Thursday, June 27, 2013
Fiduciary Task Management PART 1: Insurance Fiduciary Duty
Join me for a 2-hour CE Class on insurance fiduciary duty, August 7, 2013 at the IIABOC quarterly meeting. For more information and to register visit the IIABOC website: http://goo.gl/pFLRe
Thursday, June 13, 2013
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.
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.
What Is an Insurance Broker’s Biggest Pain?
(This article appeared in Agency Equity on May 29, 2013)
The title of this paper is paraphrased from a question recently posted as a topic for discussion on an Insurance Journal forum. Among the sources of pain mentioned by respondents was premium billing, cancellations for non-payment of premium, reinstatement of policies canceled for non-payment and frequent policy premium changes by carriers. It is important to note that all these issues happen to be related to the agency’s back office and insurance trust account daily activities.
With this article I would call attention to other known concerns to most agencies. What I have in mind is a number of trust account management functions currently missing from even the most advanced agency management systems. It suffices mention agency commission management, processing of return premium refunds and trust account financial solvency reporting. The latter is important not only because proof of trust account solvency is required by law but also because insolvency can have serious consequences for agency business. In California, a large number of insurance brokers, possibly one in three, are suspected to operate “out of trust” jeopardizing their business license and potentially risking legal prosecution for theft.
No Attention to Financial Solvency
The forum discussion’s lack of attention to the broker’s fiduciary duty is not surprising; it is common throughout social media and group discussions. Recent court cases of trust account insolvency in California should raise the level of brokers’ awareness as they likely caused real pain to some agency owners.
The apparent lack of interest in trust account solvency issues may be explained in different ways. It may be the lack of awareness of the fiduciary position brokers find themselves in when receiving and maintaining transacted premiums in their own “trust” bank accounts. Financial solvency issues are not routinely discussed by industry consultants; they are not included in Continuing Education classes (except for the two CE classes offered by Paulmar Group). Colleges offer degrees in insurance but no classes on trust account financial management. The brokers’ license renewal process requires no proof of fiduciary duty compliance. The Broker-Carrier agreement may be the only document requiring insurance brokers to maintain financially solvent trust accounts.
Causes of Insolvency
Trust account insolvency may be caused by either uncontrolled premium payment delinquency or lack of commission accounting and financial management (cases of intentionally caused insolvency are beyond the scope of this paper). Payment delinquencies are not caused only by clients’ inattention to writing payment checks but also by the agency’s inability to promptly follow up.
Endorsement billing is frequently behind because agency’s CSRs’ main job is to reliably support producers and provide quality customer service. The lack of commission accounting and management tools capable of tracking earned commission, policy by policy and payment by payment, is certainly a source of insolvency and pain. Since no current agency management system provides such utilities, some agencies use spreadsheets to determine the agency earned commission. By transferring commission based on needs, agencies may transfer either more or less than they earn. In the first case they violate insurance broker’s fiduciary duty. In the second case they may unintentionally understate taxable income and risk Tax Code violations.
Incorrect Accounting?
With no clear understanding of insurance fiduciary duty, insurance brokers feel comfortable with the use of general ledger accounting for both business operating and premium funds. As fiduciary duty is better understood, insurance brokers will come to realize general ledger accounting is inadequate for premium and return premium transactions. Since agency management systems are not likely to change their premium accounting and CPAs’ practice seems limited to general ledger accounting, insurance brokers will remain unaware of their exposure to daily violations of fiduciary duty. I am sure insurance brokers would like to do everything required to meet their fiduciary obligations but lacking accounting and financial tools they can only rely for advice from industry consultants and CPAs.
An agency’s chances of violating fiduciary duty are ubiquitous. Unquestionably insurance brokers deserve better premium accounting and a reliable financial solvency reporting system. New technology has been developed to help them in this area of agency business. For information on insurance trust account financial solvency management send email to chris@paulmargroup.com.
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.
The title of this paper is paraphrased from a question recently posted as a topic for discussion on an Insurance Journal forum. Among the sources of pain mentioned by respondents was premium billing, cancellations for non-payment of premium, reinstatement of policies canceled for non-payment and frequent policy premium changes by carriers. It is important to note that all these issues happen to be related to the agency’s back office and insurance trust account daily activities.
With this article I would call attention to other known concerns to most agencies. What I have in mind is a number of trust account management functions currently missing from even the most advanced agency management systems. It suffices mention agency commission management, processing of return premium refunds and trust account financial solvency reporting. The latter is important not only because proof of trust account solvency is required by law but also because insolvency can have serious consequences for agency business. In California, a large number of insurance brokers, possibly one in three, are suspected to operate “out of trust” jeopardizing their business license and potentially risking legal prosecution for theft.
No Attention to Financial Solvency
The forum discussion’s lack of attention to the broker’s fiduciary duty is not surprising; it is common throughout social media and group discussions. Recent court cases of trust account insolvency in California should raise the level of brokers’ awareness as they likely caused real pain to some agency owners.
The apparent lack of interest in trust account solvency issues may be explained in different ways. It may be the lack of awareness of the fiduciary position brokers find themselves in when receiving and maintaining transacted premiums in their own “trust” bank accounts. Financial solvency issues are not routinely discussed by industry consultants; they are not included in Continuing Education classes (except for the two CE classes offered by Paulmar Group). Colleges offer degrees in insurance but no classes on trust account financial management. The brokers’ license renewal process requires no proof of fiduciary duty compliance. The Broker-Carrier agreement may be the only document requiring insurance brokers to maintain financially solvent trust accounts.
Causes of Insolvency
Trust account insolvency may be caused by either uncontrolled premium payment delinquency or lack of commission accounting and financial management (cases of intentionally caused insolvency are beyond the scope of this paper). Payment delinquencies are not caused only by clients’ inattention to writing payment checks but also by the agency’s inability to promptly follow up.
Endorsement billing is frequently behind because agency’s CSRs’ main job is to reliably support producers and provide quality customer service. The lack of commission accounting and management tools capable of tracking earned commission, policy by policy and payment by payment, is certainly a source of insolvency and pain. Since no current agency management system provides such utilities, some agencies use spreadsheets to determine the agency earned commission. By transferring commission based on needs, agencies may transfer either more or less than they earn. In the first case they violate insurance broker’s fiduciary duty. In the second case they may unintentionally understate taxable income and risk Tax Code violations.
Incorrect Accounting?
With no clear understanding of insurance fiduciary duty, insurance brokers feel comfortable with the use of general ledger accounting for both business operating and premium funds. As fiduciary duty is better understood, insurance brokers will come to realize general ledger accounting is inadequate for premium and return premium transactions. Since agency management systems are not likely to change their premium accounting and CPAs’ practice seems limited to general ledger accounting, insurance brokers will remain unaware of their exposure to daily violations of fiduciary duty. I am sure insurance brokers would like to do everything required to meet their fiduciary obligations but lacking accounting and financial tools they can only rely for advice from industry consultants and CPAs.
An agency’s chances of violating fiduciary duty are ubiquitous. Unquestionably insurance brokers deserve better premium accounting and a reliable financial solvency reporting system. New technology has been developed to help them in this area of agency business. For information on insurance trust account financial solvency management send email to chris@paulmargroup.com.
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.
Subscribe to:
Posts (Atom)