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Often businesses are compelled to grant credit to certain purchasers of their goods or services in order to make sales. While sales are essential for the survival of a business, credit sales bring with them a risk of default or non-payment. Where the debtor is a large entity, the risk of this is relatively low and therefore acceptable. However, if the debtor is him/herself the owner of a relatively small business, the risk of default due to the owner's death or permanent disability is large. Where a bad debt concerns a substantial amount of money, it can have a catastrophic effect, potentially causing the creditor, through no fault of the creditor, to be declared insolvent. Can one avoid this situation? Yes, with foresight and proper planning! The need: The management of default-risk requires timely identification of potential problem areas and the implementation of an appropriate action plan. The type of client for which one could effectively utilise this, would be a debtor business with a single owner or where the amount outstanding will have a significant impact on the creditor's cash-flow should it not be repaid. The solution: The appropriate use of a life insurance policy can reduce this risk substantially by insuring the debtor's life against death or permanent disability. The creditor can accomplish this in one of two ways: Option 1 The creditor identifies a debtor for whom this scheme is required, and then applies for a suitable life policy on the debtor's life. The creditor will be the applicant/owner, premium payer and beneficiary for the proceeds. The creditor then adds the policy premium to the sales price/invoice for the goods or services sold, which the debtor has to repay. Option 2 The creditor insists, as a condition of credit, that the debtor takes out and pays for a policy on his/her own life. The debtor then cedes the policy collaterally to the creditor for as long as the debt remains unsettled. Once repaid, the cession can be cancelled. If the debtor passes away or is declared permanently disabled from performing his/her work functions while the debt is outstanding, then the policy will pay out to the creditor. The creditor offsets the amount received against the debt and repays any excess to the debtor's business or estate. The benefits: The proceeds from the insurance policy settles the outstanding debt in full on the death or permanent disability of the debtor. The creditor receives payment immediately after a successful claim is lodged. Should the policy proceeds be payable to the creditor, the death of the debtor will not negatively impact on the business' cashflow. The creditor can keep control of the risk while being able to choose which structure suits it best. The cost of a life policy is inexpensive relative to the debt amount and the financial impact of non-payment. The debtor's estate and business is released from liability for the debt due to its settlement in full.
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