How should agencies manage premium dollars?

Unlike other sales and service companies, independent insurance agencies have a management function in their daily operations. Most property and casualty insurance agencies agree not only to sell and service insurance products, but they also receive transacted premiums, maintain them for a short period of time in their trust bank accounts and then disburse them to the appropriate parties.

Insurance agencies have millions of dollars in transit through their trust bank accounts. An average agency transacts between $5 million and $10 million in premium per year. Large agencies have annual premium sales of $50 million or more. At any given time, the cash balance of an average agency’s trust bank account can be between $500,000 and $1.5 million.

Different sales and service operation
Yet unlike most sales and service companies, the income from insurance sales transactions is not available to the agency at the sales closing. This is because the agency income is embedded in the premium receipts and deposited in the agency’s trust bank account–not the operating bank account.

For the funds to become available, the income from sales must be transferred to the agency’s operating bank account after certain processing. Only then can an agency have its income available for use in daily operations.

Insurance agencies receive premium funds not as owners, but as trustees of such funds. Full accounting of premium funds received by an agency is necessary to accurately know what funds were deposited in the trust bank account, what funds were disbursed and who owns the cash balance of the trust account.

Five different parties may claim ownership to the balance of a trust bank account:

• Insurance agency (earned commissions and fees);
• Insurance companies (net premiums);
• General agents (net premiums);
• Insureds (return premiums); and
• Finance companies (return premiums).

Premiums received by insurance agencies are fiduciary funds that must be separated in bank accounts and accounting records from business operating funds so that if an agency declares financial insolvency, the agency creditors are prevented from getting access to such funds.

Current financial management
Most insurance agencies do not recognize the management of premium funds as “financial” management. Despite the amount of funds transiting through an agency’s trust bank account, most insurance agencies look at the trust account process as being limited to “paying” insurance companies or general agents on time.

In some agency management systems, insurance companies and general agents are considered “vendors,” although insurance agencies never buy anything from insurance companies or general agents. The vendors concept can be construed as proof of an insurance agency’s lack of understanding and faulty practice in premium financial management.

The transfer of earned commissions and fees is not managed through standard accounting procedures. Agencies do not maintain accounting records to monitor the transfer of commission funds from the agency’s trust bank account to its operating account. An agency’s trust account may be financially insolvent, but there is no way for the agency’s owners or managers to know it. Certified public accountants are sometimes called in to figure out whether the agency’s trust account is financially solvent based not on accounting records but on their own formulas. The trust account cash balance is never analyzed to determine who its legal owners are.

Return premiums are not included in the agency’s financial statements because no separate accounting records are maintained for return premium funds. Return premiums are journal-entered as “negative” receivables, and end up distorting both premium assets and liabilities.

In most insurance agencies, financial management of premium funds is carried out by personnel with no premium accounting or financial management understanding or training. For most people, return premium transactions are a nightmare. Many cannot understand why an agency must reimburse the commission on return premium to its trust bank account. Reconciling cancellation endorsements is a mystery to most agencies because they generally result in return premium, either to insureds or finance companies.

In current accounting practice, records do not support the production of a premium receipts and disbursement (R&D) statement to determine, based on accounting records, the amount of premium float. The trust account balance should always equal the premium float plus the personal funds occasionally maintained in the trust bank account.

Agencies are seldom sure that the cash balance of the trust account is what it should be. Instead of using premium receipts and disbursements, agencies use bank deposits and withdrawals, ignoring the fact that many withdrawals may be disbursements of funds other than earned commissions, premium remittance or premium refunds.

In a business operation, a profit and loss (P&L) statement determines the business’ profit or loss. Similarly, an R&D statement determines the premium float and helps agencies quickly and accurately establish the solvency of their trust bank account.

Fulfilling obligations
Insurance agencies undertake the obligation to manage premium funds for the benefit of insurance companies. However, in so doing, they also benefit from getting the commission income earlier, reducing operating capital requirements and staying closer to their clients.

Approximately 85 percent of independent insurance agencies choose to receive and manage transacted premiums, rather than letting insurance companies do it through direct billing.

As much as they are willing to do the job, agencies often lack the training and necessary accounting tools to perform reliable financial management of millions of premium dollars. Licensed insurance agents and brokers, acting as owners or managers of insurance agencies, often do not designate a person in the agency to act as a trustee of premium funds to carry out producer’s fiduciary duty.

