I have written on this subject many times, but I have done an inadequate job of being understood because I keep coming across agency owner after agency owner who does not know they need a balance sheet, and in fact, that they need an accurate balance sheet. It is kind of interesting that insurance agents who are in the business of insuring assets, a balance sheet variable, do not have quality balance sheets themselves.
The problem is especially bad with small agencies, although quite a few medium to large agencies have faulty balance sheets, and even their accountants do not know what a proper independent agency balance sheet looks like. Some agencies operate for decades with no balance sheets, or poor ones, and then they go to sell and learn, painfully, that they have a serious problem. An agency cannot legitimately be sold without consideration of a quality balance sheet.
An independent agency cannot be sold without a balance sheet because without a quality balance sheet, it is impossible to determine if the agency has clear title to its assets. Clear title to an agency’s most valuable asset, its expirations, cannot be determined because lacking an accurate accounting of cash, premiums receivable, premiums payable, pre-bills, binder bills, audits and so forth means there is no way to determine if the agency is in trust.
All States Are Trust States!
Most states allow comingling of funds, but 100% of the states require agencies to be in trust every day of every week of every month of every year. This requirement is the same with every carrier contract I’ve ever read. An additional contractual requirement to be in trust now exists for many networks/aggregators and is contained in the network agreement.
Well-written network agreements require members to be in trust (an interesting issue with shared carrier contracts is whether the trust requirement is joint and several.)
Carrier contracts generally stipulate that if an agency is out of trust, the carrier owns the expirations. Therefore, that agency cannot be sold. If the balance sheet is poor or does not exist, it is impossible to ascertain if the agency is in trust.
For all those agency owners who are thinking, “I’m 100% direct bill so this does not apply to me,” with no offense, no smart buyer is going to trust you on your word. You will have to present a quality balance sheet.
I feel sorry, I truly do, for all the small agencies that do not know these facts. I have not found many, if any, larger agencies that do not know these facts. They may choose to ignore the facts, but they know of them. Smaller agencies depend more heavily on their associations, their software and free advice boards as to what they should be doing. Many purchase agency management software and assume it does everything they need. They depend on their accountants to know what they are doing. However, their accountants are usually small practitioners doing a little of everything so they know nothing about insurance agency accounting requirements. Small agency owners have it tough.
Selfishly, I’d really like it if either the small agency’s management systems and/or their accountants did a better job because I am worn out being the bearer of bad news. I’m tired of being the bad guy advising agency owners that “without a balance sheet, you cannot prove you have clear title and therefore, your ability to sell is really limited.” Or advising, “Your premiums receivable and premiums payable are clearly wrong on your balance sheet and you’ll have to fix it before you can sell.” Or trying to explain to an accountant, who should have caught the problem 10 years earlier, that he needs to help his client fix the problem now. The response is always the same, “No one else ever told me this, and my client has been fine so far!”
When I get a call to help an agency prepare to sell and discover their balance sheets are MIA or junk, I cringe and often procrastinate before advising them of the problem. I especially wince if they hire an accountant or consultant who advises that I am being too detailed because that agency is being taken for a ride.
Insurance agency accounting is difficult and unique. It is not orthodox. This means using off the shelf software like QuickBooks is a bad idea because without considerable customization and lots of hard work, generic systems cannot produce a proper independent insurance agency balance sheet. The difficulty goes to the heart of why all states are trust states.
An agency is collecting money on behalf of another entity. They are holding money on behalf of another entity. Holding money on behalf of other entities is why a fiduciary trust situation exists. It is why, very unusually, an agency can be on cash accounting and still incur bad debt. Regular businesses cannot do this. The reason agencies can is because the bad debt involves other entities’ monies, not the agency’s money. The new revenue recognition rules make agency accounting even more complex.
Agency Management Systems
When you purchase an agency management system, be sure the accounting module is designed specifically for independent insurance agencies, not direct writers because their accounting requirements are not the same, and then make sure it works. I have seen several systems promise the moon, but when we tried to figure out the balance sheet, the only conclusion was to start over and eat the $20,000 to $100,000 invested in that system. Never believe a salesperson that their accounting system works without testing it and obtaining some kind of guaranty.
If your accountant is a generalist, and that applies to probably 99% of agencies, you need to help them understand the unique requirements of independent insurance agency accounting. Make no assumptions that they have this knowledge. If they advise that they know accounting for agencies, be sure they know independent insurance agency accounting. I met one CPA who advised he knew agency accounting inside and out. He did not have a clue about independent insurance agency accounting. When I asked about his knowledge level, he did not know the difference between a captive agent and an independent agency.
If you cannot educate your accountant, sharing this article with them might help.
Beyond the balance sheet, you will really benefit if you can track your revenue by line of business (personal lines, commercial lines, life and benefits). Never combine contingencies and commissions as one revenue line. Be sure your accountant understands the nature of contingencies.
I hope these tips help you avoid problems when you go to sell your agency or even when you borrow money. The banks that specialize in loaning money to independent insurance agencies require quality balance sheets just like buyers and for the same reasons. You have absolutely nothing to lose by taking these steps and lots of potential money to gain.
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