CREDIT, INSOLVENCY OR BAD DEBT INSUR ANCE. It was not until the last decade of the i9th century that attempts were made to provide insurance against bad debts. Since then two British companies have underwritten such risks profitably. In America insurance against bad debts has been pro vided by the American Foreign Credit Underwriters, Incorpo rated, which has its headquarters in New York City. Credit policies only indemnify an insured for losses due to the insolvency of his customer. Insolvency is generally defined as "an adjudica tion of bankruptcy or composition with creditors in legal form, or execution of an assignment for the benefit of creditors, or, in the case of a limited company, an order that the company be liquidated voluntarily, compulsorily, or with supervision." Since the World War universal interest has been aroused in this subject and schemes have been established in Germany as regards exports to Russia ; in Italy the Government has been searching for a satisfactory basis of action; whilst Austria, Czechoslovakia, Switzerland and Sweden have shown signs of activity.
Policies are issued to traders either as regards a single tran saction ; in respect of an open account ; or on the basis of annual turnover. Such insurance appeals not only to large traders, who in their normal experience are prepared to risk a certain amount in bad debts and who are now enabled to increase their accounts, but also to the small trader whose capital is insufficient to warrant participating in any transaction involving the slightest element of risk of loss of capital.
Certain fundamental principles apply in common with most other classes of insurance. There must be the utmost good faith (uberrima fides) between the parties, and the onus is thrown upon the proposer to disclose all material information to the insurer which may affect his view of the risk as regards acceptance, de clinature or rating. The proposer must possess an insurable in terest, or in other words must bear some relation to the transac tion to be insured, recognized by law, by which he stands to bene fit by its completion or to be prejudiced by its non-fulfilment. The principle of indemnity must also be observed and in no cir cumstances must the insured be able to obtain profit by virtue of the policy. In the event of a loss the insured must, as far as possi ble, and subject to the limitations of the particular contract, be placed in that position which he would have occupied had the loss not occurred.
Fire risks are universally insured, but credit risks are usually in sured only when some element of doubt exists in the mind of the proposer as to the stability of his customer. It is therefore an established practice that the insured must bear some proportion of each and every loss himself. If it is worth a trader's while to accept a risk then a credit insurance company will generally un dertake a proportion unless the transaction is obviously a gamble. In England an increasing business is written on home and foreign accounts. Domestic business inevitably proves the simpler in operation as debts are more easily collected at home than abroad, whilst confidential information is more readily obtainable. An increase in the number of companies transacting the business in various countries will make it easier to procure information and foreign guarantees will be granted with greater facility.
Proposal forms are required to be completed in every case and full particulars as to the name of the firm to be guaranteed, its standing, the class and extent of the account and terms of pay ment must be stated. The reason for the guarantee is often sought, particularly when additional security has never been required before.
Policies are issued in respect of individual open accounts and often in respect of all the accounts on a trader's books. The policy provides for the payment of a proportion of the net loss to the insured due to the insolvency of any trader admitted by the policy. In England the percentage paid by the company does not generally exceed 75% of the net loss limited to the sum set against the name in the schedule to the policy. Losses are restricted to those on goods sold during the period of insurance which are de livered to the debtor and invoiced and debited to him in the in sured's books. Renewal policies are so endorsed that the insured is not prejudiced in respect of transactions entered into imme diately prior to the expiry of the policy.
Another form of policy guarantees individual bills of exchange, subject to a specified date upon which the bill must be met or insolvency occur.