No disbursement of premium funds should be allowed out of the trust bank account without the trustee’s approval. Accounting audit trails should be created to assist the agency’s auditors, owners and managers.

There are several reasons why insurance agencies cannot reliably manage premium funds:

1. Agencies lack a premium accounting system and accounting procedures to capture the complexity of premium and return premium funds. What passes in today’s practice as premium accounting is inadequate for premium financial management. Agencies need a radical re-tooling before they can function as “financial managers of premium funds;
2. Agencies lack the understanding and training necessary to engage in competent financial management. Current agency personnel in charge of premium management are generally oblivious to insurance producer’s fiduciary obligations. Those employees are unaware that current management systems lack the basic accounting tools required by financial management;
3. Agencies do not have a uniform financial reporting system for premium funds endorsed by agents’ professional organizations and approved by the Department of Insurance. The only financial report on which premium funds are reported is the agency’s balance sheet, which includes premium funds along with business operating funds. No audit trails are available, nor is accounting-based premium float reporting;
4. In current accounting practice, the focus is on premium invoices, not on premium transactions. Agencies have no accounting-based information on how much of the premium transacted has been billed or paid, how much transacted net premium has been remitted to the insurance company, or how much of the transacted commission and fees have been transferred to the operating account. The policy financial status is neglected by the agency’s financial managers, who overlook the fact that trust account solvency depends on the solvency of each individual policy transacted by the agency.

Financial management objectives
Premium financial management helps to determine and report premium financial solvency, accurately establish the agency’s premium assets and liabilities, and determine the trust funds’ beneficiaries.

Because insurance agencies act as trustees of premium funds, it is essential that financial managers provide accounting-based documentary evidence of the funds’ financial solvency to the agency owners, managers and auditors.

Premium funds solvency is defined as the ability to:

• Remit premiums to insurance companies or general agents when they are due;
• Transfer commissions and fees to the agency’s operating account when they are “earned;” and
• Refund return premiums to insureds and finance companies as soon as insurance companies reimburse the net amount of return premium.

Premium solvency must be established at the policy level so that through aggregation, it can be easily determined at the carrier and agency levels. Solvency must be analyzed on a “cash” basis, as well as on an “account current” basis.

The cash solvency analysis should include only cash and credit assets on one hand, and on the other, only due and payable premium liabilities (such as earned commissions, company statement premiums, return premium refunds). The account current solvency analysis also should include premium assets and liabilities associated with invoiced premiums.

Should an agency become financially insolvent, premium and return premium funds cannot be used by the agency to pay its creditors. That is why premium and return premium assets must be clearly identified and reported on a balance sheet, preferably dedicated to premium funds only.

Trust funds beneficiaries must be accurately established so that in case an agency fails financially, premium funds can be disbursed without delay to their rightful owners. Additionally, agencies will be able to acknowledge to insurance companies what funds they have on hand ready for premium remittance.

Insurance agency needs
To demonstrate competent premium financial management, insurance agencies need:

1. New insurance premium accounting methods capable of creating accounting records for all premium and return premium transactions;
2. Agency personnel training in premium financial management and statutory insurance producer’s fiduciary obligations;
3. Uniform financial reporting systems that can be used throughout the industry by all insurance agencies. The new system must include standard financial reports such as a (a) separate balance sheet of premium and return premium assets and liabilities; (b) statement of premium receipts and disbursements; (c) solvency analysis reports; (d) statement of premium funds beneficiaries; and (e) audit trails for all ledger accounts.

Insurance agencies are currently engaged in the premium financial management of millions of premium dollars–often without the necessary knowledge, training or financial management tools. To continue to competently manage premium dollars, most insurance agencies need a complete re-tooling so that their performance can be monitored and scrutinized by the agency’s owners and managers, funds owners, and government agencies overseeing the insurance industry. Agency trustees, owners, managers and auditors will be the main beneficiaries of such changes.

Chris Marinescu is president and CEO of Paulmar Software Inc., a Southern California insurance premium accounting and solvency management firm. E-mail: chrism@paulmarsoftware.com. Emma Hart is an insurance professional with more than 15 years experience in insurance trust account management.