From Concept to Practice: Insurance Trust Account Management

The concept of trust account (TA) management has no meaning to many professionals, or they have no uniform understanding of it. There are no text books or college classes on insurance TA management, and insurance-based publications seldom organize discussions to debate TA management’s critical importance to the P/C insurance agency business.

Most insurance agency owners interpret TA management as a simple process of receiving premium payments from insureds and writing checks to carriers or general agents. Agency commission income is not formally managed; most agencies transfer commission funds to the operating account based on what they need rather on what they “earn.” Return premiums are treated as “negative receivables,” and premium credit and refunds are managed outside the general accounting system.

Premium payments and company remittance are indeed critical to any insurance agency. But is this all trust account management is about?

Insurance Code Mandates

Insurance code requires agency owners to receive premiums in a “fiduciary” capacity, not as owners but “custodians” of funds. On this basis, insurance code requires agency owners to maintain separate “trust” bank accounts for premiums and return premiums so they can be separated from the agency’s business operating funds. A separate trust bank account protects premium funds from agency creditors.

Any premium payment deposited in an agency’s trust bank account becomes “fiduciary” fund subject to insurance code regulations. One is not permitted to take funds out of the trust bank account without proper documentation of the amount of commission “earned” and an audit trail.

Premium and Commission Management

TA management can be suitably defined as “premium and commission management.” Agencies receive premium payments, generally in small amounts, policy by policy, invoice by invoice. The invoice process and especially that of endorsements is tedious and frequently requires follow-up to avoid delinquencies. Mismanaging receivables is a major cause of TA insolvency. Receiving premiums on schedule and remitting them to carriers or general agents, net of commission, is an agency’s primary focus.

No formal agency commission management procedure is provided by current agency management systems. Agencies lack the necessary financial tools to determine their “earned” commission, and most transfer commission funds based on what they need. The uncontrolled transfer of commission funds to the operating account has been a major cause of TA insolvency.

Money Management

The “premium and commission management” characterization overlooks the financial character of the TA operation. An insurance agency’s financial traffic in and out of the trust bank account can be significant, $5 million to $10 million a year in small agencies, and $50 million or more a year in large agencies. Tracking bank deposits and disbursements requires accurate accounting records and a reliable reporting system. Thus, it is only natural that TA management should be viewed as “money management.”

Premium Financial Management

TA management is, however, a lot more than money management. Premium funds are by law “earmarked” funds with a predetermined destination. They require tracking at the policy level. A $1,000 premium received by an agency for policy A underwritten by one carrier cannot be used to remit the premium of another policy B underwritten by a different carrier. Policy premium management requirements could be looked at as a comprehensive “financial management.” Accounting procedures and especially the premium reporting system must be detailed and reliable, as premiums are not simply money but “fiduciary” funds.

Financial Solvency Management

Insurance code requires the trust bank account balance to equal at least the amount of the net premium “due to the persons entitled thereto.” Failure to meet this requirement is essentially proof of financial insolvency. On this basis, TA management can be defined as “premium solvency management.”

Financial solvency is the ultimate management goal of insurance TA “custodians.” Under the insurance code standard, licensed insurance brokers are personally responsible for insurance TA solvency.

In current practice, the amount of net premium “due to the persons entitled thereto” cannot be reliably determined, especially when the “cash solvency” is investigated. Current “trust position” or “trust ratio” indicators are somehow helpful, but they are unreliable. They cannot characterize the TA “cash solvency,” and the accuracy of accounting records is highly questionable.

Premium Liability Management

The carrier-agent/broker agreement compels insurance retailers to remit transacted premiums to carriers, net of commission, whether or not they receive premium payments from insureds. To avoid earned premium liabilities in case of non-payment of premium, they are entitled to request the policy cancellation.

By virtue of the carrier-broker agreement, a $10,000 premium transaction automatically creates a $9,000 premium liability for the broker (10 percent commission assumed). The agency’s concern should therefore be not only to realize a $1,000 commission but also to protect the broker against a $9,000 potential loss.

Considering the book of business of most agencies is multi-million dollar in size, one could justifiably define TA management as “premium liability management.” To manage liability of this magnitude, insurance brokers need to set up a functional TA operation.

Trust Account Management Concept

A financially solvent insurance TA guarantees all transacted premiums and commissions, as well as transacted premium liabilities, are properly managed.

TA financial solvency is not uniformly understood primarily because insurance professionals seem unaware of insurance code mandates, and regulatory agencies fail to consistently enforce them. In today’s high-tech age, insurance brokers should be able to review simple premium financial solvency reports daily. They are too important to be left to just a casual examination.

To comply with insurance code mandates, a reliable financial solvency reporting system should assure insurance brokers:

• Each policy is financially solvent;
• Premiums owned by each carrier are financially solvent; and
• An agency’s entire TA is financially solvent.

These financial instruments are sufficient to monitor and report TA financial solvency:

• TA balance sheet;
• Solvency analysis reports;
• Cash solvency report;
• Cash and receivable solvency report;
• Premium float statement; and
• Statement of trust funds beneficiaries.

A TA balance sheet will demonstrate trust assets equal trust liabilities. This report is currently unavailable because general ledger accounting does not support it. The main reason why this report cannot be produced is the premium invoice format, which treats commission liability as “income.”

Solvency analysis reports are produced by processing the balance sheet data. They will show either a “premium surplus” or “premium deficit” for each policy, carrier, and agency. Solvency analysis reports will be available on a “cash basis” to demonstrate an agency has sufficient cash and credit assets to meet “due and payable” liabilities.

A premium float statement is similar to the P&L statement available in general ledger accounting. By listing premium receipts and disbursements, this report determines the “premium float” at all three levels: policy, carrier and agency. A policy or the whole TA is solvent when the bank account cash balance equals the premium float.

The statement of trust funds beneficiaries is generated by processing the premium float statement data. This report will list the “owners” (beneficiaries) of the TA cash balance. A TA cash balance has potentially five beneficiaries: carriers (net premiums), general agents (net premiums), agency (earned commission), insureds (return premiums, overpayments), and premium finance companies (return premiums).

Trust Account Management Practice

The practice of TA management is either scarce or entirely lacking mainly because TA operation is unusually complex. To manage it properly in accordance with insurance code mandates, insurance brokers need better accounting and a standardized financial solvency reporting system.

The “trust ratio” or “trust position” indicators are of limited help. Better reporting is required to monitor and control the TA financial solvency.

Automation and the Internet can now elevate the insurance TA management practice to the high standard of care insurance premium “custodians” need.