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5-3-89
ACCOUNTING AND REPORTING GUIDE
FOR
INSURANCE AGENTS AND BROKERS
This guide presents the views of the Insurance Agents and Brokers
Tasks Force and is intended to document the present accounting
and reporting practices followed by insurance agents and brokers.
The guide also sets forth the consensus conclusion of the Task
Force with regard to each issue raised.
This guide has not been exposed for comment nor has it been
presented to or approved by the AICPA or any other recognized
accounting standards setting organization. As such, the advisory
conclusions contained herein have no authorized sanction or
standing.
Prepared by the
Insurance Agents & Brokers Task Force
of the
Insurance Companies Committee
American Institute of Certified Public Accountants
Draft
5-3-89
ACCOUNTING AND REPORTING GUIDE
FOR
INSURANCE AGENTS AND BROKERS
This guide presents the views of the Insurance Agents and Brokers
Task Force and is intended to document the present accounting
and reporting practices followed by insurance agents and brokers.
The guide also sets forth the consensus conclusion of the
Task Force with regard to each issue raised.
This guide has not been exposed for comment nor has it been
presented to or approved by the AICPA or any other recognized
accounting standards setting organization. As such, the advisory
conclusions contained herein have no authorized sanction or
standing.
Prepared by the
Insurance Agents and Brokers Task Force
of the
Insurance Companies Committee.
American Institute of Certified Public Accountants
TA BLE OF CONTEN TS
1 Introduction.
.
............................................
...1-2
2 General Background
........
..
............................. ...3-7
3 Commission and Fee Arrangements
.......................
...8-13
6 Advances by Brokers ....................................
..
14-15
6 Commission Adjustments..................................
..
16-21
8 Investment Income ......................................
..
22
8 Broker of Record.
.
.......... ..
.........................
..
23
8 Foreign Brokerage Operations
...........................
..
24-27
10 Authoritative Accounting Pronouncements
........
. . . 28-30
12 Retail Brokers
12 Revenue Recognition ....................................
..
31
12 Regular, Negotiated, and Split or Shared Commissions. 32-35
13 Contingent Commissions
...............................
..
36-42
15 Commission Adjustments................................
..
43-45
16 Installment Billing Arrangements
.....................
..
46-47
16 Multi-year P o l i cies..................................
..
48-50
17 Direct Billing Arrangements
.........................
..
51-52
18 Fee in Lieu of Commissions
...........................
..
53-54
18 Fee-for-Service Agreements
.........................
..
55-56
19 Expense Recognition ....................................
..
57
19 Initial Direct Costs..................................
..
58-61
20 Subsequent Servicing Costs. ....
.................
..
62
20 Indirect Costs
........................................
..
63
21 Recognition of Costs..................................
..
64-67
22 Financial Statement Presentation
.......................
..
68-73
i
Page
Page
Paragraphs
25 Wholesale Brokers ................................. 74
26 Reinsurance Intermediaries
26 General........................................ 75-76
27 Operations of Reinsurance Intermediaries
...........
77
27 Assessing Needs............................... 78
28 Marketing the Risk
............................. 79-80
28 Transmitting Information and Money
.......
.
81-82
29 Drafting the Contract
.........................
83-84
30 Revenue and Expense Recognition
30 Servicing the Contracts........................ 85
30 Excess of Loss Reinsurance Contracts............. 86-87
31 Pro Rata Reinsurance Contracts
..................
88-90
32 Foreign Reinsurance
..................
..... 91
33 Retrospective Commission Adjustments
............. 92
33 Expense Recognition
...........................
93
33 Financial Statement Presentation
..................
94
34 Managing General Agents
34 General........................................ 95-97
35 Comparison of MGAs and Brokers
....................
98-101
36 Revenue and Expense Recognition
36 Commissions and Fees
...........................
102-106
38 Contingent Profit Commissions
..................
107-112
41 Expense Recognition
...........................
113-117
42 Financial Statement Presentation
..................
118
ii
Page
Paragraphs
43
........................Life Insurance Agents and Brokers
43 General.......................................... 119-123
44 Services Provided by Life Insurance Brokers
.........
124
44 Revenue and Expense Recognition
44 Commissions
....................................
125-127
45 First-Year Commissions
.........................
128
46 Renewal Commissions. .
.
.........................
129
46 Persistency Bonus Commissions
....................
130
46 Commission Adjustments
.........................
131
47 Expense Recognition
.........................
.
. 132
47 Financial Statement Presentation
...................
133
48 Expense Recognition by Brokers Affiliated with
Insurance Underwriters
.........
. ............... 134-140
50 Purchase Accounting
50 Separately Identifiable Intangibles Other
Than Goodwill.
.
....................
............
141-143
50 Intangibles— General
.........
.
..................
144
51 Renewal Rights ................................... 145-147
52 Amortization of Renewal Rights
....................
148-149
52 Employment and Management Contracts
and Noncomplete Agreements
......................
150-153
53 Affiliates and Other Investments
..................
154
53 Operational Systems
...............................
155-156
54 Leasehold Interests...............
................
157
54 Licenses
........................................
158
54 Goodwill
........................................
159
55 Glossary
iii
INTRODUCTION
1. At present, no authoritative accounting literature specifies
generally accepted accounting principles for certain of the specialized
transactions of insurance agents and brokers, and the industry has
developed diverse accounting and reporting practices in several areas.
This guide describes the industry's current accounting and reporting
practices and provides conclusions and recommendations on accounting and
reporting by insurance agents and brokers.
2. The sections of this guide on "General Background" and "Retail
Brokers" address issues primarily as they relate to the operations of
property and casualty insurance brokers. However, because of the
similarity in operations, those discussions are also relevant to brokers'
activities in accident and health insurance, group insurance plans,
employee benefits services, and short-duration term life insurance.
Subsequent sections of this guide discuss the unique considerations
relating to managing general agents, reinsurance brokers and
intermediaries, long-duration life insurance brokers, and affiliated
brokers, as well as the reporting business combination issues related to
the purchase of insurance agencies or brokerage firms.
1
GENERAL BACKGROUND
3. Insurance agents and brokers function as intermediaries between
insureds (i.e., clients) and insurance underwriters, and they distribute
a substantial portion of the insurance marketed in the United States.
Insurance is also distributed, among other methods, through direct
selling by personnel employed by insurance underwriters, mail order
sales, contacts through department stores and airports, and direct mass
media solicitation.
