While insurance brokerage accounting isn’t necessarily more complex, it is unique when it comes to integrating operations and financial reporting. Whether your agency is in the early stages of getting off the ground or you are an established one looking to grow, below are several topics that should be taken into consideration when evaluating if your insurance agency accounting and financial operations are in sync with your overall business strategy and growth plan.
The Relationship Between Systems & Brokerage Size
Deciding on what system(s) to use or implement is an important first step in building out the financial reporting function for any insurance brokerage (agency). For most (smaller) brokerages, a point of sale agency management system (AMS) is usually sufficient. These software packages are specifically designed to track customers, policies, carriers, premiums, invoicing and producer commissions. Most of these systems also have a general ledger overlay, so they can handle banking, vendor payments and other non-insurance accounting functions. However, these systems are primarily an insurance point of sale system, and therefore the general ledger module is still secondary and quite basic. As such, they lack the elegance and functionality of a standalone commercial enterprise resource platform (ERP).
A larger, more complex brokerage should consider purchasing a standalone commercial ERP (general ledger) system to use alongside their AMS system. This arrangement, although more expensive, offers several benefits. First, it keeps the insurance and operations side of the business separate from the financial reporting side of the business. From a security perspective, this is inherently a better arrangement and keeps non-finance personnel at an arm’s length from potentially sensitive financial data. Second, since the ERP is a dedicated piece of accounting software, it is better suited to handle non-insurance transactions such as prepaid expenses, payroll, fixed assets, payables, accruals, debt, equity and banking/treasury functions. It is also more customizable with respect to the chart of accounts, cost centers, location tracking, and ad hoc reporting. With a two-system arrangement, all non-insurance transactions are entered into the ERP system throughout the month. At the end of each month, the monthly insurance-related and sales transaction data from the AMS are imported into the ERP system.
Revenue is a critical number for any business, and the insurance industry is no exception. Some AMS systems track revenue natively, but for more sophisticated agencies, dedicated software and or manual tracking may be needed. At a minimum, the agency should keep track of each policy, by customer and producer, along with the renewal date(s), premium and commissions. This is a useful tool for management, as any expected renewals can be cross-referenced with the sales data to ensure all revenue is accounted for.
The brokerage’s book of business is also a valuable tool to assist with yearly budgeting and forecasting and can dually serve as template for each producer’s commission tracking. The accounting departments at the insurance carriers are prone to many of the same errors as any other business. Mistakes in reporting, although not common, do happen. By having a good revenue tracking system, this will ensure that all commissions earned by the brokerage are accounted for.
An additional revenue stream for some insurance brokerages are contingent commissions and/or guaranteed supplemental commissions (GSC). These are typically volume-driven incentive agreements between carriers and agencies and pay the brokerage additional commissions (overrides) for premiums written with that carrier. A solid understanding of the individual agreements and how commissions are generated is a key piece of the brokerage’s revenue forecast. Each agreement should be kept on file and there should be a sufficient tracking mechanism to properly account for any expected contingent and or GSC. Contingent and guaranteed supplemental commissions should be accrued on a monthly or quarterly basis.
Agency Billing vs. Direct Billing
There are two types of billing for an insurance brokerage – agency and direct bill. A brokerage should decide carefully which billing arrangement works best for their business. Many agencies utilize both methods although one method is usually more dominant than the other.
With agency bill, all invoicing and payments and handled by the brokerage. Customers pay for their insurance premiums via an agency-generated invoice. Once paid, the agency remits payment to the insurance carrier. Since the agency’s commission is included in the paid premiums, one of the main advantages to agency-billed policies are that commissions are received up front. Agency-billed policies are common in commercial placements due to the need for several different lines of coverage (e.g., property, liability, E&O/D&O, hazard, cyber). Because different lines of coverage can often be with several different carriers, from a client service perspective, agency billing may be easier as all policies can be consolidated onto one invoice. Agency-billed policies are also easier to track and manage since the agency is in control of the entire revenue cycle. This provides more opportunity for customized billing and gives the client one point of contact for all their insurance needs. Agency billing is not without its disadvantages, however. It requires more resources due to the need for additional personnel to handle the billing, collections and servicing of the policies. It is also more prone to errors as the agency generates the invoices rather than the insurance carrier.
