Trust accounting and what your agency might be missing

In insurance, sometimes we like to think it’s as simple as understanding our insureds, their risk profiles, and making sure they have the right coverage for their needs. There is a lot more to it, but the nuances of insurance feel endless sometimes. In this blog, we will dive into one of the more overlooked aspects of operating your agency in a fiscally responsible way: Trust Accounting.

As an agency owner, there is so much more to running your business than just selling insurance. You are also focused on building the right team, training them appropriately, focusing on marketing, keeping your pulse on financials and implementing the right technologies, and managing the various ways you engage with carriers and brokers just to name a few things that might keep you up at night. All of these areas require careful thought and planning, but some areas tend to be overlooked, like Trust Accounting. This is an area that is hardly ever talked about so many agency owners have no idea what trust accounting is, why it is important, and how to best position their agency until it is too late.

What is Trust Accounting?

For starters, let’s define trust accounting, and then we can get into the details that you as an agency owner need to know. Trust Accounting or Account in Trust, defined by Investopedia, refers to any type of financial account that is opened by an individual or company and managed by a designated trustee for the benefit of a third party per agreed-upon terms.

A basic example would be a parent who can open a bank account for the benefit of their child and stipulate rules as to when the minor can access the funds or assets in the account as well as any income they generate. In most cases, the trustee who manages the funds and assets in the account acts as a fiduciary, meaning the trustee has a legal responsibility to manage the account prudently and manage assets in the best interests of the beneficiary.

In the insurance context, an example would be if an insured (third party) pays for their insurance policy in full, sending the entire premium payment to the insurance agency (trustee). The insurance agency is then responsible to ensure the insurance company receives the insured’s payment minus any commission that is owed to the agency, so the insured’s policy is in force. This arises in any situation where the agency bills the customer directly. The amount of agency bill business can vary greatly from agency to agency depending on the insurance marketplace, the type of business that the agency writes, and the particular carriers and brokers that the agency has access to through their direct appointments or partner relationships. 

Why is Trust Accounting important?

While trust accounting sounds simple in practice, scaling up and tracking agency bill transactions without the right processes in place gets difficult. Agency bill transactions can become difficult to track if the right processes are not in place. Remember, as the insurance agency you are the fiduciary of your client’s policies from a financial standpoint. When payments are late from your clients or a policy cancels, headaches start to creep in and carriers come knocking for their premium dollars. If an agency does not keep close track of transactions or even worse, combines the agency funds with the funds that are being held on behalf of the carrier, the agency can quickly become ‘out of trust.’ Being ‘out of trust’ means that the agency does not have enough funds to pay the carrier the amount that is due and it will be difficult to unravel the mess. 

How can you best position your agency?

Here are the key things you need to do to stay in trust and avoid any unnecessary issues in maintaining your accounting records:

Open a separate Trust Account. This account is where you will deposit all of your agency bill receipts. By having a separate account, you can easily track the agency bill accounts and keep track of the funds that you must remit to the carrier related to these accounts. This will also limit the transactions that will need to be reviewed if a problem occurs making it easier to reconcile.

Create clear processes and procedures. The people who are involved with receiving income in the agency must have a clear understanding of what distinguishes agency bill and direct bill and how to manage the different types of income that is being collected by the agency. You will need to outline the receipts that can be deposited in the operating account as well as those that must be deposited in the trust account. For those receipts where the correct deposit account is uncertain, establish a clear process on how to resolve these questions. Providing clear guidelines on how to manage agency bill and direct bill income will minimize errors and ease the process of reconciling accounts. 

Limit access to the operating account and trust account. Do not allow anyone that does not have a clear understanding of these processes to have access to the accounts. It is important to note that a CPA or accounting firm most likely will not understand the trust accounting rules that are unique to an independent insurance agency, so the agency owner needs to make this clear from the beginning of any new accounting relationship.

Be consistent. Reconcile each account and ensure that the carriers are paid the portion that is owed to them. Once that has been completed, you can calculate the amount that the agency can keep for each of the policies. Once a month move the agency’s money into its operating account being sure that you have clear documentation for each account that makes up the total amount being transferred each month. Adopting this process will allow you to limit the number of transfers with a limited number of transactions to research if there is ever a problem.

Documentation is key. Clear records of how you reconciled each customer account is critically important. This will be essential if your agency is ever subject to an audit and ensure that the process goes smoothly.

There are a lot of things to consider when setting up the policies and procedures that you will follow to ensure that your agency is well-protected and remains financially sound. Agencies that have clean financial statements and well-thought-out policies and procedures are much better positioned in both internal and external ownership transitions than those that have messy books and questionable liabilities, so not paying attention to this can be very costly for some agencies in more ways than one. Trust Accounting is one of those areas that is not often talked about but can cause a great deal of issues if it is not managed properly. We have highlighted some of the key steps you can consider implementing to ensure that your agency stays in trust, we encourage you to dive deeper.