You expect creditors to review your company’s financials and creditworthiness when you borrow money to purchase a new property or piece of equipment. What you might not know is that insurers also review your firm’s financial health and credit rating before quoting or renewing your insurance policies. What they learn can affect your premiums and could limit your ability to secure insurance at all.
INSURANCE AND CREDIT RISK
Why do insurers care about your firm’s credit? One reason is to reduce their own credit risk. They don’t want to insure companies that could become bad-debt write-offs due to nonpayment of premiums, deductible recoveries, service fees, and other revenue streams. In other words, they want to make sure they get paid. Firms with a track record of financial well-being and timely bill payment mitigate an insurer’s credit risk.
Also, numerous actuarial studies have demonstrated a correlation between credit scores and claims activity. Insured entities with good credit scores tend to have lower claims activity, on average, than those with poor credit scores. One explanation for this correlation is that operations with well-managed finances likely exercise discipline in all other aspects of their operations. Also, employee training, property upkeep, preventive maintenance, equipment and fleet quality, employee quality, and other risk management factors that affect safety and claims activity can suffer when a firm is under financial duress. Because claims activity directly affects insurers’ profitability, they are more likely to offer coverage to firms with strong credit scores.
A third reason insurers care about your company’s financial health relates to moral hazard. Investopedia defines moral hazard as the idea that “a party that is protected in some way from risk will act differently than if [it] didn’t have that protection.” From an insurance perspective, a moral hazard concerns intentional acts the insured entity commits—such as arson—that either create or exaggerate a loss. For example, business owners have, due to financial distress, knowingly and intentionally caused a loss and made a claim to generate funds to keep a business alive. This behavior is rare—and illegal—but underwriters consider it when they scrutinize applicants’ credit ratings in search of signs of financial distress. If they identify a potential moral hazard situation, it can affect the applicant’s insurance pricing, coverage, terms, conditions, or ability to secure coverage.
IMPROVING YOUR CREDIT SCORE
If your business is a large-scale operation with substantial premiums—or if it manages its insurance risk through a high-deductible, self-insured retention or captive arrangement—potential insurance carriers likely will ask you for three years of audited financial statements. The insurers are looking for a positive net income, positive shareholder/owner equity, and positive free cash flow. If your business is a small to mid-size risk, carriers probably are screening your financial strength and acceptability by purchasing your Dun & Bradstreet or Experian score or using another credit-rating tool. That’s why you need to do everything possible to improve those scores. It’s worthwhile to research the credit-rating agencies that can affect your business. For instance, D&B posts information on its website on how to improve your company’s rating (go to iupdate.dnb.com/iUpdate/improveCreditProfile.htm). Suggested ways to improve your score are to pay all suppliers in a timely fashion, minimize debt financing, monitor your score, and contribute information to your firm’s profile.
For more information on commercial financial strength as it relates to insurance, contact your insurance agent or broker to discuss your company’s particular situation and what you can do to improve your chances of procuring the best possible insurance pricing, coverage, terms, and conditions.
Dan Curran is senior vice president and underwriting officer for Willis Programs (Portsmouth, N.H.), which underwrites RecycleGuard, the ISRI-sponsored insurance program. Reach him at (603) 334-3027 or firstname.lastname@example.org. RecycleGuard has prepared this article for informational purposes only. It is not intended to provide legal advice. Readers should not rely on this document or act upon any of the information it contains without first consulting competent legal counsel.