4. Insurance brokers act on behalf of their clients by developing risk
management programs, which can include both the retention of risks by
clients (i.e., self-insurance) and the transfer of such risks to
underwriters through insurance negotiated and placed by the broker. An
insurance agent is an agent of one underwriter (an exclusive agent) or
several underwriters (an independent agent) with express or implied
authority to act for them in dealing with insureds. The activities of
these two kinds of insurance producers and their relationships with the
underwriters are often not distinct. A producer may be a broker in one
transaction and an agent in the next. While there are legal distinctions
between insurance agents and insurance brokers, this guide does not
distinguish between the two classifications. Unless otherwise specified,
this guide uses the term "broker” to refer to both insurance agents and
insurance brokers.
5. Brokers place commercial lines and personal lines of insurance.
Commercial lines consist of property and casualty coverages for business
enterprises, which include insurance against damage to property,
liability indemnity insurance, workers’ compensation insurance, and group
life and health insurance. Personal lines consist of coverages for
individuals, which include primarily of automobile and homeowners or
tenants insurance and individual life insurance.
6. Brokers may also place fidelity and surety bonds, develop and
administer employee benefit programs and retirement plans, and furnish a
2
vide variety of advisory and consulting services, such as claims and loss
processing assistance, feasibility studies for and management of captive
insurance companies, claim reserve analyses, loss control studies,
actuarial studies, and the formulation of new kinds of insurance
coverage.
7. Brokers include retail brokers, wholesale brokers, reinsurance
intermediaries, and managing general agents.
- Retail brokers act as intermediaries between clients seeking
insurance coverage and underwriters. Retail brokers include
certain financial institutions, such as banks and securities
brokers, that also are active in marketing certain kinds of
insurance coverages.
- Wholesale brokers act as intermediaries between retail brokers and
underwriters. Wholesale brokers include excess and surplus lines
brokers and brokers that place insurance in international
insurance markets, such as Lloyd's of London.
- Reinsurance intermediaries act as middlemen between underwriters
in the transfer of insurance risks.
- Managing general agents act as agents of one or more insurance
underwriters in selecting, underwriting, and servicing business
for the underwriters represented.
Commission and Fee Arrangements
8. Brokers often are compensated for their services by commissions paid
by the underwriters. The services that a broker ordinarily provides in
return for commissions include evaluating the risk, determining the
Insurance requirements, selecting the underwriter, and placing the
insurance. The broker may also provide services after the insurance has
been placed, such as processing and collecting claim settlements for the
client. The commissions usually are stated as a percentage of the
3
insured's premium, and such commissions are referred to in this guide as
"regular commissions." The commission rates vary depending on a number
of factors, including the kind of insurance, the amount of the premium,
the broker's arrangement with the particular underwriter, and the legal
capacity in which the broker acts. Under negotiated commission
arrangements, a broker agrees with the client to handle its insurance
program for a commission rate different from the standard commission
rate.
9. The industry has also developed a compensation arrangement commonly
referred to as a ’’fee in lieu of commission” arrangement. Under such an
arrangement, a broker agrees to handle a client's insurance program for
an agreed fee, which may be more or less than the amount of regular
commissions that the broker would normally receive.
10. Many brokers provide services that do not relate to obtaining
insurance coverage and are compensated under agreements for fees for
services rendered. Examples of these types of services are underwriting
management, loss prevention inspections, risk management consulting,
claims management, employee benefit consulting, and administration of
self-insurance programs. Such brokers normally are compensated under fee
arrangements based on physical events, such as the number of loss
prevention inspections made or claims processed, or on a project basis,
such as fixed fees or hourly charges for risk management studies or for
the management of captive insurance companies. Brokers sometimes agree
to receive a single fee for service arrangements, as described in this
paragraph, and for the placement of insurance coverages; these
arrangements are referred to herein as "bundled transactions."
11. In addition to the regular commissions, negotiated commissions, and
fees in lieu of commissions received by brokers for basic services, many
brokers also receive contingent commissions from underwriters under
various types of profit-sharing arrangements. Subject to the terms of
such arrangements with the underwriters, the brokers' ultimate commission
generally depends on the profitability of the business placed by the
4
brokers with the underwriters. The contracts generally provide for
contingent commissions to be paid in the first half of the calendar year
based on the profitability of the business placed with the underwriters
in the preceding three-year period. The amounts of contingent
commissions to be received in a given year are rarely determinable by the
brokers in time for inclusion in the brokers’ financial statements for
the periods on which the contingent commissions were based.
12. Shared or split commissions may be used if more than one broker is
entitled to a portion of the commission on an insurance policy. The
primary broker generally bills and collects the entire premium and
commission and remits the share of the commission owed to the
participating broker or brokers (the sub-brokers).
13. The broker commonly bills the client, collects the total premium,
retains its commission, and remits the net premium amount to the
underwriter. Several methods are in use for billing premiums, as
follows:
- Brokers sometimes bill the anticipated premium (or some portion
thereof) when a binder is issued to expedite collection of the
premium. Later, a final invoice is issued when the amount of the
premium has been determined, when all of the applicable insurance
documents have been received, or when any necessary adjustments to
the binder billing have been made. A binder is a temporary insurance
contract created to confirm to the client that coverage is in force
pending creation of the formal insurance policy. Binders that
contain premium billings are called ’’premium-bearing binders."
- Brokers frequently bill their clients when the broker receives the
policy from the underwriter for delivery to the client.
- Brokers sometimes bill their clients on a monthly, quarterly, or
semiannual installment basis. Certain kinds of policies
occasionally are written on a three-year basis, and annual or more
frequent billings are made on these policies.
5
- On some policies, the clients pay the premiums directly to the
underwriters, which pay commissions to the brokers. This direct
billing method is used most frequently with personal lines, employee
benefit plans, and life insurance coverages.
Advances By Brokers
14. Brokers sometimes advance insurance premiums on behalf of clients to
the underwriters before the brokers receive the premiums from the
clients, thus putting the brokers at risk for the collection of the
premiums from the clients.
15. Brokers sometimes also advance claim settlements or premium refunds
on behalf of underwriters to the clients before the brokers receive the
settlements or refunds from the underwriters, thereby putting the brokers
at risk for the collection of the amounts from the underwriters.
Commission Adjustments
16. A broker's commission may be adjusted when the related premium is
adjusted, when coverages under the insurance policy are changed, when the
policy is cancelled, when errors have been made in calculating the
premium or commission, or when the premium is retrospectively rated or is
subject to audit.
17. When the terms of an insurance policy are changed, for example, by
adding to coverages, increasing deductibles, or deleting coverages, the
documentary evidence of the change is referred to as an endorsement.
Endorsements may result in additional premiums, returned premiums, or no
premium adjustment.
18. For retrospectively rated policies, premiums vary with the history
of the losses during the periods covered by the premiums. A considerable
amount of workers' compensation, group accident and health, boiler and
machinery, commercial automobile, and general liability insurance
6
coverages are written on such policies. Retrospective adjustments bring
the premiums and the related commissions to their final amounts.
