US Patent Submitted – Patent Pending for Missing Link in Insurance Industry

After the considerable amount of work undertaken by our patent attorneys, a patent application was filed on October 11, 2016 with the U.S. Patent & Trademark Office for P&C Insurance Trust Automation and Financial Solvency Management technology. Two inventors take credit for the development of this unique product: Chris Marinescu and Emma Hart.

Chris Marinescu, President of Paulmar Software, Inc. stated: this product represents the “missing link” of P&C insurance agency automation. While not competing with current agency management systems, such as: AMS or Applied Systems, this product will easily integrate with them for complete automation of P&C agencies.  By fostering the outsourcing of agency’s trust account management, this product paves the way to rapid organic growth, higher productivity and increased profit performance. A significant advantage for both P&C producing agencies and insurance companies will follow as agencies will be able to focus solely on sales and service.

This product brings to the market a new fiduciary accounting concept for P&C insurance premium and return premium trust funds, fundamentally different from business accounting. A new trust financial solvency reporting system has been developed and included.

The introduction of this product into the marketplace will change the management paradigm of the P&C insurance brokerage industry and help it become leaner and significantly more efficient.    

To learn more about this product, go to www.paulmargroup.com/missinglinkpatent Or contact Emma Hart at emmahart@paulmargroup.com or 949/233-2545.

P&C INSURANCE AGENCY AUTOMATION

PREMIUM TRANSACTIONS ARE STILL MANAGED MANUALLY!

 

Much is being said about insurance agency automation. Not enough has been said or done to help the agency owners automate premium and return premium transactions. The general perception is P&C agencies are just sales and service operations. Mostly ignored is the fact that the undertaking of trust financial duties makes P&C agencies operate much like financial institutions.

Financial Institution?

Small agencies receive and disburse on the average $3 to $5 million annual premiums. Medium size agencies’ annual premium is close to $15 million or more while large agencies’ financial traffic through their trust bank accounts may exceed $50 million a year. We know mega insurance brokerage houses transact hundreds of million dollars every year. None, regardless of their size, is equipped with financial management tools necessary to handle such an intense financial traffic.

This article is not however about agency financial management. Few recognize insurance agencies as financial institutions. It is the automation question we would like to address in this paper. Known as sale and service operations, insurance agencies are well equipped to manage customers and marketing, rating and claims. The problems they have struggled for more than 40 years remained to this day without solutions.

Automation Shortcomings

The shortcomings of insurance agency’s operation are not in the front office but in its back office. They hinder agency’s organic growth and its profit performance. Here is a sample of them:

1.    The follow-up on delinquent invoices is still manual; this affects primarily the agency’s CSRs (account managers);

2.    Endorsement AP invoices and follow up are still manual; many invoices are easily neglected by CSRs who have much more important things to care for;

3.    Agency “earned” commission is a problem affecting all P&C insurance agencies. Being unable to determine it, agencies incorrectly transfer commission funds to the business operating account based on what they “need” rather than what they “earn”;

4.    Company Statement reconciliation is still manual, although not entirely;

5.    Cancellation endorsement reconciliation is still manual; return premium refunds are simply reduced to “paying negative invoices”;

6.    Direct Bill Commission statement reconciliation is still manual. Many agencies prefer not to do it and therefore lose control over their DB commission income;

7.    The NSF check process is manual; most agencies delay or fail to request policy cancellations for non-payment of premium when payment checks are return for insufficient funds. Losses due to NSF checks can be significant;

All these processes are or should be performed in the agency’s back office. The front office is critical because it develops the agency business but a weak back office will hinder growth and diminish profits. Since trust account operation is highly regulated, the danger of fiduciary violations is not only real but always present. Some details follow.

Invoice Follow-up

Agency receivables are a primary source of trust financial insolvency. Delinquent payments disqualify an agency from timely “earning” its sale commission. In egregious cases, they can be the source of serious “earned premium liabilities”. By signing the Company-Broker agreement, agencies are obligated to remit premiums, net of commission, to insurance companies or MGAs, whether or not they receive such premiums from insureds.

Insurance customers must pay premiums on or before their due dates (as set forth by insurance companies). Despite a well-established standard, agencies continue to have “aged receivables” in excess of 30, 40 or even 60 days and risk earned premium liabilities.  For any $1,000 earned premium liability turned into a $1,000 loss, an agency must sell 8 to 10 times more premium.

Current agency management systems have not automated the invoice follow-up process.

Endorsements AP

Agencies do not maintain records of endorsements AP in the policy database. They just invoice them. Since the endorsement AP invoice is still a manual operation, CSRs may easily neglect it. It is not uncommon to see endorsement papers sitting in a box waiting to be invoiced. Delinquent endorsement payments may cause agencies to advance premiums to companies and risk losses due to non-payments.

