Trust money

Many insurance agents, attorneys, accountants, and regulators consider commingling funds to be the primary issue. Commingling occurs when a company deposits a customer's premium in the same account from which payroll checks are cut. On the other hand, if the customer's money is deposited in an account from which the only checks cut are to carriers or premium returns to clients, then the money is not commingled with operating funds (be aware some carrier contracts require separate bank accounts for each carrier).

I, personally, am less concerned about whether money is commingled than I am about someone's money being spent without their knowledge or consent.

Misconception

"If no one finds out, it doesn't matter." That belief unfortunately is common among many agency owners whose agencies are out of trust. When an agency is out of trust, it is robbing Peter to pay Paul. Just because Peter doesn't know he's being robbed doesn't make it ethical or legal. Just because after robbing Peter to pay Paul, the agency robs Jane to pay Peter and Peter, Paul, and Jane are never the wiser, it's still unacceptable.

Professional advisors

Accountants often do not understand this issue because most industries do not hold hundreds of thousands, and even millions, of other people's dollars in a fiduciary capacity. They do not expect it, they don't ask about it, and the way most agencies' financial statements are formatted, the issue does not stand out.

Another factor is that Generally Accepted Accounting Practices do not have a specific rule requiring accountants to identify the specific amount of trust money that is supposed to be being held in trust. This is unfortunate and misleading. For example, the publicly traded brokers' audits and filings state that the broker holds money in a fiduciary role, but no calculation is provided to show that enough money is being held in trust. Under such guidelines, the accounting firms meet their obligations without actually offering any information of value.

Another problem occurs when an agency's accountant erroneously assumes all the cash is the agency's to spend, so they advise the agency to bonus out the cash to minimize taxes. When this occurs, the agency often ends up out of trust.

Many attorneys have no knowledge about insurance agency/broker accounting. In these situations, the agency owner must bridge the gap by explaining that a trust account is like the attorney's own escrow account. Otherwise, the attorney will likely write buy-sell agreements, cluster agreements, broker agreements, and so forth without any consideration of the agency's obligations to not spend money that does not belong to the firm.

Consultants and investment bankers often downplay the importance of the trust account because it is bad for their own business. Additionally, many seem to bring a unique perspective that as long as the agency is sold first, who cares? Others simply don't understand the terminology, or their ultimate clients are only concerned with more generic debt/equity ratios. Frankly, what difference does it make if a firm has four times interest coverage ratios or can cover their interest expense 20 times over if the firm is spending money that is not its to spend?

Intent

Rarely are agents' intentions to purposely do anything wrong. Many agency owners know their intentions aren't bad, so they do not believe they're doing anything wrong. But there's no room for ignorance or fantasy regarding these situations. Most meth heads did not intend to turn to crime for their fixes, either. So when caught stealing to support their habit, should they just be turned free?

Impact

Being out of trust violates the ethics of the industry and violates carrier contracts. For example, a typical carrier contract might state: "Agent shall hold as a fiduciary trust, all premiums collected by or paid to Agent for insurance issued in Company's name, separate and apart from any money belonging to the Agent."

Being out of trust decreases an agency's value. If the owner can sell a shell of a corporation, then maybe there is no impact. It happens. Some buyers just don't care. Some buyers are not that ethical. They plan to sell or flip their own firm to someone that does not understand the situation, so they don't care. In most situations, though, value is clearly diminished. Some agency's trust deficiency may be small enough so the value impairment is less than the value of the entire firm and the seller at least nets something. But the penalty is often significant.

The fix

Borrowing money to make the trust account whole is preferable to not doing anything. Equity is truly the best solution, though, because the money should come from the owners. The problem is that often the owners don't have the cash to put into the agency and since the contribution is with after-tax dollars, it is expensive. The problem with using lines of credit to fill the hole is that the agency is borrowing short-term money to fill a long-term equity hole. The hole needs to be filled permanently and never re-dug. But again, it might be better than doing nothing.

Bottom line

A poor trust ratio reveals much about the ethics and management ability of the agency owners, for better and for worse. With the large audit returns being experienced today, having adequate capital is more important than ever. Agencies with good trust ratios and solid capitalization have awesome opportunities. I'm more excited about the opportunity these agencies possess than I have been about the market in a long time. Realizing the benefits may take some time, but when these cards are played right, the opportunities are huge.

For the others, I cannot think of a worse time to be out of trust. This really is the perfect storm of potential disaster for those agencies that are out of trust. Today is the best day to begin fixing the problem.