19. For certain kinds of insurance, the insureds' records are audited at
the ends of the policy periods, often by the brokers or their
representatives, to determine the amounts of premiums to be charged for
the periods of coverage. For example, the insureds' payrolls, number of
employees, values of properties held, gross receipts, or units sold may
be audited during or after the policy periods to ascertain the amounts of
premiums that are due for the coverages provided. Additional premiums or
return premiums are determined based on these audits.
20. For certain kinds of insurance, variable premiums (referred to as
"reporting-form premiums") are charged based on predetermined rates
applied to values that change throughout the policy period. In those
instances, the premiums generally are calculated, reported, and remitted
by the insured to the insurer on a periodic basis, often monthly.
Examples of coverages for which reporting-form premiums are common are
workers' compensation, general liability, builders' risk, and broad form
cargo policies. For these types of coverages, the reporting-form
premiums and related commissions generally are not reasonably
determinable prior to notification from the insured via the reporting-
form mechanism.
21. Brokers' commissions are subject to return in whole or in part if
policies are canceled and the related premiums are returned. There are
three different kinds of policy cancellations, generally referred to as
follows:
- "Flat" cancellations, in which the entire premiums are returned.
- "Pro rata" cancellations, in which proportionate amounts of the
premiums related to the unexpired portions of the policy periods are
returned.
- "Short rate" cancellations, in which amounts specified in the
contracts are returned, which amounts are less than the amounts
calculated on a pro rata cancellation basis.
7
Investment Income
22. Brokers collect premiums from insureds and, after deducting their
commissions, remit the balance to the insurance underwriters. Brokers
also collect claim settlements or premium refunds from underwriters on
behalf of insureds. Until remitted to the underwriters or the insureds,
brokers hold those amounts as fiduciaries. These funds generally are
invested in short-term cash equivalents, and the investment income earned
on these funds is retained by the brokers. Certain states have varying
restrictions on the investment of the funds, which include limiting the
nature of the acceptable investments, investing the funds within the
state, or obtaining permission of the underwriters to retain the
investment income. The total investment income that the brokers earn
includes investment income on the foregoing funds and on their own funds.
Broker of Record
23. The broker of record, i.e., the broker at the date when the
insurance was placed, generally is entitled to retain the related
commission income if the client changes brokers during a policy period.
Also, brokers of record customarily are not contractually obligated to
continue providing services under the policies; however, a broker of
record may voluntarily decide to continue to do so.
Foreign Brokerage Operations
24. A number of the larger U.S. based brokers have, for some time,
maintained brokerage operations in foreign countries in addition to their
operations in the United States. These foreign brokerage operations were
often established and maintained to meet the local service requirements
of the large multinational clients of the U.S. based brokers. In
addition, particularly in the highly-developed local economies, such as
in the United Kingdom and Western Europe, these foreign brokerage
operations represented efforts by the U.S. based brokers to offer the
same services to the foreign business entities and individuals as the
8
brokers provide in the United States. U.S. based brokers also have
acquired foreign brokerage operations to gain direct access to worldwide
insurance underwriting markets such as Lloyd's of London.
25. As a consequence of the diverse objectives for which U.S. based
brokers have established operations in other countries, such investments
have taken various forms, including wholly-owned subsidiaries, branches,
joint ventures, and minority interests in local brokers in the foreign
countries.
26. The kinds of services offered to clients in foreign markets often
are similar to those offered in the domestic market. As a result, the
fundamental issues in accounting and financial reporting by U.S. based
brokers that are the subject of this guide also generally apply to their
foreign operations that are consolidated with the domestic operations or
included on an equity basis in their financial reports prepared in
conformity with generally accepted accounting principles in the United
States. Nevertheless, local customs or business practices, as well as
legal requirements and restrictions, often affect the specific issues in
each country and need to be considered when financial reports are
prepared.
27. In addition to the accounting and financial reporting issues unique
to brokers discussed in this guide, all other aspects of accounting for
the foreign operations of U.S. based brokers should conform with
generally accepted accounting principles in the United States. For
example, foreign accounting practices that may need to be modified to
conform with U.S. accounting standards could include revenue and expense
recognition practices, accounting for income taxes — particularly
deferred taxes, amortization of goodwill, interim reporting, equity
accounting, foreign currency translation, and fixed asset valuation. The
means of conforming those practices is beyond the scope of this guide.
9
Authoritative Accounting Pronouncements
28. An insurance broker provides services. No specific accounting
pronouncements now address revenue recognition for service transactions.
FASB Concepts Statement No. 5, "Recognition and Measurement in Financial
Statements of Business Enterprises," paragraph 84, provides only the
following general guidance:
In recognizing revenues...the two conditions (being realized or
realizable and being earned) are usually met by the time...services
are rendered to customers.
29. In October 1978, the Financial Accounting Standards Board ("FASB")
invited comments on a draft statement of position, "Accounting for
Service Transactions" (hereinafter referred to as the "Draft SOP"), which
was prepared by a task force of the AICPA's Accounting Standards
Executive Committee. The project was later incorporated into the FASB's
conceptual framework project, and the conclusions of the Draft SOP have
not been issued as an authoritative pronouncement. The AICPA task force
summarized its revenue recognition conclusions for service transactions
in the Draft SOP as follows:
Revenue from service transactions should be recognized based on
performance, because performance determines the extent to which the
earnings process is complete or virtually complete. Performance is
the execution of a defined act or acts or occurs with the passage of
time. Accordingly, revenue from service transactions should be
recognized under one of the following methods:
Specific performance method - Performance consists of the
execution of a single act and revenue should be recognized when
that act takes place.
Proportional performance method - Performance consists of the
execution of more than one act and revenue should be recognized
based on the proportionate performance of each act. For
example, if the service transaction involves a specified number
of similar acts, an equal amount of revenue should be
recognized for each act. If the transaction involves a
specified number of defined but not similar acts, revenue
recognized for each act should be based on the ratio of the
seller's direct costs to perform each act to the total
estimated direct cost of the transaction. If the transaction
10
involves an unspecified number of similar acts with a fixed
period for performance, revenue should be recognized on the
straight-line method over the performance period.
Completed performance method - If services are performed in
more than a single act, the proportion of services to be
performed in the final act may be so significant in relation to
the service transaction taken as a whole that performance
cannot be deemed to have taken place until execution of that
act. Revenue should be recognized when that act takes place.
Collection method - If there is significant degree of
uncertainty surrounding realization of service revenue (for
example, many personal services), revenue should not be
recognized until collection.
30. Brokers provide diverse kinds of services, many of which do not
readily fit into the classification system in the Draft SOP. The
broker’s performance usually consists of more than a single act, and the
acts generally are not similar. While certain acts to be performed may
be defined, many are not defined. Though the placement of the policy may
constitute the most significant act, it may not be the final act.