Current agency management systems have not automated the endorsement AP invoice and follow-up.

Agency Commission

Agency commission on sales is the very reason insurance agencies are in business. The difficulty of having it easily available is a real nuisance; the sale commission is realized in the agency trust not in the sale and service operation area of business. To transfer it to the business operating account, agencies must determine it and then create an audit trail. Trust funds are regulated to prevent illegal disbursements. The problem is aggravated by the fact that sale commissions are embedded in every payment an agency receives and deposits in the agency trust. 

None of the agency management systems on the market today offers agencies the tools to determine the “earned” commission.  Many agencies use separate spreadsheets to track payments and related commissions. Since this is labor intensive and generally unreliable, most agencies transfer commission funds to the business operating account generally based on what they need to cover operating expenses.

Commission transfer out of the agency trust bank account is the second most important source of trust financial insolvency. If agencies transfer more than they earn, they violate insurance fiduciary duty and risk legal consequences.  If they transfer less, they may understate taxable income and risk IRS audits.

No current agency management system offers insurance agencies help in processing the agency sale commission and its transfer to the agency’s business operating account.

Co Statements

The processing of Co Statements or MGA invoices is only partially automated. Agencies use AMS, Applied Systems or similar agency management software, to manually reconcile the company statements by verifying statement line items against the agency’s invoice payments. Paid invoices are checked for company remittance and included on a computer-generated list (voucher) that is attached to the remittance check along with the Co Statement.

Company Statement premium items that are not paid (remitted) are manually identified on the Statement along with an explanation.

The Co Statement manual reconciliation is tedious and labor intensive.

Cancellation Endorsements

Most cancellation endorsements result in return premium to be refunded to either insureds or premium finance companies. In current practice, the cancellation endorsement process is misunderstood. Interpreted as “returned merchandise”, return premiums are processed as negative invoices neglecting that, before writing a refund check, the agency must receive from the insurance company the return net premium and from the agency’s business operating account the “unearned commission”.

While “unearned” net premium is generally reimbursed on Co Statements as credit, seldom or never agencies return to the agency trust account the “unearned commissions”. Agencies will refund from the trust account return “gross” premiums without returning/reimbursing first the “unearned commissions”. The difference will illegally come from premiums received under different policies.

No agency management software has offered insurance agencies automated procedures to manage cancellation endorsements and related premium refunds.

Direct Bill (DB) Commission

The reconciliation of DB Commission Statements is tedious and time consuming. The DB policy commission may be paid by insurance companies either in full after the down payment is received or gradually as installments are paid by insured. Keeping track of DB commission payments is a real challenge. Many agencies trust the insurance Company. Reconciliation is too expensive and is therefore not done. 

No agency management system today offers insurance agencies an automated reconciliation of DB Commission Statements. Some third party software companies have developed reconciliation software but their integration with AMS, Applied Systems or similar software applications continued to be a real challenge.

NSF Checks

NSF checks do occur and can be quite aggravating, especially if an agency advanced premiums, net of commissions, to insurance companies. To avoid “earned premium” liabilities, agencies should immediately request the policy cancellation for non-payment of premium. If they do not, the policy continues to “earn” premium until it is cancelled. According to the Company-Broker Agreement, all “earned premiums” must be paid by the agency.

Some agencies do request policy cancellations following NSF checks but many do not. No agency management system offers agencies an automated NSF process.

 

Final Thoughts

The latest research and development effort lead to the development of a massive premium database encompassing all elements of premium and return premium transactions: policy transaction, billing, payments and bank deposits, agency commission, company remittance, return premium credit and refunds, DB policy commission.

Intense programming of premium and return premium transactions has resulted in the achievement of some major automation goals. Here are the agency’s back office functions that are now fully automated: 

1. Premium invoice and follow-up;
2. Endorsement AP billing and follow-up;
3. Agency commission income process;
4. Company Statement process;
5. Cancellation endorsement reconciliation and premium refund process;
6. DB policy commission statement reconciliation;
7. NSF check processing.

For more information on these achievements, contact Chris at chris@paulmargroup.com or visit www.paulmargroup.com.

Article written by Chris Marinescu, President of Paulmar Group LLC.

INSURANCE TRUST (FIDUCIARY) ACCOUNTING:

WHY IS IT DIFFERENT FROM STANDARD TRUST ACCOUNTING?

For more than 40 years P&C insurance premium accounting has remained an industry problem without solution. Insurance retailing agencies continue to struggle managing premium funds. The attempt to use financial accounting for premium accounting has failed. Finally, the long overdue solution has been found. Insurance Trust Accounting is however not the same as standard trust accounting. This paper explains why.  

