The Continued Importance of Trust Monies, Correct Accounting, and Doing Business with Stable Insurance Companies

By | August 15, 2022

There was some recent news that the Florida Department of Insurance (DOI) is requiring all agencies to return to the state all of their unearned commissions if they did business with a particular carrier that the DOI had to take over. This order to return all unearned commissions for that carrier is a great reminder about how to run an agency.

The carrier mentioned above was primarily a homeowners insurance company, but until this last year or so, the number one kind of carrier to go insolvent or become impaired over the past 10 years has been health insurance carriers — particularly the new carriers organized under the ACA guidelines. Chalk that up to another thing the federal government does not do well, which now includes setting up guidelines for a new insurance company’s capital requirements. Nevertheless, the lesson above applies to all types of carriers.

Let me make some simple assumptions.

Let’s say there is a fairly successful personal lines agency with 1,000 customers who are insured by a specific carrier. Homeowners premiums in Florida tend to be remarkably high and let’s further assume the homes that are insured are middle class homes with around $500,000 in Coverage A. A decent guess for coastal Florida would be calculated by averaging the home values of the northern and southern parts of the state. The average premium is $5,000 for a basic HO-3 homeowners policy. A 12% commission, which is $600, multiplied by 1,000 customers equals $600,000 in commissions. Let’s further assume the policies have expiration dates that fall equally around the calendar. Also, let’s assume this is all direct bill business and the carrier pays upfront, a quite common reality. That means $300,000 of the commissions are unearned and must be returned by the agency.

Would you have $300,000 in the bank to return to the state?

Don’t Do Business With Weak Carriers

The first lesson is to not do business with weak carriers. The property/casualty industry has become more robust over the last 25 years, and a substantial portion of the people in the industry today have no working knowledge of insolvencies and weak carriers. They do not remember the fiascos from the ’90s where some sizeable P/C carriers went insolvent overnight. Insurance companies, regulators and rating companies all became more serious at that point relative to carrier financials.

The unbelievably low interest rates and hot stock market have enabled carriers that would likely have failed to be sold early. The net result is the industry has lost institutional knowledge and has become complacent.

This combination has resulted in agencies not paying as much attention to whether or not the carriers they write with are unstable, even if they have a decent rating. (By stable, I am not suggesting they do not have the correct financial wherewithal per the regulatory and rating parameters relative to claims paying abilities — but for so many carriers to go out of business recently in short order, one should look a little closer).

I currently find that many people have zero knowledge of what happens when an insurance carrier insolvency occurs and they do not even know that state guaranty funds exist, much less what they cover or how they process claims. Many people trust the government agencies to take care of it. Keep your fingers crossed so that you can continue to not think through the problems that an insufficiently staffed, much less insufficiently funded guarantee fund can cause an agency.

I would also be cautious about assuming the state DOI can simply assess enough money and collect enough money to quickly solve the shortfall. I am not sure how the DOI can assess carriers that are already broke or nearly broke and actually claim receipts. I saw one do that recently though.

And then of course, the DOI may want you to repay your unearned commissions.

Maintain Accounts Correctly

The second lesson is to maintain your accounts correctly so that if something like this happens, you have the current numbers so you can manage your cash properly. I have written extensively about the magnitude to which agents and advisors misunderstand trust laws.

Two sets of laws exist. The set most familiar to agents and some advisors is the commingling of funds laws and regulations. These rules prohibit agencies from commingling their operating monies and their trust monies. Only about 14 states have commingling laws.

Agents and advisors in the other states then proclaim, “We’re not a trust state so we don’t have to worry about trust monies!” That conclusion is seriously wrong.

All 50 states and the federal government have trust laws. A trust law is not the same thing as a commingling law. What those states do not have is a commingling law, but they do have trust laws.

A trust law stipulates that an agency cannot spend money it is holding on a fiduciary basis. Agency bill business is a good example whereby the agency collects money upfront but does not immediately submit that money to the carrier. While it is holding the money, it is acting in a fiduciary capacity and is responsible for not spending that money. An agency that is “out of trust” is an agency that has spent fiduciary monies.

This is why the trust ratio is THE MOST IMPORTANT balance sheet ratio applicable to insurance distributors.

Failure to be in trust may automatically trigger a clause contained in most carrier contracts that stipulates that if the agency is out of trust, the carrier immediately gains ownership of the agency’s expirations. No notification. The fact that you paid your premiums on time is a moot point.

Fiduciary monies also include money held on behalf of carriers, audit returns, and sometimes commissions that are unearned. A relatively new accounting rule, ASC 606, applies to insurance agencies and brokers. Agencies and brokers are now supposed to account for all commissions on an accrual basis. While the purpose of the rule was not to support proper trust accounting, it does so anyway.

Your accountant needs to understand the importance of insurance distribution accounting and how it differs materially from other types of businesses’ accounting requirements.

Unearned commissions are a form of fiduciary monies. The carrier has paid a commission upfront in the expectation that the agency will perform its duties throughout the year. In an insolvency, that carrier is often taken over by the state. The state may demand, as Florida recently did, the return of those unearned commissions. Failure to return the unearned commissions may then result in the loss of ownership of the agency’s expirations.

What do you do if you have no choice but to represent weaker carriers? First, truly assess whether you have no choice.

I have clients writing in the same cities where one declares they have no choice and the other determines they do have a choice. The former is usually only interested in making sales, sales and more sales. In their minds, they have no choice because to continue to make order taker level sales, they need any and every carrier available because order takers and peddlers sell price.

If the situation is more extreme and the agency truly has no choice, be sure you are effectually notifying your clients of the carriers’ ratings, do your accounting correctly, and LEAVE EXTRA CASH in the agency. Do not take all the cash out even if your accountant advises differently. The accountant needs a better understanding of the situation and should not be making recommendations purely on the basis of taxes. You will not have to worry about taxes if you go out of business. Protect your agency and leave a little extra cash in it, especially if you are writing with carriers you think might be weak.

Topics Carriers

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Insurance Journal West August 15, 2022
August 15, 2022
Insurance Journal West Magazine

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