11
RETAIL BROKERS
Revenue Recognition
31. The two major sources of a broker's revenues for services are
commissions and fees. The kinds of services provided by the broker, the
kinds of insurance coverage for which the services are provided, and
other circumstances may affect the consideration of when revenue should
be recognized.
32. Regular. Negotiated, and Split or Shared Commissions. Most regular,
negotiated, and split or shared commissions are determined as percentages
of the clients' premiums. Historically, practice has varied regarding
the methods used to recognize commissions associated with placing
insurance risks with underwriters. Some brokers recognized commissions
as of the billing date of the related insurance policy. Others
recognized commissions as of the effective date of the policy. Still
others recognized commissions as of the later of the billing date or the
effective date. As used herein, the term "effective date" is used to
mean the date from which protection is afforded under an insurance
policy, and, with respect to endorsements, the date from which an
endorsement to a policy amends the existing insurance coverage.
33. At the effective date, the broker becomes entitled to the commission
because the insurance coverage has been placed with the underwriter and
the premium is owed by the client. The effective date is more objective
than the billing date because the broker may have some discretion in
selecting the billing date. If the premium is billed on or before the
effective date, the broker's work has been substantially completed and
the related costs to produce, market, and place the coverage have been
incurred on or before the effective date. As such, the amount of the
commission related to the services provided has been determined, the
premium is receivable, and the commission has been earned as of that
date. If the premium is billed after the effective date, significant
12
portions of the work generally are performed and the related costs are
incurred between the effective date and the billing date. Historically,
most of the larger and publicly held brokers have recognized commissions
as of the later of the effective date or the billing date.
34. Revenue should not be recognized before the effective date, even if
it has been billed before the effective date (advance billings).
Revenues to cover selling and other costs incurred should not be accrued
before the revenue recognition date (as defined in paragraph 34) because,
among other reasons, realization is not assured until a transfer of risk
has been effected through the issuance of an insurance policy. Brokers
historically have not deferred the recognition of commission revenue to
future periods. Although certain costs related to a policy may be
incurred after the billing or effective date, those costs typically are
incurred at the discretion of the broker to retain or increase business
with the client and not because the broker is obligated to service the
policy in force.
35. Accordingly, for any given policy, revenue from regular commissions,
negotiated commissions, and shared or split commissions should be
recognized on the revenue recognition date, which is the date on which
all of the following criteria are met:
Protection is afforded under the insurance policy.
The premium due under the policy is known or can be reasonably
estimated.
The premium is billable to the client.
36. Contingent Commissions. Historically, most brokers have recognized
contingent commissions when received or on notification of the amounts
from the underwriters. Generally, there is only a short time period
between notification and receipt.
37. Contingent commissions often cannot be reasonably determined or even
approximated by the broker until receipt or notification from the
13
underwriters. The amounts generally are calculated by the underwriters,
separately for the business placed by each of the broker's locations with
the underwriter's local offices. Contingent commissions typically are
based on the profitability of business written during a running
three-year period. Indications of profitability during the early stages
of a three-year period may be entirely offset by losses during the later
stages of the three-year period. For example, contingent commissions
relating to 1989 activity will be calculated in 1990, 1991, and 1992,
based each year on the cumulative experience for the three previous
years. Therefore, to accrue contingent commissions at the end of 1989,
estimates would have to be made not only of the underwriting results of
1989, but also of the amount of and the quality of business that will be
written and placed with the underwriter over the remainder of the
three-year period.
38. Even though FASB Statement No. 5, "Accounting for Contingencies"
("FASB 5"), deals primarily with circumstances involving uncertainty as
to the recording of possible losses, paragraph 17 concludes that:
Contingencies that might result in gains usually are not reflected
in the accounts since to do so might be to recognize revenue prior
to its realization.
Adequate disclosure shall be made of contingencies that might result
in gains, but care shall be exercised to avoid misleading
implications as to the likelihood of realization.
39. FASB 5 defines a contingency as an existing condition, situation, or
set of circumstances involving uncertainty as to possible gain or loss to
an enterprise that will ultimately be resolved when one or more future
events occur or fail to occur. The conditions surrounding contingent
commissions are sufficiently uncertain and inherently subjective so as to
preclude recognition before receipt or notification based on the criteria
in paragraph 8 of FASB 5.
40. In rare cases, contingent commissions may be reasonably estimated by
the broker before receipt of cash or notification from the underwriter.
14
As such, the profits earned on such business placed by a broker over a
stated period, from which the contingent commission is computed, could be
estimated by the broker from historical trends and from current
information received from the underwriter.
41. However, retail brokers typically lack sufficient information
concerning the profitability to the underwriter on business placed and
the inherent uncertainties in determining the ultimate commissions
(principally because of the unknown amount of losses that will be
attributable to the insurance placed), so the brokers have no way to
reasonably estimate and accrue contingent commissions. Accordingly,
unless a broker obtains such information and unless all contingency
periods have expired (for example, the running three-year period
described in paragraph 37), contingent commissions should be recognized
by the broker as operating revenue on the earlier of the receipt of cash
or notification from the underwriter of the amount to be received.
42. Under some arrangements, adverse underwriting results attributable
to business placed by a broker in future periods could require the broker
to return contingent commissions received in earlier periods. Such
adjustments should be handled as recommended in paragraph 44 for
commission adjustments.
43. Commission Adjustments. Commissions initially recognized by brokers
often are changed because of policy cancellations, revisions in coverage,
final determinations of premiums billed on binders, retroactive or audit
adjustments, or premium adjustments based on volume. Historically, the
industry practice has been to record such changes when the events occur.
44. Just as contingent commissions generally can be recognized as
revenue only on receipt or notification, it is usually not possible to
accurately estimate the amounts of commission adjustments in advance.
Therefore, commission adjustments resulting from the type of events
referred to in paragraph 43 generally should be recognized when the
events occur. However, if policy cancellations and return premiums
15
can be reasonably estimated in advance, a provision should be made for
the expected related commission adjustments when the commissions on this
business are initially recognized.
45. Premiums to be paid by insureds on a reporting-form basis, as
discussed in paragraph 20, generally are not subject to reasonable
estimation. Therefore, the related commissions should be recognized when
notification is received from the insured.
46. Installment Billing Arrangements. Generally, insurance premiums are
determined and billed annually. However, brokers sometimes bill their
clients for annual policies in quarterly or monthly installments.
Historically, some brokers have recognized their commissions as each
installment was billed to the client; others have recognized the entire
amount of the commission when the transaction was initially recorded.
