by Angi Bemiss, November 2005

National Underwriter

One of the hot topics of insurance agency accounting and valuation right now is direct bill.  As Hamlet would have pondered, “To accrue, or not to accrue – that is the question.”

Why is direct bill (“DB”) a hot topic?  It’s handled incorrectly by many agencies.  There are treatment inconsistencies within the industry (from agency to agency).  It makes a difference in the value of an agency.  We have seen the correction of improper DB balances materially affect the price paid for an agency, and it sometimes does not get identified as an issue until the due diligence process takes place.  And, we see a lot of money lost or wasted due to reconciliation activities that are ineffective or are focused on inconsequential items.

Direct Bill for the Baffled

I am frequently asked “What’s the ‘best’ method for handling direct bill?”  Then, there follows several sub-questions.  Should you accrue, or not?  If you accrue, what should you accrue?  Should you reconcile?  If you reconcile, should you do it for all departments?  Should your CSRs invoice DB policies?  Or, should everything be done in the accounting department?  Are the carriers accurate in making DB commission payments?  To put all this in perspective, last year I prepared a booklet entitled “Direct Bill for the Baffled,” because none of these questions have simple “yes” or “no” answers.

I am frequently the coordinator of the due diligence teams for banks that are making their first insurance agency acquisition.  I always preface the engagements by explaining that I can still remember my first exposure to agency accounting.  I had been an accountant for ten years, but yet I felt like a total idiot.  Why?  Simply stated, agency accounting is not what you learn in school!  Then, I quickly assert (quoting Hamlet one more time) that there is good news:  “Though this be madness, yet there is method in ‘t.”

First, there are many standard industry accounting practices – especially for agency-billed policies.  Most agencies record commissions on an accrual basis.  And, they account for those commissions consistently – up-front on annual-billed policies, and by installment effective date on installment-billed policies.  So, within any 12-month period you record a year’s worth of commission regardless of the billing method.  Then, there’s the concept of “later of invoice or effective date.”  I show them a simple exhibit with 3 different scenarios -- a future bill, a current bill, and a late-billed item – so they can see show how the concept works.  So far, so good.

Next we move on to direct-billed accounting practices, and things get a little more interesting.

1.  Is the agency set up to accrue?  Industry Answer:  Probably 50/50 – half the agencies accrue, and half are on a cash basis.

2.  If so, are they doing it for all lines?  Industry Answer:  Not usually.

3.  Do they reconcile?  If so, are they really reconciling or are they simply “flagging” transactions to get them onto a production report?  Industry Answer:  The majority of agencies aren’t really reconciling.  Rarely do we find an agency that has a list of open DB commission items that ties to the DB Commission Receivable on their balance sheet.  Now, we’re in muddy water.

4.  How can you have a receivable on your books without a subsidiary ledger that ties to the GL balance?  Industry Answer:  Great question!  Now, a red flag gets raised.

5.  Why isn’t there consistency?  Industry Answer:  The automation vendors built a lot of flexibility into their system to allow for different preferences.  That resulted in inconsistencies and, in some cases, what I refer to as “bad books.”

Why is it this way, and what is right?  How can you avoid “bad books”?

When asked by agency principals what they should do about direct bill accounting, here are my recommendations:

1.  Accrual is best, because it is consistent with what you are doing on agency-billed policies.  (Remember, consistency is one of the basic principles of good accounting.)

2.  The accrual should be between one and 1.5 months of your average monthly DB commission income.  For example, if your agency’s annual DB income is $6 million, an accurate accrual balance is most likely between $500,000 and $750,000.  If it’s more than that, it is probably wrong.  (We see this in a lot in agencies that are not really reconciling.  The DB Commission Receivable balance may include years and years of old items and balances – that will never be received.)  Take a look at your carrier DB statements and see how many months in arrears they are, on average.  Some group carriers pay in the current month, so there’s nothing to accrue.

3.  The accrual should not include future installments.  Your DB Commission Receivable balance should accurately reflect the commissions that are “in the pipeline” for transactions effective up through the current month.  (This is consistent with how agency-billed commission is reported.)

4.  Your accrual should be for all lines – commercial, personal, and individual/group.  (We frequently see instances where commercial and personal are accrued, but where individual/group is on a cash-basis.)

5.  Your CSRs should enter DB invoices.  They have the source documents, and it’s the only way that you are truly able to reconcile between the agency’s records and the carrier’s records.  Otherwise, you are accepting the carrier’s amounts on all items.  Their records should be accurate, but the reconciliation identifies discrepancies in commission rates and, more importantly, missing commission dollars.  Additionally, this generates current production information.

6.  If you accrue DB commission income, you should also accrue the corresponding producer commission compensation expense.  This addresses another accounting principle – matching expenses with revenue.  (Unfortunately, we rarely see this done correctly.)

7.  Reconciliation should only be done where the amounts are material and cost-justified.  In general, I recommend that you reconcile commercial and individual/group.  Do not reconcile personal on a per-policy basis (see note below).  With the prevalence of carrier interface on personal lines, you would probably be reconciling the carrier’s commission remittance to the carrier’s downloaded commission receivable – useless.  Additionally, you will rarely find sufficient errors that “pay for” the cost of the reconciliation personnel.  Also, the carriers’ remittance practices vary greatly.  Some pay your commission up-front, and some pay in installments.  Matching up commission receipts with a commission receivable becomes a nightmare. 

Note:  On personal lines, I recommend that you reconcile by carrier on a lumpsum basis.  That is, compare the carrier’s remittance for a 12-month period with your expected commission for the 12-month period.  You can easily obtain your expected commission by running a production report.  This method isn’t precise, but it will alert you to any carriers where there are gaps between their payments and your expectations.  As a comment, experience has shown that the personal carriers are extremely accurate.

In summary, the topic of direct bill can be baffling.  Lest you think that “the lady doth protest too much,” remember that there is a method to the madness.  Be consistent.  Match revenues and expenses.  Monitor your DB Commission Receivable balance.  And finally, invest reconciliation staffing dollars where they will pay for themselves.

Angi Bemiss is a principal and senior vice president of Reagan Consulting, Inc.  She may be reached at 404.233.5545 or at angi@reaganconsulting.com.  Reagan Consulting is an Atlanta-based financial and management consulting firm serving the insurance distribution system.