Direct-billed policies, as their name implies, relegate the entire invoicing and collections process with the insurance carrier. The carrier invoices the customer directly and the customer in turn, pays the carrier directly for the premiums due. Once the carrier has collected payment, it sends the agency’s commission to the brokerage. Direct-billed policies are more common for personal lines coverage and worker’s compensation. The advantages to direct-billed policies are obvious – they require far less resources for the brokerage since the carrier is handling the entire billing process. The biggest disadvantage of direct-bill policies is that the brokerage does not receive their commissions upfront and must wait for the carrier to send payment. Also, depending on how many policies are involved for a particular customer, the customer may receive multiple invoices from different carriers rather than a single consolidated invoice.
Regardless of the bill method, both agency bill and direct bill require compliance with the revenue recognition (ASC 606) standard. While an in-depth discussion of how ASC 606 applies to insurance brokerages is beyond the scope of this document, accounting personnel should be familiar with the standard and accrue any earned revenue accordingly.
Utilization of Trust Accounts
Due to their pass-through nature, all agency-billed policy premiums are paid “in trust” to the brokerage that facilitates placement of coverage. All premiums received and paid are done via a premium trust account. Since a portion of all premiums paid to the trust account represent the agency’s commission (revenue), at periodic intervals, these commissions should be transferred to the brokerage’s operating account.
It is important that funds between the operating account and trust account are not comingled. Premiums should be remitted to the carriers from the brokerage’s trust account and operating expenses should be paid from the brokerage’s operating account. All direct-bill commissions paid to the brokerage should be deposited into its operating account.
The accounting team should have a good understanding how to correctly calculate the required balance in the premium trust account and make the corresponding operating cash transfer at least monthly. Many brokerages make the mistake of transferring money to the operating account based on cash or expense needs and not necessarily what is earned. A worse scenario occurs when the brokerage transfers more funds than is allowable to its operating account, leaving a cash shortfall and putting the brokerage “out of trust.” Without a solid understanding of the trust vs. operating accounts, this could mean improper reporting of cash balances in both accounts. This can affect the brokerage’s ability to manage cash and expenses.
Producer and Agency Commissions
“Producer” is the industry term for an insurance salesperson. They are responsible for prospecting for clients and bringing them to the table to place coverage for clients. In accordance with ASC 606, producer commissions should be booked when coverage is bound. While there are many ways to structure producer compensation agreements, it is a best practice to accrue commissions as they are earned, but payment to producers should only occur once the client pays their policy premiums via direct or agency billing.
If a third-party agency is utilized to place coverage, these agency commissions should also be booked along with producer commissions and paid as cash is collected.
A captive insurance company is a wholly owned insurance company formed to insure the company that it is owned by. It is, in effect, a form of corporate self-insurance. Some key takeaways:
- A captive insurance company is a wholly owned subsidiary insurer that provides risk mitigation services for its parent company or related entities.
- The potential benefits of having a captive insurance company include lower insurance costs, tax advantages, underwriting profits and greater control over coverage.
- Captive insurance companies can be helpful when the commercial insurance market is unable or unwilling to provide coverage for certain risks.
- Drawbacks include overhead expenses, compliance issues and the potential to be underinsured.
- Most Fortune 500 companies today have captive insurance companies.
A captive insurance company should not be confused with a captive insurance agent, who is an insurance agent who only works for one insurance company and who is restricted from selling competitors’ products.
Pulling It All Together: Business Partnership
The finance team members should function and view themselves as business partners across all departments. The ability to work with producers, brokers and client service team members helps operations understand the financial reporting requirements and needs of the business. It is equally important for the finance team to also understand the operations side of the business. Also, both parties need to have a mutual understanding of their own opportunities and challenges. By partnering together, the departments can make life easier for each other, work better together and help to maximize revenue, profit and organizational efficiency.
We invite you to download our guide below to learn more about building cross-departmental momentum toward organizational goals. If you want to explore working with any of our team of 100+ finance and accounting consultants, please contact us to start a discussion!