Insurance Trust Account Management: Can an Agency Survive without it?

(This article appeared in Agency Equity on June 12, 2013)

There is no question a P&C insurance agency business can survive without formal management of its trust account. A real estate broker’s business would not. Real estate brokers hire escrow companies to do it safely and accurately. Fiduciary violation of an escrow account is unacceptable to a real estate broker. Not so with insurance brokers. They proved to survive insurance trust account difficulties without outside help and no formal management.

Trust Account Management
In a previous article published by Insurance Journal I argued trust account management was ultimately financial management. An average agency’s trust account is busy receiving and disbursing millions of dollars, $5 to $10 million in small and medium agencies, $50 million or more in large agencies.

An insurance policy transaction is in some ways similar to a loan transaction. The loan amount goes on the books and the lender monitors the payoff amount on a continuous basis. In the same way an insurance broker transacting a $10,000 policy monitors its progress to the end of the policy term: how much was invoiced, how much was paid, how much was remitted to the carrier, how much commission was transferred to the operating account, etc?

Actually, this is what insurance brokers would do if agencies truly practiced formal management of premium trust funds.  In fact, agency managers never ask these questions. What matters is to know if invoices were paid and whether net premiums were timely remitted to carriers. It appears the overall policy financial management has not been of concern to agency managers.

Formal Management
Insurance Code mandates insurance brokers to manage premiums policy by policy. One cannot use the premium received on one policy to remit it on a policy underwritten by a different carrier. Each policy therefore should be financially managed to show solvency.

Insurance Code defines financial solvency very vaguely.  In California, Section 1734 of the Insurance Code requires brokers to maintain in the trust account at least the amount due to the “persons entitled thereto”. The Insurance Commissioner clarified the requirement for individual policy financial management to prevent one carrier’s funds to be remitted by the broker to another carrier.

Formal trust account management may be defined as policy financial management based on information stored in accounting records. An agency may practice formal management by using spreadsheet information but this is at best, unreliable. Only accounting records are guaranteed reliable as they are based on “double entry” procedures and therefore difficult to erase or edit at will.

General Ledger Accounting
Attempts to generate usable information for formal trust account management have failed. The inadequacy of General Ledger (GL) accounting’s to create accounting records of policy transactions, the legal sale documents of insurance products, should be considered as the main reason. In merchandise accounting the invoice is a sale document; that is why an invoice generates accounting records: “assets” in the seller’s balance sheet and “income” in the P&L statement. Not so with an insurance policy sale transaction.

There are other issues with using GL accounting for premium transactions. For example, sales commission on a premium invoice is declared “income” to the agency’s operating account when in fact it is only a “liability” in the trust account. Everything related to a premium invoice should be clearly understood as a “trust” transaction with “receivables” due to the trust account. Invoice payments are deposited in the trust bank account and net premiums are remitted out of the same trust account. The practice of declaring an invoice’s sales commission as “income” to the operating account reflects the GL accounting’s inability to represent, in accounting terms, the true business nature of premium transactions.

Additionally, GL accounting treats “return premiums” as “returned merchandise” and creates awkward accounting records, such as “negative” premium receivables and “negative” income”. Insurance professionals understand a return premium refund is conditional upon “receivables”, such as: return net premium from the carrier and “return commission” from the agency’s operating account.

Trust Ledger Accounting
A formal management of insurance trust account can exist only if different accounting is used to create records of premium and return premium transactions. This new accounting has been developed as part of Paulmar’s Insurance Trust Account Technology. Premium funds have been taken out of the agency’s general ledger and placed into a separate “trust” ledger of accounts. This is why Paulmar branded the new accounting procedures as “Trust Ledger Accounting”.

Trust Ledger (TL) Accounting starts with the premium transaction itself and continues to manage it as the premium is invoiced, paid, deposited in the bank and disbursed either as net premium to carriers, sales commission to the agency operating account or premium refunds to insureds or premium finance companies.

Chris Marinescu is president of Paulmar Group LLC, a software developer and insurance trust account service provider. Insurance Trust Account Technology, Trust Ledger Accounting and Trust Account Management Outsourcing Technology are trademarks of Paulmar Group LLC.