Premiums, premium finance and premium trust accounts

Agents’ legal issues: Premiums, premium finance and premium trust accounts

Kleinman, Randall

Agents’ Legal Issues provides a brief general overview of a complex area of law and neither the author nor Rough Notes intends it to be taken as legal advice for any specific legal problem. For a specific problem, consult legal counsel that understands the law of insurance agencies, and provide all the details.

Premiums are a fun topic. While a column on legal issues sometimes has to discuss somewhat more adversarial concepts such as lawsuits (!), everyone likes to talk about premiums. Premiums are usually incoming payments; bringing them into an agency also brings with them a feeling of success. Not to mention commissions.

Traditional premiums are still the lifeblood of most agencies. In spite of a lot of talk a few years ago regarding fee-based consulting, the vast majority of agencies earn most of their income from premium transactions. Even on the life insurance side, fee-based financial planning has made less of an impact than was predicted a decade ago.

Insurance payments and the role of the agent

This article will look at a number of legal issues connected with premiums. First, we’ll look at what an insurance payment may consist of, including not only premium, but also a quick look at service and inspection charges as well as premium taxes. Second, we’ll look at premium trust fund accounts (sometimes also referred to as “premium fund trust accounts”), and some of the rules connected with them.

While this article will be general in nature, because the insurance laws vary from state to state, nevertheless this will give you a sense for the types of laws you might see.

A premium by any other name

There are several different types of payments that a buyer of insurance may be asked to make. Let’s go through some of them.

Premium. We generally think of the premium as the lump sum that the insured pays prior to the inception of a policy. However, premium can come in from different sources and at different times. For example, a premium finance company (see below) may make the payment for the insured. As another example, a premium audit may bring in premium long after the policy has expired.

It’s even possible that no payment may be necessary. Not only do a variety of life and health policies provide for waiver of premium payments during the insured’s disability, but in some instances an insurer may have the legal obligation to give a credit to the insured, toward payment of premium obligations that have been unpaid, as a result of money that the insurer owes the insured. Such money might even include loss payments owed or dividends owed.

The situation becomes even cloudier where the money owed is under an entirely separate policy than the one for which premium is owed. For example, if an agent or carrier group has sold a policyholder both a whole-life policy and a homeowners policy, must the cash value of the whole-life policy be borrowed against to pay current the homeowners policy? Generally no, but a few courts have ruled that an insurer holding money from any source due to the insured must use the money to prevent a default in premium payment.

On the other hand, if a policy has been agreed to by the insured, and a loss occurs before the insured is required to send the premium to the agent, then the carrier may be required to honor the agreement, issue the policy, and pay a covered loss, and the insured may be required to pay the premium when due.

Payment of premiums must be made on time, although a failure on the part of an agent to give statutorily-required notice may by law extend the time for payment of the premium. Life policies may have provisions for a grace period within which to pay premiums late; it is much less common to see such a provision in property/casualty policies. An agent should not assume he or she has authority from the carrier to extend the time for payment of premium unless it is clear in the agent’s contract that he or she may do so.

Buyers of insurance have asserted many interesting excuses for nonpayment of premiums over the years. Court cases show the following excuses that have been made: poverty, illness, insanity, unconsciousness, illiteracy, out of state at a funeral, absent for seven years and presumed dead, pending litigation, and Act of God. (The courts are split as to whether an Act of God can excuse the payment of premium.)

While most excuses for non-payment fail in court, a couple interesting ones did succeed. After the Civil War, for example, a couple Southern courts ruled that certain Southern insurance contracts were still in effect, even though premiums were not paid during the war by Southerners to carriers in the North, although some Northern courts tended to disagree. Also, in an old New York decision dating back to 1933, a court ruled that Ukrainian holders of Russian life insurance policies were not in default by virtue of their failure to pay premiums to an Americanbased insurer as a result of the upheavals caused by the Soviet Revolution and the consequent closing of the insurer’s Russian office. However, the decision was later reversed.

There are occasions when premium can come in after the policy has incepted, through the payment of installment premium, or of premium audit assessments, or of premiums owed retroactively after the policy has expired. Agents sometimes advance premium to carriers on behalf of insureds (where legally permitted), and in the event of non-payment of the premium by the insured to the agent, the question arises whether the agent acted on behalf of the carrier or whether the debt is due to the agent. Such debts tend to be hotly contested in court: expect the debtor to deny requesting an advance of premium, or to argue that the only remedy for non-payment should be policy cancellation.