47. Because the revenue recognition method is tied to the performance of
the service and is not tied to the cash flow effects of the broker's
billing arrangements with its clients, the entire commission should be
recognized when the transaction is initially recorded. Furthermore,
under APB Opinion No. 10, "Omnibus Opinion— Installment Method of
Accounting," the installment method of recognizing sales revenues should.
be used only if there is "no reasonable basis for estimating the degree
of collectibility." The collectibility of installment billings for
annual insurance policies ordinarily can be reasonably estimated when
these types of transactions are initially recorded.
48. Multi-Year Policies. Certain property coverages occasionally are
written under policies that cover a number of years, typically three
years. Such a multi-year policy may permit the policyholder to lock-in
the premium rate for a period of years and thus be protected from
increasing rates during the period. Under multi-year policies, premiums
may be billed in one amount or in periodic installments. Historically,
some brokers recognized a portion of the commissions on multi-year
policies as the periodic premiums were billed. Other brokers recognized
16
the entire commission in the year in which the policy became effective or
when the first installment premium was billed.
49. If the policyholder is not obligated to continue coverage after the
first year, a multi-year policy should be viewed as a series of annual or
short-term policies rather than as a single policy with installment
billings. Though a multi-year policy is written to cover several years,
there generally is little assurance that premiums will continue to be
received, because, for example, if premium rates fall, the policyholder
could discontinue coverage for the subsequent years. Accordingly, the
commission revenues on such multi-year policies should be recognized as
revenue annually when the policyholder pays the annual installment and
continues coverage.
50. If, under a multi-year policy, the policyholder is obligated to
continue coverage for the entire policy period, the policy is a single
policy covering all the years and the periodic premiums should be viewed
as installment billings. Because the broker's method of revenue
recognition is tied to the performance of the service and is not tied to
the cash flow effects of a broker's billing arrangements with its client,
the entire commission for the multi-year period should be recognized when
the transaction is initially recorded.
51. Direct Billing Arrangements. Brokers generally bill their clients
for the gross premium, retain their commission, and remit the net premium
amount to the underwriter. However, the underwriter sometimes bills the
clients directly or the brokers bill the clients but the clients remit
the gross premium payments directly to the underwriter. These
arrangements, commonly referred to as "direct bill" transactions, often
pertain to personal lines coverages and to life, health, property, and
liability insurance distributed through associations and other mass
marketing channels. Because the gross premiums from the clients are
remitted directly to the underwriters, the broker receives its
commissions directly from the underwriter. Historically, brokers
17
generally have recognized such commissions as revenue on the earlier of
the receipt of cash or notification from the underwriter of the amount to
be received.
52. If it is possible to reasonably estimate the amount of commissions
that have been earned, the commissions attributable to direct bill
business should be accrued. However, because the percentage of persons
solicited that will purchase insurance coverage and the amount of
insurance they will purchase is difficult to project, it usually is not
possible for the broker to reasonably estimate the commissions from such
business. In such cases, commissions on those types of direct bill
transactions should continue to be recognized as revenue on the earlier
of the receipt of cash or notification from the underwriter of the amount
to be received.
53. Fee in Lieu of Commissions. Rather than receiving commissions from
an underwriter, a broker may agree to handle a client's insurance program
for a "fee in lieu of commissions" to be paid to the broker by the
client. Historically, some brokers have treated these transactions
similarly to the way that they have treated "fee-for-service
arrangements" and have recognized revenues over the policy period; other
brokers have recorded these fees in the same manner as they recognized
their regular commissions.
54. Accepting a fee for an insurance placement transaction does not
change the nature of the transaction, and, accordingly, those fee
revenues should be recognized in the same manner as regular commissions,
as described in paragraph 35.
55. Fee-for-Service Agreements. For services, other than insurance
placement services, provided under a fee-for-service agreement, as
described in paragraph 10, brokers generally have recognized revenue as
the services were provided. Fees received for bundled transactions,
which are also described in paragraph 10, often have been allocated
between insurance placement revenue and service agreement revenue, using
18
recognition methods appropriate to each revenue component. There is
general agreement that this method is appropriate for recognizing revenue
on these types of fee-for-service transactions.
56. Therefore, fees for non-insurance placement service agreements, as
described in paragraph 10, should be recognized as earned, which is
ordinarily over the period in which the services are provided. For
bundled transactions, reasonable and consistent allocations should be
made between the revenue components, and the revenue should be recognized
in accordance with paragraph 35 and the first sentence of this
paragraph. A loss should be recognized currently if it is probable that
the future costs related to the service agreement will exceed future
revenues.
Expense Recognition
57. Brokers incur a variety of costs to generate revenues. As a service
business, the industry incurs costs that are predominantly payroll and
payroll-related and costs for travel and entertainment, rent, and other
general and administrative activities. Services performed by a broker
and their related costs can vary considerably depending on the kind and
size of the risk to be insured, the nature of the insurance program and
the coverages required, and whether the business is new or renewal
business. For purposes of analysis, a broker's costs can be classified
as initial direct costs, subsequent servicing costs, and indirect
costs.
58. Initial Direct Costs. A substantial portion of brokers' costs are
incurred before the dates that the policy periods begin and are directly
associated with negotiating and placing or renewing the insurance
coverage. These initial direct costs relate to brokers' analysis and
evaluation of risks and marketing efforts to place or renew the policies.
59. Risk analysis and evaluation can range from a relatively simple
study of employee bonding risks to major undertakings to analyze and
evaluate the complex worldwide risks borne by multinational clients.
19
This type of risk analysis and evaluation often results in the
preparation of formal proposals or recommendations by the brokers to the
clients or prospective clients.
60. Marketing consists of placing the risks with the underwriters in the
worldwide insurance underwriting market that can best meet the needs of
the client. The marketing process requires the evaluation of the
underwriters' capacities, specialties, costs, and other factors.
61. Initial direct costs do not include prospecting costs associated
with efforts to obtain new or renewal business from existing clients or
business from potential new clients, even though prospecting costs may be
incurred for risk analysis and evaluation and marketing efforts similar
to those for the renewal of existing insurance policies. Such
prospecting costs are indirect costs, as discussed in paragraph 63, not
initial direct costs.
62. Subsequent Servicing Costs. A broker may also incur costs for
providing services after the effective date of the insurance policy.
These costs, referred to herein as "subsequent servicing costs," are
directly associated with insurance coverage that has been placed by the
broker and relate to, among other matters, services such as billing,
collecting, and remitting premiums, performing periodic engineering
inspections of the clients' facilities, handling and processing claims
reported by the clients, reviewing the adequacy of existing coverage, and
monitoring changes in risk exposure. In certain instances, the broker
may be obligated to provide such services by contract or agreement.
However, the broker usually provides these types of services, at its
discretion, to maintain client relationships, even though not
contractually obligated to do so.