The exports credit guarantee scheme established by the British Government in 1926 is dissimilar to any form of insurance hitherto devised. The trader is protected against the debtor's failure to meet his obligation on a definite date from whatever cause. In most cases the guarantee does not exceed 75% of the amount of the credit granted, although in certain instances a guarantee for the full amount of the credit may be obtained. (A. G. M. B.) Credit insurance in the United States was first written by The U.S. Credit System Company, organized in 1888 in Newark, N.J.; the first policy issued late in 1889. The premium was divided into expense, guarantee and reserve and the business written on the Tontine plan with 65o policies. of $5,000 each making a series, a total of $3,250,00o at risk to a series. Each series paid its own losses as the funds of one series could not be diverted to another series unless a profit was made, which profit had to apply to the liquidation &f any deficit of prior series. This plan proved unsatis factory and was discontinued by amending the original charter granted by New Jersey, so that all funds were available to pay any losses incurred. Original policies provided for payment of premium and required the insured to sustain agreed percentage of loss on gross annual sales before the company was liable. This percentage, based on applicant's previous credit loss experience, was termed "initial" or "own" loss. The initial loss determined governed the policy's amount and the limit of individual coverage, the policy issued for twice the amount of the largest debtor's limit, in turn double the amount of initial loss. The excess of the amount agreed to be borne by the insured was the policy amount, subject to debtor's limits and the face of the policy, hence the "Excess Bad Debt Insurance." Amounts insured on individual debtors were based on ratings of a mercantile agency selected by the policyholder when the policy was applied for. The meaning of insolvency was confined to that arising from bankruptcies, re ceiverships, absconding debtors with no assets or a judgment that the debtor was unable to pay in full.
Companies were organized to write this form of insurance only, but their underwriting experience was generally unprofitable, owing to lack of knowledge of carrying costs and of other require ments for safeguarding the company's and the policyholder's inter ests. After the great financial depression in 1893 the Ocean Acci dent and Guarantee Corporation, Ltd., took up the business, mod ernized policy forms, improved underwriting conditions and stabil ized the business so as to gain and retain the insuring public's confidence. A number of larger casualty companies followed this pioneer lead. This branch of insurance has since been successfully and increasingly underwritten in the United States. It is now called credit insurance. The fundamental principles of the original idea still operate in broadened scope.
The most modern credit insurance policy covers the policy holder's annual shipments, operates in a dual capacity, provides adequate guarantee against loss due to insolvency of debtors, and assists in minimizing the insured hazards. The most compre hensive credit insurance now protects against abnormal or unex pected loss from delinquent, dilatory debtors sold in the ordinary course of business, the policy undertaking to collect from such debtors or pay when "normal loss" is exceeded. In credit granting there is generally some loss during the business year. "Normal Loss" is loss understood as inherent to the risk, fixed by class statistics and individual experience. In this essential credit in surance differs from fire, marine, tornado, burglary and other branches of property indemnity. The coverage in these lines is against a happening considered less certain than credit loss. Over head can provide for known or normal loss, only insurance for the abnormal or catastrophe loss.
Diverse forms are issued for varying needs but generally "in solvency" includes bankruptcy or insolvency petition, assignment, receivership, compromise, attachment, execution, death or insanity of sole debtor, chattel mortgage, absconding, confession of judg ment, transfer or sale of stock in bulk, a debtor's business taken over by a committee. Besides these insolvency definitions collec tion policy forms provide for assigning accounts as insolvent, after becoming due and payable under original terms of sale. Under this form accounts can be filed as an insolvency when they become past due on original terms of sale or, at the policyholder's option, within an agreed number of days after original due date.
Original underwriting conditions have greatly improved. Or iginal policies limited coverage to $Io,000. In $Ioo,000 could be had on a single account. Principal credit insurance com panies pooled loss statistics for a period of years, resulting in ex perience normal loss tables showing average experience on any given sales basis in over 40o different businesses. The larger pro portion of U.S. credit insurance policies cover the policyholder's annual sales volume, but the demand for coverage on individual debtors is met by single credit account policies, though this par ticular underwriting experience is still developing. Considerable hazard attends credit insurance underwriting, including future business conditions, reasonable expectancy of business depression in cycles, when credit losses reach large proportions, and the espe cially important factor of moral hazard, the control of the insured hazard being in the policyholder's hands to a greater extent than in other insurances. It therefore demands of underwriters a broad general knowledge of business and of local conditions, acquaintance with different specific hazards and keen judgment of human nature obtained only through wide experience over a number of years.
See J. G. Legg, Loss of Profits Insurance (1938).