1      Financial Accounting for Premium Funds

Financial accounting is used to keep track of a company’s financial transactions. Its concept and rules are well understood by those who practice it. It has been used by professionals in all sectors of the economy.

Many years ago financial accounting was adapted by the Property & Casualty (P&C) insurance industry to keep track of premium and return premium financial transactions.

Standard accounting methods have not been very useful in the P&C industry mainly because, upon deposit in the agency trust bank account, insurance premium and return premium funds become fiduciary funds. As fiduciary funds, insurance premiums are subject to a financial management different from that of business operating funds.   

The difference between the premium fiduciary funds’ economic nature and that of business operating funds has not been well recognized by insurance professionals and, as a result, no effort has been made to this day to develop a suitable accounting method for these funds. It has become apparent the management of P&C insurance premiums has different rules and requires different accounting procedures.

Accounting methods and financial management of fiduciary funds in other industries, such as real estate or legal profession, did not prove to be a good model. The one thing that emerged useful was the need for separation of fiduciary funds from business operating funds. Real estate brokers, for example, employ outside escrow companies to manage real estate trust funds.

2      Insurance Trust Accounting

Little or nothing is known about P&C Insurance Trust Accounting. In current practice trust accounting is generally associated with the escrow or lawyers’ trust accounting. The need for trust accounting in the P&C insurance industry has not been widely recognized likely because P&C insurance agencies are considered merely sales and service operations, not financial institutions. Insurance fiduciary duty is however on the books and is mandatory for all insurance agents and brokers who receive premium payments under insurance policies or premium finance agreements.

Aware of fiduciary duty mandates, P&C insurance agencies have been waiting for an accounting solution that could help them manage the agency’s trust account operation. Current agency management systems, such as AMS or Applied Systems, have not addressed to this day insurance agency’s need for insurance fiduciary accounting.

Insurance Trust Accounting is not taught in college; there are no text books on insurance premium accounting and trust financial management. Insurance agencies are currently required to manage financial traffic varying from a low $5 million in small agencies to $100 million or more in large agencies.  This financial operation would logically qualify them as financial institutions; no one in the industry recognizes them as such.

3      Insurance Fiduciary Duty

Most commercial insurance products are retailed through the independent agency system, a community of independent insurance agents and brokers appointed/approved by insurance companies and/or general managing agencies. Insurance companies grant insurance agencies the right to receive transacted premiums and maintain them in agency-owned trust bank accounts.

Independent P&C insurance agencies, whether retailing or wholesaling, agree on a voluntary basis to receive transacted premiums from insureds or finance companies and maintain them in trust bank accounts of the so called “pooled” type. The designation refers to the fact that premium funds received under more than one policy or from more than one insured are maintained in a single common trust bank account.

Since premium funds are owned by others, insurance brokers agree to receive them in a fiduciary capacity and become “trustees” or “custodians” of funds until they are disbursed to legal owners.

4      Insurance Trust Financial Management

Trust financial transactions are numerous and complex. In the beginning money flows from insureds to the agency’s trust account, to insurance carriers and to agency business operating account. During the policy term, a policy cancellation may reverse the flow from insurance carriers and agency operating account to the agency trust account and back to the insured.

Keeping track of such flow of money requires good financial management. That is why insurance trust account management may be referred to as “money management” or “trust financial management”.

The ultimate objective of trust financial management is to monitor, control and report trust financial solvency. As in business for profit, trust financial solvency management implies control over the trust assets to prevent disbursements of funds to entities other than those legally entitled to them. In California, misappropriation of premium trust funds for personal use or to cover agency operating expenses is punishable by a loss of business license and/or theft as provided by law. Similar provisions are included in the Insurance Codes adopted by other States.

The Company-Broker Agreement places on insurance brokers the responsibility to remit to the insurance company transacted premiums, net of commissions, whether or not they received such premiums from insureds. The brokers’ legal obligation is referred to as “transacted liability”. Unless the policy incoming premium flow is properly managed, the agency is liable for transacted premiums, net of commissions. For this reason, trust account management may be also understood as “fiduciary liability management”.

5      Daily Financial Transactions

Capturing premium daily transactions in accounting records is fundamental to Insurance Premium Accounting. Such transactions include: policy transaction/sale closing, invoices and payments of premium, bank deposits, agency earned commission and its transfer to the operating account, company premium remittance, net of commission. Everyone is a financial transaction taking place in the insurance trust and, for this reason, they all must be recorded in a trust ledger, separate from the agency general ledger. On the way back to insured, return premiums must be also recorded in the trust ledger: return premium reimbursements, net of commission, agency unearned commission reimbursements and return premium refunds to insureds of finance companies.