63. Indirect Costs. All costs incurred by brokers other than initial
direct costs and subsequent servicing costs are indirect costs. Indirect
costs include primarily payroll and payroll-related costs, travel and
entertainment, rent, data processing, and other selling and general
20
administrative costs. Indirect costs also include prospecting costs
associated with efforts to obtain new or renewal business from existing
and prospective clients.
64. Recognition of Costs. Historically, brokers generally have treated
all costs incurred in providing their services as period costs and,
accordingly, have expensed them as incurred. The industry generally has
not accumulated or analyzed the costs of its services by function or by
insurance policy nor has it allocated costs between prospecting and
servicing.
65. The consumption of the economic benefits during a period is measured
either directly or by relating it to revenues recognized during the
period. Recognizing a broker's costs and expenses as incurred matches
the costs required to generate revenues on a period-by-period basis.
FASB Concepts Statement No. 5, "Recognition and Measurement in Financial
Statements of Business Enterprises," paragraph 85, states that, in
general, expenses are recognized when an entity's economic benefits are
used up in rendering services.
66. Historically, brokers have not deferred initial direct costs.
Because the recoverability of such costs from future revenues is not
assured until the coverage is placed and billable to the client, all
initial direct costs and indirect costs should continue to be treated as
period costs and expensed as incurred.
67. Brokers typically are not obligated, either by contract or by
industry practice, to provide services subsequent to placing the
insurance. However, brokers generally do provide various services after
placement of the coverage so as to retain or increase business with the
clients but not because they are required to service the policies;
accordingly, these subsequent servicing costs should be expensed as
incurred as period costs. However, if a broker specifically obligates
itself by agreement with the client to provide services after placing the
coverage, and the subsequent costs can be associated directly with the
21
policy placed by the broker, a portion of the broker's related revenue
should be deferred (or costs should be accrued if such costs exceed
deferrable revenues) and recognized as the services are performed.
Financial Statement Presentation
68. Brokers usually bill their clients for placing insurance, and the
clients pay the brokers. Thus, at the revenue recognition date for a
given policy, a receivable and a payable are recorded in the broker's
accounting records. The receivable due from the client represents the
premium that the broker will later pay to the underwriter plus the
commission or fee for the services provided by the broker. The payable
to the underwriter is due either on or after the effective date of the
insurance policy (an agency transaction) or at or after collection by the
broker (a broker transaction). As described in paragraphs 14 and 15,
brokers may advance premiums to the underwriters on behalf of their
clients or may advance claim payments or return premiums to clients on
behalf of the underwriters. The advances may be made because of the
payment terms to the underwriter or because the brokers wish to avoid
cancellation of their clients' coverages.
69. Because brokers generally collect cash from clients before they pay
the underwriters, brokers generally have favorable cash flows. Until
remitted to the underwriters, these funds are held by the brokers in a
fiduciary capacity for the underwriters. Such funds (referred to herein
as fiduciary funds) generally are invested in short-term cash
equivalents, and the resulting investment income is retained by the
brokers. Certain states have varying restrictions on the investment of
such funds, which may include limiting the nature of acceptable
investments, investing the funds within the state, or obtaining
permission of the underwriters to retain the investment income. Brokers
also earn investment income on their own funds.
70. Historically, publicly reporting brokers have used two different
methods to present their balance sheets. Under one method, often
22
referred to as the gross method, accounts receivable have included the
total amount of premiums, including commissions and fees, due from
clients, and the payables to underwriters have included the total amount
of collected and uncollected premiums to be remitted to underwriters.
Under this method, the amounts of premiums included in both accounts
receivable from the clients and accounts payable to underwriters are
usually disclosed in the financial statements. Also, under the gross
method, fiduciary funds are included in the cash or other appropriate
caption on the balance sheet, and the amount and the related restrictions
on the use of such funds are disclosed in the notes to the financial
statements.
71. Under the other method, commonly referred to as the net method, only
the total amount of commissions and fees due from clients is included in
the accounts receivable from clients. The amounts receivable from
clients and the payable to underwriters related to uncollected premiums
are not presented on the balance sheets but typically are disclosed in
the notes to the financial statements. Under the net method, fiduciary
funds are not included in the assets on the balance sheet but are
separately disclosed, either in the notes or on a memo basis on the
balance sheet.
72. The gross and net balance sheet presentation methods are found in
practice because differing facts and circumstances determine whether the
unremitted fiduciary cash, the premiums receivable from the insureds, and
the related premiums payable to the underwriters are assets and
liabilities of the brokers and therefore includible on the brokers'
balance sheets or whether such cash and receivables are assets of the
underwriters since the brokers are merely acting in a fiduciary
capacity. This divergence results primarily from the unclear nature of
the implied or contractual legal relationships of the parties involved
and the varying business practices followed by the brokers which
determine the obligations created by those practices. Statement of
Financial Accounting Concepts No. 6, "Elements of Financial Statements,"
sets forth the essential characteristics of a liability and includes a
statement to the effect that "the existence of a legally enforceable
claim is not a prerequisite for an obligation to qualify as a liability
23
if for other reasons the entity has the duty or responsibility to pay
cash, ..." (see Concepts 6, paragraphs 35 and 36, including footnote
22). Consequently, even though some brokers' arrangements with
underwriters related to premiums receivable from the insureds are not
legally enforceable liabilities, their business practices indicate that
the premiums payable to underwriters meet the definitional criteria for a
liability and should be included in the brokers' balance sheets as
liabilities. Similarly, fiduciary funds and premiums receivable,
including future installment billings, for these brokers meet the
definitional criteria for assets set forth in Concepts 6, paragraphs 25
and 26, and should be included in the brokers' balance sheets as their
assets. Other brokers, based on their business practices, are acting
only as fiduciaries, and, thus, the foregoing items should not be
included in their balance sheets; under their business practices, the
fiduciary funds, the premiums receivable from the insureds, and the
related premiums payable to the underwriters do not meet the definitions
of assets and liabilities in Concepts 6 and therefore are not included in
the brokers' balance sheets. Accordingly, because the gross and net
presentation methods are not alternatives for the same circumstances,
each broker needs to evaluate its business practices, including formal
and informal agreements with insurance carriers and clients, to determine
if the gross or net presentation method is appropriate under the specific
facts and circumstances. However, regardless of whether such items are
or are not presented separately in the brokers' balance sheet (i.e.,
using either the gross or the net presentation method), the amounts of
fiduciary funds, premiums due from clients, advances to underwriters and
clients, and premiums payable to underwriters should be disclosed in the
brokers' financial statements.
73. Investment income on fiduciary funds should be included in operating
revenue and the amount should be disclosed in the brokers' financial
statements.
