What Is Accounts Receivable Insurance?
Accounts receivable insurance protects a company against financial losses caused by damage to its accounts receivable (AR) records. This type of coverage is important because the loss of accounts receivable records may render a firm unable to collect money customers owe.
- Accounts receivable insurance provides coverage against losses incurred by a company when they are unable to collect from customers that owe the business money.
- Accounts receivables are created when a company lets a buyer purchase their goods or services on credit.
- In addition to covering direct losses due to non-payment, AR insurance will often also cover indirect costs, such as interest payments due on loans secured by receivables.
How Accounts Receivable Insurance Works
Accounts receivable insurance protects a variety of situations involving a company's accounts receivable records. First, it will cover a firm for sums that can't be collected from customers due to records being damaged or destroyed by a covered peril. Accounts receivable coverage will also cover a policyholder for interest charges on a loan obtained to offset uncollected sums.
The coverage also provides reimbursement for collection costs in excess of your normal collection costs. Most businesses incur regular costs for collecting money owed by customers, such as a bookkeeper spending a few hours each month reminding customers that payments are due. Accounts receivable insurance covers expenses over and above these normal costs, which come as a direct or indirect result of a loss. One example of such a cost is hiring a temporary worker to assist with collection activities.
Accounts receivable insurance will also cover the costs of reestablishing your accounts receivable records, such as the costs of hiring an information technology (IT) consultant that specializes in data loss recovery.
Insurers may include accounts receivable insurance as part of an "extended coverage" endorsement attached to a property policy. However, this insurance may not be the same as a separate accounts receivable endorsement because it may be subject to exclusions that apply to buildings and personal property.
Calculating Accounts Receivable Insurance Losses
The precise manner in which losses are calculated may vary between insurers, but most follow the same general principles. First, an insurer calculates total accounts receivable for the twelve months prior to the loss. Next, it divides this sum by twelve, which gives an average monthly receivable.
For example, suppose a firm's accounts receivable records are destroyed in a fire on Jan. 1, 2022. The insurer will add up receivables for the period Dec. 31, 2020, to Dec. 31, 2021, and then divides that number by 12. If your annual receivables are $1 million, the monthly average is $83,333.
Since sales can be cyclical throughout a given year, the insurer will then consider whether normal fluctuations in a business caused receivables to be higher or lower than the monthly average on the date of loss. Considering the timing of the loss, the insurer will then increase or decrease the monthly average.
Major insurers often offer accounts receivable insurance, such as American International Group (AIG) and Nationwide Insurance Co.