Groundbreaking Accounting System for the Insurance Industry

Why Creating/Inventing It Was Necessary

In my previously published papers, I repeatedly argued against the improper use of general ledger business accounting for insurance premium and return premium transactions. I reached this conclusion after years of studying the P&C agency trust accounting and its governing standard.

Insurance fiduciary duty and its profound implications upon the P&C insurance agency’s financial operation have apparently received little or no attention from the agency owners or vendors of agency management systems. I presumed this attitude was likely encouraged by a belief that the trust account operation is so complex that no one would have knowledge or skill to capture it in accounting records.

To those unfamiliar with Sections 1733 and 1734 of the CA Insurance Code, P&C insurance agencies must not only maintain premiums and return premiums in separate “trust” bank accounts but also manage them in compliance with fiduciary laws. Due to its inherent limitations to business operations, general ledger accounting has apparently obscured the meaning of “insurance fiduciary compliance” and, as a result, no one has attempted to break outside its conceptual boundaries.

Understanding the risk of failure but confident a solution will be found, I put together a development team and embarked in a long and tedious effort to create/invent a new trust accounting system for the P&C insurance industry.

The natural thought barriers raised by general business accounting were so high that we had to think completely out of the box in tackling the development of a new accounting system. These barriers are briefly reviewed in this paper because their removal became the foundation blocks of the new insurance trust accounting.

Barrier No. 1: Invoice Accounting

Insurance agencies have always used general ledger (business) accounting for premium transactions because they thought they were no different from merchandise or service sales. General business accounting begins with the seller billing the buyer for merchandise or service purchases. The invoice generates “assets” and “income” in the seller’s general ledger.

 The first barrier to overcome was the concept of current premium invoice accounting. In general ledger accounting the “invoice” is a “sale” document. In the P&C insurance the “sale” document is not the premium invoice but the insurance policy. The premium invoice is only a reminder to pay what insured had already agreed to when the policy coverage was bound.

Foundation Block No 1: Insurance premium accounting must begin with the policy transaction, not premium invoice.

Barrier No.2: Assets and Income Accounting

Upon receipt, fiduciary law requires premium payments to be deposited in a fiduciary “trust” bank account. They become fiduciary funds. If payments must be deposited in trust it is only logical that the premium invoice must also originate in trust. In an insurance trust, however, there is no “income”, only assets and liabilities. A premium invoice originated in an insurance trust will therefore generate premium assets, receivable from insured, and premium payables, premiums, net of commission due to insurance carriers, and sales commission due to the agency operating account.

Foundation Block No. 2:  In premium accounting an invoice generates trust assets and trust liabilities. The general ledger invoice model is incompatible with insurance premium accounting.

Barrier No. 3: Different Management Objectives

The main purpose of business accounting is to report profit/loss and help the agency determine its tax liability. An agency Balance Sheet includes business assets and liabilities necessary to establish the agency’s financial solvency.

Premium fiduciary accounting has completely different objectives, all related to the need to monitor and control the trust financial solvency:

• Generate a separate Trust Balance Sheet;
• Balance Sheet data will be utilized to established the Trust Financial Solvency;
• Generate a Premium Float Statement (aka Statement of Premium Receipts and Disbursements);
• Premium Float Statement data will be utilized to report Trust Funds Beneficiaries;
• Generate financial reports at all three levels of trust financial management: policy, carrier and agency.

Foundation Block No. 3: Insurance premium accounting must facilitate the reporting of trust financial solvency. Business accounting is incompatible with insurance premium accounting.

Barrier No. 4: Return Premium Accounting

In general business accounting, returns of merchandise are entered in the general ledger as negative invoices, i.e., creating negative assets and negative income.

Insurance return premiums are not merchandise returns; they are premium transactions in “reverse”, i.e., from insurance companies back to insureds. Return premium transactions generate “receivables” and “payables” in the same way premium transactions do. The only difference is receivables are due from insurance companies and agency, while payables are due to insureds and/or finance companies.

Return premium accounting is as complicated, if not more complicated than premium accounting. 

