The continuing importance of trust funds, proper accounting and doing business with stable insurance companies

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

The carrier mentioned above was primarily a homeowner’s insurance company, but until the last year or so, the main type of carrier to go insolvent or go out of business in the last 10 years was health insurance carriers — especially the new carriers organized under the ACA guidelines. Chalk it up to yet another thing the federal government is doing badly, including developing guidelines for capital requirements for new insurance companies. However, the above lesson applies to all media types.

Let me make a few simple assumptions.

Let’s say there is a fairly successful personal lines agency with 1,000 customers who are insured with a particular carrier. Homeowners premiums in Florida tend to be extremely high, and let’s say the insured homes are mid-range homes with about $500,000 in coverage A. A decent guess for coastal Florida would be calculated by averaging the north and south home values state. The average premium is $5,000 for a basic HO-3 homeowner’s policy. 12% commission, which is $600 multiplied by 1,000 customers, equals $600,000 in commissions. Let’s also assume that the expiration dates of the policies coincide exactly with the calendar. Also, let’s assume it’s a direct billing business and the carrier pays up front, which is a fairly common reality. This means that $300,000 in commissions are unearned and must be returned by the agency.

Do you have $300,000 in the bank to pay back to the state?

Do not do business with weak carriers

The first lesson is not to do business with weak carriers. The property/casualty insurance industry has grown stronger over the past 25 years, and a significant portion of the people in the industry today do not have a working knowledge of bankruptcies and weak carriers. They don’t remember the fiasco of the 90’s when some major P/C carriers went bankrupt in no time. Insurance companies, regulators and rating companies at that time became more serious about the financial performance of carriers.

Incredibly low interest rates and a hot stock market have allowed carriers that likely wouldn’t have sold before. The end result is that the industry has lost institutional knowledge and become complacent.

This combination has resulted in agencies not paying as much attention to whether the operators they write with are unstable, even if they have a decent rating. (By stable, I don’t mean that they don’t have adequate financial strength according to the regulatory and rating parameters for claims-paying ability – but for so many carriers to have recently gone out of business on short notice, you have to look a little closer) .

Now I see that many people are completely ignorant of what happens when an insurance company becomes insolvent, and they don’t even know that state guarantee funds exist, much less what they cover or how claims are processed. Many people entrust this to government institutions. Keep your fingers crossed that you don’t continue to think about the problems an understaffed, much less underfunded guaranty fund can cause an agency.

I would also be cautious about assuming that a state DOI can simply assess enough money and raise enough money to quickly solve the deficit problem. I’m not sure how DOI can evaluate carriers that are already broke or near broke and actually require receipts. Although I have recently seen one do it.

And then, of course, the DOI can demand that you return your unearned commissions.

Keep your records correctly

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

There are two groups of laws. The set most familiar to agents and some advisers is the mishmash of fund laws and regulations. These rules prohibit agencies from commingling their operating funds and trust funds. Only about 14 states have miscegenation laws.

Then agents and advisors in other states proclaim, “We’re not a trust state, so we don’t have to worry about trust money!” This conclusion is seriously wrong.

All 50 states and the federal government have trust laws. Trust law is not the same as combined law. These states do not have a commingling law, but they do have trust laws.

Trust law provides that an agency cannot spend money it has on a trust basis. A billable agency business is a good example of an agency collecting money upfront but not immediately passing it on to the carrier. By holding the money, he acts as a fiduciary and is responsible for not spending that money. An agency that is “not trusted” is an agency that has spent fiduciary funds.

This is why the trust ratio is the MOST IMPORTANT balance sheet ratio that applies to insurance company distributors.

A lack of trust can automatically trigger a provision contained in most carrier contracts that provides that if the agency has lost trust, the carrier immediately takes title for the duration of the agency. There are no notifications. Whether you have paid your dues on time is a moot point.

Fiduciary funds also include money held on behalf of carriers, audit reports, and sometimes unearned commissions. A relatively new accounting rule, ASC 606, applies to insurance agencies and brokers. Agencies and brokers must now account for all commissions on an accrual basis. Although the rule was not intended to maintain proper fiduciary accounting, it does so nonetheless.

Your accountant should understand the importance of insurance distribution accounting and how it differs significantly from the accounting requirements of other types of business.

Unearned commissions are a form of fiduciary funds. The carrier paid the commission in advance, hoping that the agency would fulfill its obligations within a year. In case of bankruptcy, this carrier is often taken over by the state. The state can demand, as Florida recently did, that these unearned commissions be returned. Failure to return unearned commissions may result in loss of ownership for the term of the agency.

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

I have clients who write in the same cities where one states they have no choice and the other states they do. The former is usually only interested in sales, sales, and sales again. In their view, they have no choice because in order to continue selling at the consignee level, they need any carrier, as consignees and shippers sell price.

If the situation is more extreme and the agency really has no choice, make sure you are effectively communicating carrier ratings to your clients, keeping your records correct, and LEAVING EXTRA CASH with the agency. Don’t withdraw all cash, even if your accountant advises otherwise. An accountant needs to have a better understanding of the situation and should not make recommendations based solely on taxes. You don’t have to worry about taxes if you go out of business. Protect your agency and leave a little extra cash in there, especially if you’re writing with carriers you think might be weak.


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