CREDIT PROTECTION 1. Efforts to secure protection.—It may be said of all credit information, both that which is furnished by the mercantile agencies and that which is obtained from other sources, that its chief purpose is to afford protection against losses from misplaced credits. As a means of protection, information of this kind is most commonly relied upon and is also in readily available form.
Various means have been devised for the purpose of augmenting the protection thus offered. Some of these means are legal measures, devised with a view to repossessing the owner whenever it becomes evi dent that his goods have fallen into the hands of per sons who are either unable or unwilling to pay for them. Others seek protection thru the principle of insurance. We shall here consider the latter.
2. Credit insurance.—Considering the peculiar na ture of credit, it is not surprising that the principle of insurance should have been applied to such trans actions. The credit indemnity companies claim to supplement the commercial agencies in two respects: (1) by providing against incalculable losses thru the application of the theory of averages to the field of credit extension; (2) by aiding the credit-giver with such information as comes from the close investiga tion of the creditor's own business, made necessary by the requirements of the insurance company.
The insurance company makes an investigation of the wholesaler's books in order to ascertain the aver age credit loss for the past five years. This first or "average" loss must in every case be borne by the in sured. The indemnity company regards this loss as within the realms of certainty, and insists that inas much as the province of insurance is to deal with un certainties, the initial or average loss cannot properly be a subject of insurance. Only such losses as are in excess of the initial loss are insurable. Under the terms of the insurance bond, the wholesaler is re quired to sell only to those retailers whose commer cial rating is above a certain grade, the premiums charged being governed largely by the grade of rat ing allowed. The amount of credit that can be
granted to any one customer is made to depend, under the regulations imposed by the credit insurance com pany, upon the terms of the policy and upon the cus tomer's commercial rating.
For the purpose of illustration, let us assume that a certain wholesale firm has gross sales of $100,000 a year, and that the average annual loss, based upon figures covering a period of five years, is $1,000, or 1 per cent. The amount of insurance allowed to this firm may be represented by a bond for, say, $2,500 on which there is an annual premium of $125, or five per cent of the amount of the bond. In accordance with the terms of the policy, all losses up to and including $1,000 must in this case be borne by the wholesale firm. This amount is the "initial" loss. Only on sub sequent losses—that is, losses between $1,000 and $2, 500—will the insurance be operative.
Losses sustained as a result of the failure of "rated" customers—those having a capital credit rating of a certain grade—are covered by the full amounts, or perhaps by an agreed percentage thereof ; while losses of the "off-rated"—those with poor rating or with none—are never covered for more than a part of the loss.
The credit insurance company invariably investi gates the character of the commercial house to be in sured. It considers the line of business in which the applicant is engaged, the class of customers with whom he deals, and finally the business policy pursued by the applicant himself. The basis for determining the amount of the initial loss, the percentage and fixed limit of indemnification and the premium per year, are disclosed by the insured's own books, which tell what class of customers he has, as well as the volume of business, the size of the accounts carried, the terms of sale, the amount of collections and the general credit policy of the house.