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Losing a Key Customer: The Blindside Risk

When assessing risks, virtually any business owner knows to insure the enterprise against the possibility of losing a key person. But does the same discipline exist regarding the key customers of the business, the loss of any one of whom could just as easily jeopardize the future of the company? For today’s risk managers, it certainly should.

Because the loss of a significant customer can be an existential threat to a business, captive insurance companies and their clients have developed and refined reimbursement coverage. Stated simply, reimbursement coverage is designed to replace income lost, as well as additional expenses, that result from the loss of a key customer.

Such losses are not ordinarily covered by the conventional insurance market. One basic reason is that there are almost always extenuating circumstances that attend the loss of key customers, making conventional insurance problematic. The resultant gaps in standard coverage represent an opportunity for captive insurers to solve the problem.

Who is key?

In order to properly cover the event of key customer losses, the first objective is to determine which accounts rise to the status of key customers. For our purposes, a key customer is defined as any account that represents at least 5% of the company’s gross sales. For many companies and other organizations, that is often a larger group than appears at first blush.

Most often, key customers are named on the Declarations page of the policy, but the policy may also make provisions for a key customer not specifically named. There are situations where a company or organization dealing with certain types of customers, such as municipalities and government agencies, can have a particular customer rise to the level of key customer due to an increase in volume of business after the policy inception, and the sudden loss of that customer could have a major impact on the bottomline.

One risk, many causes. 

Among the most common causes of key customer loss is bankruptcy or insolvency. Such processes, especially in their later stages, happen quickly and out of sight of the general public and thus represent a challenge for risk managers.

Additionally, loss of key income often attends takeovers or mergers, as well as changes in management which can alter the direction of a business. In one representative case, a client had been a customer of a company for two decades. Even so, a change in the business plan that followed a new manager hire resulted in the loss of business. The new manager simply chose not to honor the verbal agreements of the previous regime. Cases like this are commonplace in the annals of business, especially among family-owned companies in which working business relationships that have been honored for many years are suddenly radically altered or terminated.

Another cause of key customer loss occurs coincident with the discontinuation of a product line or service. For example, when a company is acquired by another organization, due to the merger, they decide to no longer use the product or services that the insured currently provides.

What losses are covered?

Reimbursement coverage is generally applied to loss of the income that would have been earned in the absence of the triggering event. This is defined as gross sales minus the costs of production or the costs of providing services.

So far, so good. However, the loss of a key customer often has cascading effects on a business or organization. The resulting loss mitigation expenses are typically the kinds of expenses incurred in order to reduce further loss under the policy. To cite just one example, a company will often have to hire a scout or search firm to replace the lost customer. These examples reveal why it is important for managers considering loss of key customer risks to look at the full scope of possible effects that can flow from an event.

There are many strategies, such as diversifying one’s client base, that can mediate the effect of key customer loss and all should be considered in a company’s grand risk strategy. But while key customer loss is difficult to foresee, it is virtually impossible to prevent.

Even 5% of a company’s revenue, once lost, can threaten the life of an organization. Loss of key customer insurance provided by a captive is your best protection against such a thing happening.

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