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Credit risk insurance is insurance that covers risk of either credit extended, such as business credit, or credit received, such as consumer credit risk insurance. Business credit insurance is the more common type of insurance sold, and it essentially covers any possible loss that might arise from non-payment of goods delivered. Consumer credit risk insurance insures the repayment of their personal loans.
Business credit risk insurance is an insurance policy that covers the payment risk involved in the delivery of goods or services sold on open credit. It usually covers a collection of buyers and pays them an agreed percentage of a receivable or invoice that remains unpaid as a result of prolonged bankruptcy, default of payment, or insolvency on the part of the buyer. Business credit risk insurance is acquired by businesses to insure they do not suffer a loss if a buyer defaults on payment.
This type of insurance can be important to a business because typically the top 20% of the accounts it maintains are responsible for about 80% of its profits. If one of those accounts were to be unable to pay, it could cause considerable damage to the accounts receivable department and the overall business. Business credit risk insurance can also serve a business in other ways, as they can borrow against their accounts receivable and increase their sales credit without as much risk or worry.
With business credit risk insurance, there is usually a monthly premium charged that is calculated as a percentage of the sales for the month being charged, or as a percentage of all outstanding receivables. Either way, it is usually a fairly low price. One of the stipulations of this type of insurance is that there is a limit on the credit the business can give a client in order for the sales to that client to be insured.
Consumer credit risk insurance, on the other hand, allows consumers to insure repayment of loans they received in the event they are unable to pay due to job loss, disability, or death. It can be acquired to insure a variety of consumer loan types including car, education, credit card, home equity, and mortgage loans. In the event of a payment for a consumer loan, the amount repaid would not go the consumer, but instead would be repaid to whatever institution made the loan, usually a bank or credit union.
Purchases of consumer credit risk insurance are typically either paid as a lump sum payment added to the loan, which increases the loan amount and the finance charge, or in a monthly premium. The monthly premium is usually calculated by multiplying the amount of the loan at a given time by a specific premium rate. Premium prices also usually depend on whether it is a close or open-ended loan. Close-end loans are for a set amount, whereas open-end loans can be increased in amount at any time.