Insurance Agency Trust Accounting — More Important than Ever

My articles regarding insurance agency accounting seem to elicit some of the most positive feedback of any subject I discuss. Trust accounting is the bedrock, the most essential aspect of insurance agency accounting – bar none.

Insurance agency/brokerage trust accounting means accounting for all the monies you hold in trust for both clients and carriers. Such monies can be credits to be returned to clients, monies paid by clients ahead of their due date, monies held on behalf of carriers, and even in certain market niches, contingencies.

Good trust accounting consists of holding these monies in a trust account separate from all other monies. It also consists of having specific payable and receivable accounts, separate from operating payables and receivables. The payable account is typically known as premiums payable and sometimes binder bill, to use an old-fashioned term for billing clients ahead of their policy effective date.

The receivables are typically known as premiums receivable. These are PREMIUM accounts, and this is an important distinction. Premiums are not owned by the agency. The agency has no title to premiums. Premiums are held in trust, which is why trust accounting exists.

Trust accounting is why an agency using cash accounting can incur bad debt. Typically, a business using cash accounting cannot incur bad debt. But when related to trust accounting, you can have bad debt because you are making the other party whole on monies that were never your monies. This is why agencies’ accounting is a combination of cash and accrual, rather than one or the other.

Trust accounting is problematic for many reasons including the fact that the trust ratio, the way an agency’s trust position is measured, is not a GAAP (Generally Accepted Accounting Principles) measure, so most accountants know nothing about it. This sometimes leads to bad advice, like spending the money that you are, by law, holding on a fiduciary basis.

The trust ratio is (generically because the legal definition varies by state): cash + premiums receivable / premiums payable + credits + binder bill. This ratio must be greater than one or the agency is out of trust and likely operating illegally, and almost definitely in violation of their carrier contracts.

All States Are Trust States

All 50 states, territories, and the District of Columbia have trust laws. Considerable misunderstanding exists in our industry complicating trust accounting further. That misunderstanding is that only a handful of states are trust states. All states are trust states. The difference is that most states allow commingling of operating money while a handful prohibit commingling. But just because commingling is permitted does not make it a good idea.

Trust accounting is further complicated because many agency management systems are not built to do trust accounting at all, and others do it poorly. This might not matter to you unless the insurance commissioner investigates (which is unlikely) or until you sell your agency, which is guaranteed.

When I value agencies using systems that cannot manage trust accounting, I must always explain that unless you can prove you are in trust, you are not readily sellable because if you are out of trust, your carrier contracts likely stipulate that they now have title to your book of business.

Even if your agency is located in a state where you may legally commingle accounts, it is not a good idea. One important reason it is not is because by doing so, you are making it easier for plaintiffs to pierce your corporate veil, especially if you pay personal expenses, use corporate vehicles for personal use (without maybe doing all the correct paperwork), etc. This will be doubly true if you are out of trust.

Relative to the corporate veil, the plaintiff’s position is likely to be that by not protecting client assets per the firm’s fiduciary responsibility and by commingling client monies with operating monies and maybe personal expenses, the corporate veil does not exist. The argument has logic to it and plaintiffs seem to be winning more such cases in many industries.

Historical reasons still exist for not commingling monies, such as, it is simply better management. A good practice is to create a trust account specifically named “trust” account in order to have more banking protection if a bank was to go insolvent.

Another reason is due to what I am afraid is an increase in fraudulent insurance products. The market today is so hard and rates so high that it is easier for fraudsters, some of which have licenses and some do not, to sell their products.

Desperation causes agents to make bad decisions relative to the markets they use. I have already seen agencies severely damaged because they failed to investigate their markets adequately. The worst thing to do with these markets is to commingle your clients’ monies with your operating funds because it makes it appear you are part of the fraud or at least way too sloppy to actually be caring for your clients.

Different states have different laws as to when ownership and responsibility shifts between an agent and a market. For example, when a retail agent sends the money to the broker, is the responsibility now with the broker? The answer is that it varies. I have had clients successfully sued after they forwarded large checks to a broker who disappeared with the premium monies. Sometimes it is the broker’s carrier who sues the retail agency and sometimes the client. But if the monies are all commingled, then it looks like you have sloppy accounting, and that you are being lazy in completing due diligence on your markets, as well.

With a good agency management system, good trust accounting requires no more effort once your bookkeeper is educated on the subject. My clients with good bookkeeping also tend to be more successful because it makes them more aware of how much money is actually theirs that they show on their balance sheet.

Good bookkeeping protects agents from being out of trust and helps make their corporate shield stronger. All states require you to be in trust 365 days a year. Your carrier contracts require it, too. Do your trust accounting correctly to gain all these protections and avoid the serious consequences of failure. Other than your agency, what else do you have to lose?