Accounting transactions become much more complicated when, after a down payment, the policy premium balance is financed. The financed amount remitted directly to an insurance company is a financial transaction that takes place outside the agency trust account; nevertheless, accounting records of this transaction are necessary because insurance brokers are legally responsible for all policy financial transactions, whether inside or outside the agency trust account. 

6      Financial Accounting Engine

Financial accounting keeps track of a company’s financial transactions, creates accounting records and summarizes them in two financial statements: Balance Sheet and Income Statement. The engine of financial accounting is the sale invoice which creates income and assets, cash or receivables, in the seller’s general ledger.

The business invoice is an instrument of sale, whereby a buyer acquires a merchandize or service in exchange for a sale price. Invoice accounting marks the beginning of financial accounting.

Insurance Trust Accounting is powered by a different engine: the policy. Its objective is similar to that of cost accounting. It does not compute insurance policy cost (this was already established) but in a similar way manages the incoming and outgoing flow of money related to a single insurance product: the policy.

That is why Insurance Trust Accounting may be also understood as Insurance Policy Accounting.

7      Invoice vs. Insurance Policy

Is the business invoice as relevant in the P&C insurance industry as it is in other industries? The answer is an emphatic NO. It cannot be because, in the P&C insurance industry, the invoice is not an instrument of sale; the insurance policy is.

The sale of insurance products is consummated upon the binding of insurance policies. In this industry, premium invoice is just a document that reminds insureds to pay a premium they already agreed to when the policy was signed.

One may want to compare the premium invoice with the loan coupon used in the lending industry to remind borrowers to send a payment.

The financial status of insurance policies is the core objective of premium accounting in the same way a bank depositor’s account is in banking accounting. Banks know and are able to report the account balance of each of its bank depositors.

8      Insurance Trust Accounting Equation

P&C Insurance Trust Accounting cannot be the same as business accounting. The business invoice process does not exist or is very different in policy transactions. There is no income in the P&C Insurance Trust Accounting, only assets and liabilities. The accounting equation is simply reduced to Trust Assets = Trust Liabilities. There is no agency owners’ equity in a P&C insurance trust.

9      Why Agency Owners Need Insurance Trust Accounting

80% or more of the agency accounting effort is related to insurance premium accounting. Absent premium funds, P&C agency financial accounting is relatively simple. P&C agencies have no inventories and few are involved in transactions other than insurance policy transactions.

A fully automated Insurance Premium Accounting will significantly reduce the agency workload while providing the means to fully control and report the agency’s trust financial solvency. Insurance Premium Accounting: 

1. Automates the premium billing and follow up process, currently considered the first most critical source of trust financial insolvency;
2. Eliminates receivables aging as inconsistent with required insurance premium payment on or before the coverage becomes effective. As a result, earned premium liabilities are eliminated;
3. Introduces the concept of “cash on hand” vs. “cash in the bank” to prevent theft in the handling of payment checks;
4. Automatically determines and reports agency “earned” commissions for full control over the commission funds transfer to the operating account. Mismanagement of agency commission income is considered the second most important source of trust financial insolvency;
5. Improves the Company Statement processing through automatic reconciliation and generation of remittance check vouchers;
6. Reconciles cancellation endorsements and automatically processes premium refunds to insureds or finance companies;
7. Reconciles Direct Bill Commission Statements, currently a labor intensive process;
8. Creates a commission reserve account in the agency trust to simplify the reimbursement of unearned commission to the trust account;
9. Reports agency production based on sales along with agency and producer transacted commission income;
10. Reports the agency trust financial solvency of each policy, each insurance company and entire agency trust. 

10   How Insurance Companies Benefit From Insurance Trust Accounting

Insurance companies’ business prospers when producing agencies sell more and are able to minimize the cost of managing premiums. Using Insurance Trust Accounting, producing agencies will offer insurance carriers real benefits:

1.         By controlling receivables and having the Company Statement process fully automated, delinquency of premium remittance can be entirely eliminated;
2.         Company bad debts/write offs will be also eliminated if remittance delinquency is eliminated;
3.         Carrier’s in-house workload will be reduced if producing agencies’ remittance process is automated;
4.         Workload reduction will reduce carriers’ operating costs;
5.         Carriers will be able to directly verify the solvency of premiums maintained by producing agencies.

P&C insurance industry will become more productive and more efficient if both carriers and producing agencies can improve the management of insurance premium funds. Insurance consumers will also benefit from a better service and possibly lower premium rates if the industry can operate more efficiently.

Insurance Trust Accounting is currently being offered to P&C insurance retailers. For more information, visit www.paulmargroup.com or contact chris@paulmargroup.com.  

Article written by Chris Marinescu, President of Paulmar Group. Copyright by Chris Marinescu, July 12, 2016