Insurance agency accounting: a practical guide for small independent agencies

Almost every agency deals with two billing methods, and they're accounted for differently.

Direct bill. The carrier bills the policyholder and collects the premium. You never touch it. The carrier then pays your commission, usually monthly, with a statement listing each policy. Your accounting job is to record that commission and to check that the statement is right.

Agency bill. You invoice the policyholder, collect the premium, keep your commission, and send the rest (the net premium) to the carrier. The carrier sends you an account current statement showing what you owe. Here you're handling the carrier's money, so you need tighter records: who has paid you, what you've sent on, and what's still outstanding.

Many agencies use direct bill for most personal lines and agency bill for some commercial accounts. Set up your books so you can always tell the two apart.

Premium you collect on behalf of a carrier or a policyholder is held as a fiduciary. Most states don't allow agencies to mix it with their own operating money. In practice that usually means a separate premium trust account.

What each state requires varies. As one example, Michigan's insurance department says a separate premium account is required whenever an agent receives premium, whether the policy is agency bill or direct bill. It also says the commission can move to the operating account once the policy is bound or effective, and that on a mid-term cancellation the unearned commission goes back into the premium account before the return premium is refunded.

Rules that hold almost everywhere:

• ·Deposit every premium payment into the trust account, including the occasional direct bill payment a client hands you.
• ·Move your commission to the operating account only when your state's rules say it's earned.
• ·Never pay agency expenses, payroll or loans from the trust account.
• ·Keep return premiums owed to policyholders in the trust account until you pay them out.
• ·Each month, check that the trust account balance covers everything you owe carriers and policyholders.

State insurance departments look closely at trust accounts during audits, and a shortfall is treated seriously even when no one meant to do anything wrong.

Cash or accrual. On a cash basis, you record commission when it arrives. On an accrual basis, you record it when it's earned, which for agency bill is usually when the policy takes effect. Cash is simpler, and many small agencies start there for direct bill. Accrual gives a truer picture of how the agency is doing, especially if you have much agency bill business. Choose with your accountant and stay consistent.

Keep commission types separate. A short, clear set of income accounts makes problems visible. A simple starting point:

• ·Commission income: direct bill
• ·Commission income: agency bill
• ·Contingent and bonus commission
• ·Agency fees
• ·Commission chargebacks (recorded separately, so you can see how much is taken back)

Chargebacks are worth their own line. When a policy cancels mid-term, the carrier takes back the unearned commission, and those deductions can be large in a month with several cancellations. You can estimate what a chargeback should be with our cancellation calculator, which shows the return premium and the commission taken back.

Producer pay is an expense. Commission you pay to your own producers is a cost of the agency, not a reduction of its income. Whether producers are employees or contractors changes your payroll and tax reporting, so settle that with your accountant.

A monthly routine catches most problems while they're still easy to fix. Do these in order, every month:

1. 1.Reconcile the operating bank account to your books.
2. 2.Reconcile the premium trust account, and check that its balance covers what you owe carriers and policyholders.
3. 3.Check every carrier commission statement against your book of business, line by line. Our step-by-step guide to reconciling commission statements walks through the method.
4. 4.Review agency bill receivables. Follow up on anything unpaid, and don't let old balances sit.
5. 5.Reconcile each carrier's account current, and pay the net premium on time.
6. 6.Review chargebacks and return premiums, and pay out any return premium owed to policyholders.
7. 7.Pay producers based on commission actually received.
8. 8.Read your profit and loss, balance sheet and cash flow. Commission arrives in uneven waves, so profit and cash rarely line up in the same month.

It helps if the person who records payments isn't the only person who reconciles the accounts. In a small agency that might be the owner reviewing the bookkeeper's reconciliations each month.

• ·Unchecked carrier statements. Short pays, missing renewals and chargebacks larger than they should be all look normal on a long statement. If nobody compares each line with what you expected, nobody finds them.
• ·Old agency bill receivables. Premium you've already paid the carrier but never collected from the policyholder is a direct loss.
• ·Return premiums left in the trust account. Money owed to a policyholder still has to be paid. If you can't reach them, your state's unclaimed property rules apply.
• ·Mixed accounts. Paying a bill from the trust account “just this once” is how shortfalls start.

Most small agencies use some mix of three things:

• ·An agency management system. It holds your policies and clients, and many include accounting features for agency bill invoicing, carrier payables and trust accounting.
• ·General accounting software, such as QuickBooks, for the operating books, payroll and taxes.
• ·Spreadsheets for whatever falls between the two, which is very often commission reconciliation.

The gap is usually the same one. General accounting software records the commission deposit as one number. It doesn't know which policies that deposit was supposed to cover, or whether any were left out. That check needs your policy list on one side and the carrier's statement on the other.

A good bookkeeper can run the month-end routine. Bring in an accountant who works with insurance agencies when:

• ·you're setting up or fixing a premium trust account
• ·you're preparing for, or responding to, a state insurance department audit
• ·you're moving from cash to accrual accounting
• ·you're setting up producer pay, splits or contractor arrangements
• ·you're buying, selling or valuing a book of business

Ask whether they already work with other agencies. Someone who knows agency bill, trust accounts and commission statements will save you time and mistakes.

Of everything in the month-end routine, checking carrier statements line by line takes the longest, and it's the step most often skipped.

Insurance Commission Reconciliation does it for you. Upload your carrier statements and your book of business, and it matches every line, flags short pays, missing payments and chargebacks that don't add up, tracks each carrier's dispute deadline, and exports a dispute packet you can send to the carrier. Your first reconciliation is free, and no card is needed.