Foundation Block No. 4: Insurance return premiums generate receivables and payables in the insurance trust, in the same way premium transactions do. The returned merchandise concept is incompatible with insurance premium accounting.

Barrier No. 5: Funds Transacted Outside Agency Trust Account

Premium financing is routinely practiced in the P&C insurance industry. Agencies set up loans to finance an unpaid premium balance after the insured makes a down payment. The financed amount may be either paid to the agency or remitted directly to the insurance company/general managing agency. In the case of policy cancellations, often resulting in return premiums, the insurance company refunds the “unearned premium, net of commission” to the premium finance company, while the agency returns “unearned commission” to the same.

Direct remittance and direct refund transactions bypass the agency trust account. However, insurance fiduciary accounting must include the financial records of both direct remittance and direct refund because, by statue, the insurance agency is ultimately responsible for all policy financial transactions.

Foundation Block No. 5: Insurance premium accounting must include direct remittance and direct refunds.

Barrier No. 6: Financial Solvency Reporting

There is no concept of trust financial solvency in current practice. This is because general ledger accounting does not report it. Agency owners are unable to verify the trust financial solvency for which they are personally responsible. Because the general ledger accounting does not support trust financial solvency reporting, CPAs use formulas. No formula has been proposed for establishing the trust cash financial solvency.

Foundation Block No. 6: Insurance premium accounting must report the trust financial solvency at all three levels required by fiduciary laws: policy, carrier, and agency.

Final Thoughts

The development effort of more than 12 years has resulted in the creation/invention of a new and long overdue insurance premium accounting. Referred to as Insurance Fiduciary (Trust) Accounting or Trust Ledger (TL) Accounting, this unique accounting system will assist agencies in managing both daily trust operations and trust financial solvency.

The current lack of premium and return premium accounting has been a major cause of financial insolvency of agency P&C trust funds. In California, violations of insurance fiduciary duty expose agency owners to a loss of business license and/or potential prosecution for theft.  Similar provisions are included in the statutes of other states. 

Insurance agency owners will be now able to fulfill their fiduciary obligations as legal “custodians” of premium and return premium funds.

Article written by Chris Marinescu, President of Paulmar Group LLC

Chris Marinescu has Master Degrees in Civil/Structural Engineering and Engineering Economics. Chris has published 15 articles on P&C insurance agency fiduciary duty and trust financial solvency management and teaches two CE classes on insurance fiduciary duty. Chris also maintains a structural engineering consulting practice which is currently limited to the seismic performance assessment of existing buildings and structures.

 For more information on Insurance Fiduciary (Trust) Accounting, visit Paulmar  Group at www.paulmargroup.com or contact the author/inventor at chris@paulmargroup.com.

Insurance Fiduciary (Trust) Accounting

Despite its rigorous legal requirements, insurance fiduciary accounting is unavailable to users in current practice. P&C insurance retailers and wholesalers are legally mandated to maintain insurance trust accounts but current technology does not even help them determine trust beneficiaries. Nor can they determine agency commission income, an impediment that certainly threatens the agency financial solvency.

Fiduciary accounting is trust accounting. Insurance trust accounting technology has been finally developed and is now available to P&C agent‐brokers as a service. This article purports to clarify its concept and practice. 

American Institute of CPAs

In 2007 American Institute of CPA (AICPA) published a Practice Guide for Fiduciary (Trust)
Accounting (Guide). The Guide was prepared for “accountants who perform fiduciary accounting services”.

Fiduciary accounting is considered “specialty” accounting. Prior to 2007 fiduciary accounting
did not benefit from a “practice guide” developed for use at the national level. The 2007
Guide creates uniformity in the fiduciary accounting practice and empowers both trustees
and trust beneficiaries to better monitor and control the management of fiduciary trusts.

Accountants specializing in fiduciary accounting generally work for “trustees” who retain them on an outsourcing basis. Their services are provided in a fiduciary capacity.

Fiduciary accounting evolved out of the need to outsource complex accounting to specialty
professionals who have the knowledge and technology to perform it reliably.