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WHOLESALE BROKERS
74. The revenue and expense recognition and the financial statement
disclosure considerations relating to the operations of wholesale
brokers, as briefly described in paragraph 7, are similar to those of
retail brokers; accordingly, the conclusions in the paragraphs on retail
brokers also apply to wholesale brokers.
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REINSURANCE INTERMEDIARIES
General
75. Reinsurance is a transaction whereby one company, the assuming
company, agrees for a consideration to indemnify another company, the
ceding company, against all or part of the loss that the ceding company
may sustain under a policy or policies it has issued. Reinsurance
intermediaries facilitate the business of reinsurance by bringing
together reinsurance sellers (assuming companies or reinsurers) and
reinsurance purchasers (ceding companies or reinsureds). Reinsurance
intermediaries generally represent the ceding companies and refer to such
companies as clients. Reinsurance intermediaries usually design and
negotiate the terms of reinsurance, place reinsurance, accumulate and
report transactions, distribute premiums, and collect and settle claims
between the two parties to the reinsurance agreement.
76. Reinsurance may be transacted under broad automatic contracts called
treaties, which are usually renewed annually and which cover some portion
of particular classes of business underwritten by the insurers. Treaties
may either be pro rata or excess. In pro rata treaties, the assuming
companies and the ceding companies share proportionally in the premiums
and losses; in excess treaties, only the ceding companies' losses above a
fixed negotiated point, known as the ceding company's retention, are
reinsured and separate reinsurance premiums are charged for that portion
of the overall risk. Reinsurance also may be transacted under
facultative agreements, which cover specific individual risks and require
the ceding companies and the assuming companies to negotiate and agree on
terms and conditions of reinsuring each risk. In general, treaty
reinsurance is a more significant part of reinsurance intermediaries'
business than facultative reinsurance; however, some intermediaries deal
only with facultative reinsurance.
26
Operations of Reinsurance Intermediaries
77. Although there are certain unique characteristics of reinsurance
intermediaries' operations and functions, in general, some of their
operations and functions are similar to those of typical retail brokers.
Both reinsurance intermediaries and retail brokers operate in service
industries and their operating revenues consist principally of the
commissions, often referred to as brokerage, and fees that they receive
for performing their services. Their costs are also related principally
to the services that they perform. Such costs are primarily payroll and
payroll-related costs, travel and entertainment, rent, data processing,
and other selling and general administrative costs.
78. Assessing Needs. Similar to retail brokers, who often must assess
the insurance needs of their clients and counsel with them to meet those
needs, one of the main functions of reinsurance intermediaries is to
identify and assess ceding insurance companies' reinsurance needs and to
counsel and advise them to help them meet those needs. In summary,
reinsurance intermediaries assist their ceding company clients to
determine the clients' needs, to put the clients' risks before the
assuming company's underwriters in as favorable a light as possible, to
obtain the best terms for the clients when the reinsurance is placed, and
to process claim settlements, collect amounts from assuming reinsurers,
and pay the ceding insurance companies. To perform these duties, the
reinsurance intermediaries must know the reinsurance market, be able to
select the most suitable reinsurer for each risk, prepare and have
executed by all parties the contract of reinsurance in its proper form,
and provide help and guidance in the processing and handling of claims.
Both retail brokers and reinsurance intermediaries normally perform those
functions by visiting their clients to become familiar with their
operations and insurance or reinsurance needs. Both draw on their
experience and knowledge of the insurance or reinsurance industry to
counsel their clients in fulfilling their insurance or reinsurance needs.
27
79. Marketing the Risk. Both retail brokers and reinsurance
intermediaries normally represent their clients in finding and analyzing
the kinds, terms, and quality of insurance or reinsurance available.
Both retail brokers and reinsurance intermediaries are therefore
interested in negotiating the best terms available on behalf of their
clients while at the same time placing their clients' risks with
financially sound and reputable underwriters acceptable to the clients.
Sometimes, a retail broker may place a client's risks with several
different underwriters. It is common for a reinsurance risk to be placed
with a number of reinsurers and through corresponding brokers, and the
reinsurance intermediary must deal with those various parties on behalf
of the client. If the business cannot be fully placed, the terms of the
coverage may be significantly revised after consultation with and the
approval of the client to make it more acceptable in the reinsurance
market. In some situations, a client’s reinsurance needs may not be
fully met until after the effective date of the primary coverage.
80. Both retail brokers and reinsurance intermediaries work on behalf of
their clients, are compensated by the underwriters assuming the risk, and
generally receive commissions based on percentages of the insurance or
reinsurance premiums. Thus, the interests and method of compensation of
retail brokers and reinsurance intermediaries are generally similar.
81. Transmitting Information and Money. Both retail brokers and
reinsurance intermediaries usually are responsible for transmitting
information and money between their clients and the insurance or
reinsurance companies. Retail brokers normally are responsible for
transmitting premium and loss information on behalf of their clients to
underwriters. Also, it is customary for retail brokers to bill and
collect the insurance premiums from their clients on behalf of the
underwriters, and the brokers may collect loss proceeds on claims from
the underwriters and transmit them to their clients.
82. Reinsurance intermediaries act as conduits between the ceding and
assuming underwriting companies through which premiums are paid and
losses are collected. Reinsurance intermediaries normally receive and
28
transmit all correspondence and accounting documents between the ceding
underwriters and the assuming reinsurers or corresponding brokers.
Premiums normally are paid to reinsurance intermediaries for transmittal
to the assuming reinsurers, and the intermediaries present the ceding
companies' proof of loss reports for claims to the assuming reinsurers
and collect funds on the ceding companies' behalf, and, if needed,
arrange for the establishment of and the drawing on letters of credit.
If differences of opinion arise, the reinsurance intermediaries, like
retail brokers, represent their clients in resolving the difference.
83. Drafting the Contract. One of the main functions of reinsurance
intermediaries is to draft reinsurance agreements, which are binding
contracts documenting the arrangements that have been negotiated between
the ceding and assuming companies. Once drafted, the agreements normally
are presented to the ceding companies for approval and signing and then
to the assuming companies for their approval and signing. Although some
reinsurance contract language is relatively standard, many reinsurance
agreements involve matters that require extensive negotiation, and the
reinsurance intermediaries normally represent the ceding companies in
such negotiations. Because facultative reinsurance agreements involve
unique risks, they may involve relatively greater efforts by the
intermediaries in negotiating and drafting than do treaty reinsurance in
comparison to the amounts of risks transferred. Because facultative
reinsurance agreements involve specific risks, the brokers assist in the
completion of certificates of reinsurance. The terms of the reinsurance
agreements are usually reviewed by both the ceding and the assuming
companies at least once a year, and the reinsurance intermediaries
normally represent the ceding companies during the renewal negotiations
in the same manner as in the original placements.