Fees. There are several types of fees that should not be confused with premiums. Service charges, inspection fees, and consulting fees are sometimes charged in addition to the premium. States vary considerably as to how they treat such fees. Some states absolutely prohibit such fees. Other states limit how they may be imposed. For example, in Illinois, a service charge must be evidenced by a written document signed by the insured, showing the amount of the charge. Some states require additional proof that the size of the fee is reasonable. Several states allow consulting fees, or commissions, but not both. Separately from regulatory rules, don’t charge any fees without checking first with the carrier (and looking at your contract with the carrier), to make sure you are permitted by the carrier to charge the fee.

Taxes. You’re probably used to having the carrier handle any premium taxes. However, if you do surplus lines business, or purchasing group business, you may get involved in the collection and remitting of taxes. In such a case, it is necessary to find out your state’s position as to whether fees are considered “premium” for taxation purposes. Bad accounting practices can get you in trouble with tax authorities here.

Premium financelenders of premium

Many insureds need help financing their purchase of insurance. One of my friends, for example, can afford to buy a new car, but is daunted by the extra amounts needed for taxes, licenses, insurance, maintenance, and gas. The insurance can often be financed (along with some of the other items), and premium finance companies are a prime source. However, they are not the only source, since banks, consumer loan companies, and others may be permitted by state law to make such loans. In addition, insurance companies may circumvent the need for financing in some cases by allowing installment payments or short-term policies. At least in Illinois, an insurance agent himself or herself is considered to be “financing” premium if 10% or more of the accounts receivable are over 90 days due.

Some agents start their own premium finance companies. The amount of assets needed can be far less than that required to start a bank. However, there are a number of large, active finance companies happy to handle the financing, and to take the risk off the agent’s back. Insurance being a highly regulated business, the amount of permissible loan charges may be set by statute, and loan agreement forms may have to be filed with insurance authorities. If there is a default in payments to the finance company, the company must go into action (see below).

A typical financing agreement may have to be prepared according to precise statutory guidelines, with relatively little leeway. Like most bank loan agreements, it will typically state the amount financed, the down payment, the principal owed, the finance charge-expressed both in dollars and in percentage annual interest-the number of installments, with the date and amount of each, the policy or policies involved, and other information. The premium check is usually made out to the insurer, unless the agent has authority to receive the money in the agent’s name.

If the insured defaults in payments to the financing company, the financing company usually has a contractual right (based on the financing agreement, and on the insurance policy wording) to cancel the policy on behalf of the insured, and to receive the return premium. However, the finance company may have to notify the insured, as well as mortgagees and other third parties and additional insureds, before cancellation can take place. The carrier will usually refund premium to the finance carrier based on the rights of the finance agreement, except that if more refund premium exists than is needed to pay back the finance company, the insured should receive the remainder.

Premium fund trust accounts

I’ve always been amused by two common names for these accounts. A “premium fund trust account” is an account held in trust where premium funds are put. A “premium trust fund account” is an account where a fund is put, consisting of premiums being held in trust. They’re really the same thing, although the statutes describing them may vary from state to state.

If all your premiums are direct bill, then your PFTA is not going to be a problem. However, if carriers and insureds and regulators trust you to hold money in such an account, then there are statutory rules to follow.

Many agents are unaware of the rules for such accounts. First of all, your state may prohibit certain types of investments for the account, such as out-of-state bank deposits, certain bonds, stocks, etc. Investments as routine as money market funds may be prohibited if the money market fund invests in non-allowed investments. Even if your state has no specific rules about how you handle insurance trust funds, the general law regarding trusts and trustees has detailed rules as to how you handle funds placed in your care.

You may also enjoy receiving the interest generated by such an account, but since you are holding the money in trust, the interest may belong to the person for whom you are holding the money-it could be the insured, or the carrier, or a wholesaler, depending on the circumstances and on contractual obligations. Some states require an agent to receive written permission before keeping the interest generated by trust accounts.

It used to be that insurance regulators audited the trust accounts of agents fairly regularly, but in these days of budget cutting for government, there are fewer government auditors around to do so. As a result, it is possible that an agency’s trust funds may become depleted. That should never happen if an agent is honest and keeps competent accounting records. Not only is dipping into a trust fund potentially a criminal offense, but the resultant debt may not be one that is dischargeable in bankruptcy. So stay out of those trust funds!

You don’t often read about premiums, premium finance and premium trust funds. There tends to be more interest about marketing and commission levels, which is natural. But the nuts and bolts of handling premium are very important to an agency that wants to continue bringing in commissions without problems.

The author

Randall Kleinman, JD, CPCU, CLU, has been a member since 1984 of The Law Firm of Malloy & Kleinman, PC., of Des Plaines, Illinois, which emphasizes legal work for insurance agents. Recently, he was elected president of the Chicago-Northwest Suburban Chapter of CPCU, one of the CPCU Society’s largest chapters.

Copyright Rough Notes Co., Inc. Jul 1996

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