Should my business use UCC filings or credit insurance to protect unpaid receivables?

On the one hand, the sales team is tasked with growth through landing new customers and winning new deals. On the other hand, the credit team’s goal is to mitigate risk and prevent bad debt from building up on the balance sheet. In other words, sales is encouraged to take risks while credit is incentivized to avoid them at all costs.

Insurers Cutting Coverage and Cancelling Policies

Suppliers have leaned on credit insurance to safeguard their balance sheet, and credit teams have become comfortable with offloading that risk for a healthy annual premium. But with insurers cutting coverage and cancelling policies to protect their own earnings, credit teams are being forced to rethink the tools they use to ensure the financial security of their company. UCC filings are back in favor. The insurers, long on the side of financial security, are now harming businesses.

Trade Credit Insurance, also known as Accounts Receivable Insurance, is the insurance you can buy to protect your invoices against non-payment. Sellers pay a premium to receive payments if buyers miss their deadlines or file for bankruptcy. It has broad international acceptance, including in Europe and Asia.

In better times the premium is easy to justify as insurance premiums are seen as a line of defense against some portion of cash receivable risk. When recession comes, insurers will not only drop weaker accounts, but also pull entire portfolios out of coverage. The creditor is left with less coverage than expected.

The pandemic hit every part of the economy hard, including credit insurance. Downturns bring more business failures, claims, and payouts. Many credit insurers have cut their policyholders’ coverage to protect their own profits. These losses in coverage are an unwelcome expense. James Daly, CEO of Euler Hermes North America, said it cut coverage 15% across all industries, including retail.

Fifteen percent is no rounding error. If your credit insurance company is giving you less coverage for the same premium, should you still be paying for the service?

Security Interest

There is an alternative. Under Article 9 of the Uniform Commercial Code, a trade creditor can secure its goods or accounts receivables with a customer’s personal property. The security interest is the creditor’s stake in the personal property or fixtures securing the debtor’s duty to pay or perform. Many creditors require a security agreement before extending credit. In the agreement, the debtor pledges specific assets as collateral. On default, the creditor can sell the collateral. If the sale price is higher than the debt, the debtor gets the surplus. If the sale price is less, the debtor still owes the difference.

Article 9 also reaches all consignments, letter-of-credit rights that support other collateral, and leases intended as security. And there’s more. Article 9 governs the sales of accounts and chattel paper, as well as other financing devices such as trust receipts, conditional sales, chattel mortgages, and field warehousing.

No lien lasts forever. In Article 9, the period of protection is five years (10 years in Wyoming). However, don’t let your lien lapse. If the financing statement is not timely continued, it lapses, and the security interest goes with it. Creditor beware. Once the debtor has paid, it’s good practice to record a lien termination.

Compared to Credit Insurance, UCC Filings Are Cheap

Asking the credit insurer to cover everything is too expensive and too risky. Relying on credit insurance is no longer a sound choice for most domestic sales. UCC filings for all domestic sales and those to Canada, Mexico, Australia, and New Zealand can help fill the gap. And if you still need insurance to protect your export receivables, UCC filings can work alongside.

Credit insurance can cost from .2% to .8% of estimated annual sales. A business with $10 million in sales can expect to spend $20,000 to $80,000 a year on insurance, not to mention deductibles. In many areas, a lien can be filed for about $200, and as noted, it lasts five years. There are no annual premiums or deductibles.

With UCC filings the creditor decides which accounts to secure and how much exposure to take on. Credit insurers require you to insure solid accounts to cover the risks of weaker ones. Credit insurance companies are in business for profits, not favors. Premiums from the strong accounts offset the cost of payouts from likely defaults.

A UCC filing does not judge a debtor’s creditworthiness. If it did, it would end when your customer’s credit worsened. Imagine Delaware calling you to say they will unperfect your UCC. It does not happen. Unlike insurance, the filing holds regardless of the debtor’s creditworthiness or the economy at large. But it only holds if filed properly in the first place.

The public record is hugely valuable in volatile times. Recording a Financing Statement publicly acknowledges the agreement. Credit insurance offers nothing like it. Take a hypothetical. Say your customer tries to secretly sell its business. A prospective buyer will check the public record and discover your UCC filing. There is no hiding your security interest.

UCC filings give a competitive edge, especially in a fiercely competitive market. If you can sell to the accounts you would ordinarily turn away, or raise credit lines for the ones you already have, think how much revenue that would mean.

None of this means credit insurance is dead. Though credit insurance is failing suppliers domestically, globally it still has a real role to play. Actuaries do a lot of analysis for you and monitor insured accounts on your behalf. Still, domestic suppliers get security for far cheaper with UCC filings. To get the best of both, insure up to the insurer’s limits and file a UCC for the remaining balance. Credit insurers may be abandoning you in hard times, but a lien will not. Look to insurance and UCC filings together, not either-or.