in this case 25k div by 30k equals 83 percent so of the 10k recover, 83 percent would go to the insurer, let try another - debt 30k credit limit 15k monies recovered 15k so, 15k div by 30k equals 50 percent apply this to the money recoved - in this case half and therefore 7,500 would be allocated against the insured debt and 7,500 against the unisured debt (and opening a new account and continuing to trading on cash - without the consent of the insurer any such trading and money subsequently received is considered to be salvage money) at the end of the day the insurer is not looking for ways to get out of paying the debt, they are just taking a fair and reasonable approach, you can't expect them to bail you out if you have not taken "due care and prudence" to mitigate the debt.
So at the end of the day it is important to either have a credit limit to cover the debt or keep the account within the credit limit or at least be aware of the risk you run. (Not all salvage clauses run this way - one insurer runs a first in first out approach, although this doesn't always run in the favour of the policyholder - it can be very much case by case if you want specific examples and more information, please get in contact).

Due Care and Prudence - Credit insurance is very much an intangible product in that it is not about picking the tab up at the end of the day but is there to help you trade upwards with confidence in the knowledge that should a customer go belly up on you that your cash flow will be protected and it is there to help you try and avoid any bad debts - some people look at credit insurance as an investment and that they should get some money out of it to justify the premiums, but what of fire insurance, do you want a fire every year to justify the premiums? So the insurer enlists "Due Care and Prudence" and would expect you to take every care to avoid a bad debt as though you were not insured, if you take this stance, then you could reasonably expect the insurer to pay out should you hit a problem - the relationship between you and the insurer is one of trust.

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