Accounting Best Practices for Property and Casualty Insurance Agencies

Key Takeaways

• Insurance agency accounting differs from standard small-business accounting because agencies handle client funds in trust accounts that are not agency revenue.
• Only commissions, broker fees, and contingent income should be recorded as sales revenue on a P&C agency’s income statement.
• Operating accounts and trust accounts must be kept separate as commingling funds can trigger license revocation or prosecution.
• The balance sheet should show the trust account balance as an asset and the amounts owed to insurance companies as an accrued liability.
• Monthly bank deposits are not a reliable proxy for revenue; reconcile to commission statements to avoid overstating revenue and earnings.

After reviewing thousands of financial statements from insurance agencies, we have found that accountants often do not understand how agencies operate, which can lead to misleading and often inaccurate financial statements.

One of the primary purposes of an Income Statement is to aid owners in understanding the agency’s cash flow over periods of time.  The purpose of a Balance Sheet is to report the financial position of a company at a certain point in time with regard to its assets and liabilities.  To create these statements accurately and so they have meaning to an agency owner, is to first understand what constitutes sales revenues in a P&C agency.

Agency Sales Revenues

Clients of insurance agencies can be billed two different ways, and these are typically defined as direct bill (or company bill) and agency bill.  Most personal lines of insurance are handled as company bill in that the insurance company sends the bill to the customer and the customer makes the payment directly to the insurance company.  For example, car and home owner insurance bills come directly from the company that is insuring the car or the home and the premium is paid directly to that company by the policy holder.  Once the bill is paid, the company then sends a commission payment to the agency that sold the policy.

Often with commercial or business insurance, the agency that sells the policy will bill the customer directly and it is up to the agency to make the payment to the insurance company.  Most state laws require insurance agencies to set up a trust (escrow) account to temporarily hold these funds for the insurance company until the company is paid either by electronic transfer or by a check sent from the agency.  For example, if the agency bills a client for a $1,000 premium and is entitled to a 15% commission, the flow of funds works as follows:

• The client pays $1,000 to the agency, which is deposited into the agency’s trust account.
• $850 is paid from the trust account to the insurance company.
• $150 is paid from the trust account to the agency’s operating account as the commission earned.

When creating an income statement for a P&C agency, it is recommended that only commission payments, broker fees and other contingent income be included as sales revenues.  Any amounts paid to the insurance company from the trust account should be treated as a pass through for accounting purposes.  This practice will best reflect the true operation of the agency and will eliminate common accounting errors.  It will also provide the agency owner with a more accurate depiction of the operation of the agency.

Agency Sales Expenses

The largest expenses incurred in most insurance agencies are payroll and commissions.  These expenses generally account for 30% to 50% of the revenues received by an agency.   A best practice is to break out the payroll and commissions as separate expenses so the agency owner can better understand the costs associated with sales and service.

Some agencies book commission expenses as a Cost of Goods Sold instead of an operating expense.  The standard industry procedure is to post employee producer commissions as an operating expense and book commissions due to external producers or agencies as a Cost of Goods Sold.  The key difference is generally one of control: Who owns the account?  If the agency does not own the account, then book the commission expense as a Cost of Goods Sold.

Reconciling the Income Statement

Many accountants and bookkeepers use an agency’s bank statements to determine monthly sales revenue.  A problem that arises from that process is that non-agency revenue can, and often does, get reported as revenue.  The non-agency revenue includes customer premiums and also transfers from other bank accounts, such as the owner’s personal account.  We have reviewed financials from numerous agencies that had overpaid income taxes due to the accountant over-stating revenue.

To prevent this type of error from occurring, both the accountant and the agency owner should compare the bank deposits to monthly carrier commission statements.

As a general practice, agencies should:

• Review carrier commission statements on a monthly basis.
• Reconcile the statements to the AMS and accounting systems. If the agency does not use either, then simply enter the monthly commission deposits into a tracking spreadsheet.
• Save electronic copies of every statement for at least 36 months.

Reconciling the Balance Sheet

Under Assets on the balance sheet, the accountant should include both the operating account balance and the trust account balance. Under Liabilities on the balance sheet, entries should be made for the amounts due to insurance companies from the agency’s trust account.

Some states may not require agencies to maintain separate operating and trust accounts, but the practice should be maintained anyway.  The Internet is filled with stories of agency owners being prosecuted and losing their licenses for improperly using trust funds.  Agencies should never be out of trust (e.g., carrier payables > cash + receivables).  If an agency has cash flow problems, set up a line of credit.

Summary

The accounting issues highlighted in this article are based on common errors or situations that our team has encountered working with agency clients over the years.  By incorporating the best practices listed above, an agency owner and their accountant will:

1. Have a better understanding of the agency’s operating performance.
2. Minimize the risk of the agency falling out-of-trust with carriers.
3. Be in a better position to sell because it will be easier to prove revenue and profit.

For anyone needing further assistance, feel free to contact our team.  We have extensive experience working with insurance agencies of all types and offer financial consulting services.

Frequently Asked Questions About Insurance Agency Accounting

What’s the difference between agency bill and direct bill?

Direct bill, also known as company bill, is when the insurance carrier sends the bill to the customer and the customer pays the carrier directly.  The carrier then sends a commission payment to the agency.  Most personal lines policies, such as auto and homeowners, are handled this way.  Agency bill is when the agency invoices the customer, collects the premium into its trust account, and pays the carrier.  Most commercial and business insurance is agency bill.  The distinction matters for accounting because agency bill premiums flow through the trust account and are not agency revenue.  Only the commission portion is revenue.

Is insurance agency revenue the premium collected or just the commission?

For an insurance agency, revenue is the commission, broker fee, or contingent income earned on a policy, not the customer’s policy premium. Premium dollars that pass through the agency’s trust account on the way to the insurance carrier are not income to the agency and should not appear on the income statement as sales.

Do P&C insurance agencies need to separate trust accounts from operating accounts?

Yes. Most states require a separate trust (escrow) account for client premium funds, and even where it is not strictly required, keeping the accounts separate is a recommended standard practice. Using trust funds to cover operating shortfalls has cost agency owners their licenses and led to criminal prosecution.

Should commissions paid to producers be recorded as COGS or as an operating expense?

Producer commissions are typically operating expenses, not cost of goods sold, except for the case of external producers where the agency does not own the accounts.  Breaking out payroll and producer commissions as separate expense lines gives the owner a clearer view of sales and service costs.