P&C Insurance Trust

Few outside the P&C insurance industry, and not very many in the industry, know or understand the nature of the P&C insurance trust. Most independent insurance P&C agents‐brokers receive transacted premiums in a fiduciary capacity and maintain them, generally less than 60 days, until they are disbursed to legal owners. Agency owners place premium funds in “trustee bank accounts” consistent with the rules of fiduciary duty.

The 2007 Guide omits any reference to P&C insurance fiduciary duty insurance retailers are
mandated to conform to when receiving premium payments from insureds. True, the P&C insurance trust is more dynamic and much more demanding in its daily management than other trusts, such as estate or real estate trusts. More rules apply to the management of premium funds than to other trust funds.

Although fiduciary duty is universal, not all states recognize the need for insurance agent‐brokers to maintain a trust account. Only 23 states require them to place premium funds in “trust”. Without placing them in trust, separate from business operating funds, premium funds cannot be audited for solvency as fiduciary duty requires.

Insurance Fiduciary Duty

Insurance fiduciary duty is set forth by Insurance Codes. Fiduciary accounting practice as defined by the 2007 Guide equally applies to P&C agent-brokers as they also have a legal mandate for fiduciary duty. The Duty to Manage, Duty to Loyalty, Duty to Account and Duty to Disclose set forth by the Guide apply to P&C insurance trust as much as they apply to a real estate trust or any other type of trust. An insurance trust account is a legally‐mandated financial instrument of insurance premium management.

Insurance Trust Accounting

The Guide‐defined principles of fiduciary accounting apply without question to the P&C
insurance brokerage industry. However, the insurance premium transaction’s unique nature
makes insurance fiduciary accounting practice more encompassing. Its basic requirements
remain the same: report insurance trust beneficiaries and report premium financial solvency. Insurance trust accounting addresses and provides solutions to other important legal
mandates, such as: 

(1) Determine insurance agency commission income so that agencies can transfer it to their
business operating accounts. Insurance trust “income” is embedded in the very bank deposits of premium payments. The latter have a “net” component which is due carriers and a “sales commission” which is due to the agency. Since agencies receive premium payments on a daily basis and in relatively small amounts extraction of the sale commission from bank deposits has proved insurmountable to this very day. General ledger accounting cannot do it. Only insurance trust accounting is able to separate “earned” commission in the agency trust and make it available to the agency for transfer to the business operating account.

(2) Determine premium financial solvency not only at the trust level but also at the policy level and that of carriers underwriting the agency business. This requirement is in the insurance fiduciary law because premium funds are “earmarked” funds. Premiums owned by one carrier cannot be disbursed to another carrier without prior consent.

Trust Accounting Tenets

One major tenet of insurance trust accounting is the starting of accounting process with the policy transaction, the only legal sale document in insurance. Since premium invoice is not a “sale” document, the application of general ledger business accounting to premium transactions is not only inadequate but also detrimental. 

Another important tenet of Insurance Trust Accounting is the placing of premium funds into a “trust” ledger, separated from the agency general ledger (GL) of accounts. Financial management of premium and return premium funds require 65 ledger accounts at minimum. In current practice only four premium accounts are used in the agency general ledger.

Insurance Trust Accounting’s most important tenet is the separation of trust ledger accounts in (a) Balance Sheet accounts and (b) Float Statement account. This division enables
Insurance Trust Accounting to generate trust Balance Sheets and trust Float Statements
(Receipts and Disbursements Statements). The latter are similar to the Income Statements in GL accounting. Both financial statements are used to determine the trust financial solvency at all three law‐mandated levels.

Trust Accounting Practice

The practice of Insurance Trust Accounting requires knowledge of accounting principles,
fiduciary duty and agency daily operations. Rarely do small and/or medium size agencies
have staff with prerequisites to learn them. Larger agencies may have accountants trained to practice it.

The best and most cost effective way for agencies to introduce Insurance Trust Accounting in their daily operation is to outsource it in the same way fiduciary accounting is outsourced in other industries. Trust accounting service is similar to the payroll service: agency provides source docs; the outsourcing partner enters data and performs all trust management functions. The agency will be promptly directed to transfer its “earned” sales commission to the operating account and carriers will receive upon request premiums, net of commission.

Benefits to Agency Owners

The outsourcing of Insurance Trust Accounting offers agency owners significant benefits:

• Full compliance with fiduciary duty;
• Significant reduction of agency workload;
• Potential for profit margin increase by 20% or more;
• Full control over premium and return premium funds;
• Potential for organic growth with no additional payroll;
• Complete and accurate accounting records;
• Reliable reporting of agency production and trust financial solvency;
• Opportunity to use agency resources exclusively for sales and service;
• Reduction of agency E&O risk exposure;
• Peace of mind for agency owners and managers;

For additional information visit Paulmar website: www.paulmargroup.com or send email to
Chris@Paulmargroup.com or contact Paulmar Group at 800.830.9093

Chris Marinescu is President of Paulmar Group LLC, a software developer and trust accounting service provider. 

Insurance Trust Accounting

Current Premium Accounting

Insurance Trust Accounting has been long overdue in the P&C brokerage industry. Its recent development was prompted by the need to manage premium financial solvency and enable agency to manage its commission income. For the longest time, premium and return premium accounting has been an adaptation of general business accounting to insurance premium transactions.

All agency management systems on the market today have sold general ledger (GL) accounting as sufficient for premium and return premium transactions. Accountants and CPAs struggle finding ways to report trust funds solvency. Using formulas rather than accounting, they confirm the GL accounting’s inadequacy for premium and return premium transactions.

As adapted for premium transactions,GL accounting proved unable to process the agency “earned” commission. The current practice of transferring commission funds to the agency business account based on “need”,is the second most important cause of insurance trust financial insolvency.

Insurance Trust Accounting

Following the development of Insurance Trust Accounting, Paulmar Group has offered it to P&C independent agents and brokers for more than two years. Uniquely conceptualized, Insurance Trust Accounting is a mirror of premium and premium business transactions. It uses a different ledger of accounts, separate from the agency general ledger, and recognizes the policy transaction as the sole insurance “sales” document. Premium invoice function is reduced to the status of “reminder” of payments.Premium invoice is not an insurance “sales” document (as it is in GL accounting) and therefore its journal entry no longer creates “income” records in the agency general ledger.

Insurance Trust Accounting is branded Trust Ledger (TL) Accounting^TM and is commercially distributed as NOBL Technology^TM. The TL accounting software application fully automates insurance trust daily operations and reliably reports both production and trust financial solvency. It is offered to insurance agencies on outsourcing basis. Agencies will provide source documents, Paulmar Group(outsourcing partner), will create data records and perform trust management functions, such as: billing and follow-up, bank deposits, commission funds transfer, company remittance, return premium refunds, DB Commission Statement, personal (non-fiduciary) funds maintained in the insurance trust bank account. NOBL automatically converts premium and commission data records into accounting records. No manual journal entries are used in TL accounting.

Benefits

The benefits to insurance agency owners are significant:

•    Guaranteed agency’s compliance with fiduciary duty;
•    Peace of mind for agency owners and managers;
•    Complete and accurate accounting records;
•    Total control over premium and return premium funds;
•    Reliable reporting of agency production and trust financial solvency;
•    Significant reduction of agency workload;
•    Opportunity to dedicate agency resources exclusively to sales and service;
•    Choice for agency owners to grow organically with no additional payroll;
•    Potential for the agency to increase profit margin by 20% or more.
•    Reduction of agency E&O risk exposure;

For additional information visit Paulmar website: www.paulmargroup.com or contact Paulmar Group at 800.830.9093

Insurance Trust Account Service To Independent P&C Insurance Agencies

Paulmar Group offers P&C insurance agents and brokers a unique Trust Account Service similar to the ADP payroll service. Agency provides source documents, Paulmar manages premiums and commissions from the time they are transacted until they are disbursed to their owners. Trust Account Service offers outstanding operational and economic advantages to its users. Learn more about Trust Account Service on my website.

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

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.

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.