84. Retail brokers typically are not involved in drafting insurance
policies on behalf of their clients. However, some retail brokers may
have arrangements with insurance companies that permit them to exercise
considerable latitude in the wording of insurance policies. Under
29
certain unusual arrangements, retail brokers may have as much latitude in
drafting insurance policies on behalf of their clients as reinsurance
intermediaries do in drafting reinsurance agreements.
Revenue and Expense Recognition
85. Servicing the Contracts. Reinsurance intermediaries, at their
discretion, customarily service and report the run-off of claims and
related reinsurance recoverable amounts associated with the agreements.
Due to the long-tail nature of certain liability lines, reinsurance
intermediaries may report claim activity to the assuming companies five
to ten years after the treaties expire. Similarly, retail brokers may
service and report their clients' claims covered by the insurance placed
by the brokers. For many kinds of insurance normally handled by typical
retail brokers, it is also common for such brokers to report claims
activity to underwriters after the insurance policies expire. As with
retail brokers, reinsurance intermediaries typically are not obligated,
either by contract or by industry practice, to provide services
subsequent to the placement of the reinsurance contracts. Reinsurance
intermediaries provide, at their discretion, claims processing, and other
services after placement of the coverage, typically to retain or increase
business with the clients rather than to meet any obligation to service
the reinsurance contracts. Accordingly, these subsequent servicing costs
should be expensed as incurred as period costs. However, if the
reinsurance intermediary specifically obligates itself by agreement with
the client to provide services after placing the reinsurance contract,
and the subsequent costs can be associated directly with the reinsurance
contracts placed by the reinsurance intermediary, a portion of the
intermediary's related revenue should be deferred (or costs should be
accrued if such costs exceed deferrable revenue) and recognized as
revenue as the services are performed.
86. Excess of Loss Reinsurance Contracts. Excess of loss reinsurance
contracts generally are written for annual periods, with premiums
typically paid on a quarterly or semi-annual basis. At the inception
(effective date) of excess of loss reinsurance contracts, equal quarterly
30
or semiannual deposit premiums to be paid by the ceding company to the
assuming companies are agreed-on based on information available to
estimate the premiums that will be written or earned under the
contracts. These deposit premiums may represent minimum or guaranteed
amounts that guarantee a minimum commission to the reinsurance
intermediary. Premium adjustments often are determined and billed after
the last quarter to arrive at the ultimate total premium, and it is also
common practice for such deposit premiums to be adjusted before the last
quarter or in the subsequent period.
87. Because the estimated deposit premiums, in the aggregate, generally
do not exceed the ultimate premiums to be earned, reinsurance intermedi
aries should recognize revenue from commissions, brokerage, and fees in
lieu of commissions from excess of loss reinsurance contracts as each
deposit premium becomes billable. Because the deposit premiums are
estimated, the business written during the contract period determines the
final premium due. When this information is known, the cedants are
billed for the differences between the deposit premium and the ultimate
premium. Revenue related to these premium adjustments should be recog
nized by the reinsurance intermediaries when billed. In circumstances
where there is a minimum guaranteed commission, the minimum commission
should be recognized by the reinsurance intermediary at the Inception of
the contract since the revenue recognition method should not be tied to
the cash flow effects of the intermediary's billing arrangements with its
cedents and markets.
88. Pro Rata Reinsurance Contracts. Pro rata reinsurance contracts
usually provide for continuing coverage and, as such, usually have no
expiration date, but continue until the business runs off, that is, until
the covered claims are settled and paid or the contracts are canceled.
At the inception (effective date) of pro rata reinsurance contracts,
there generally is insufficient information to reasonably estimate the
amount of premiums that will be written or earned under the contract.
Consequently, reinsurance intermediaries do not recognize commission
revenues at the beginning of the contract, but rather as the ceding
companies report information on premiums written and pay their
reinsurance premiums. Premiums written are the amount of the premiums
31
billed or collected on the underlying insurance policies; premiums earned
are the pro rata portion of the premiums written applicable to the
expired period of the policies. The ceding companies generally report
the premiums written and the reported or incurred claims to the
intermediaries on a periodic basis, and the intermediaries, in turn,
report this information to the assuming companies. There generally is a
lag between the end of a reporting period and the date on which a ceding
company submits reports to the assuming companies.
89. Pro rata reinsurance contracts usually provide for settlements
between the ceding company and the assuming company on a net basis, i.e.,
the ceding company deducts reimbursements due from the assuming company
from premiums due to the assuming company. However, the intermediaries’
commissions are based on the gross premium amounts, not the net cash
settlement amounts.
90. For pro rata reinsurance, the reinsurance premiums are not predeter
mined. Therefore, based on ceded premiums included in the periodic
statements that are received from the ceding companies, reinsurance
intermediaries should recognize revenue from commissions, brokerage, and
fees in lieu of commissions from pro rata reinsurance contracts on the
date that the premiums are billable to the assuming companies.
91. Foreign Reinsurance. Another aspect of reinsurance intermediaries'
operations that differs from those of typical retail brokers is the
relatively large volume of reinsurance involving foreign insurance
organizations for which pertinent and desirable financial data may not be
readily available. As a consequence, the reinsurance intermediaries may
undertake to review and evaluate the financial responsibility and
stability of such foreign entities on behalf of the ceding companies; the
reinsurance intermediaries may provide this service to their clients
because the intermediaries can accumulate such financial information
periodically and make it available to all of their clients. The ceding
companies, not the intermediaries, decide which assuming companies are to
be used. Also, a reinsurance arrangement between a U.S. entity and a
number of foreign entities often involves more than one intermediary and
generally implies an increased time lag for the U.S. entity to receive
32
information on the results of the reinsurance contract, and the detail
and the classification of the information provided can vary
significantly. As a result, adequate information to make accounting
estimates for foreign reinsurance assumed often is not available on a
timely basis; for similar reasons, financial data needed to evaluate the
financial condition of foreign insurance companies is frequently not
available on a timely basis.
92. Retrospective Commission Adjustments. The premiums on some
reinsurance arrangements are retrospectively rated. The amounts of the
claims determine the amounts of the reinsurance premiums, which, in turn,
determine the amounts of the reinsurance intermediaries' commissions. As
with retail brokers, the retrospective adjustments, which could result in
additional commissions or return commissions, should be recognized when
such amounts become known to the reinsurance intermediaries.
93. Expense Recognition. Reinsurance intermediaries’ costs are similar
to those of retail brokers; accordingly, the conclusions described in
paragraphs 66 and 67 for retail brokers also apply to reinsurance
intermediaries and brokers.
Financial Statement Presentation
94. The conclusions on financial statement presentation for retail
brokers, as described in paragraphs 72 and 73, also apply to reinsurance
intermediaries and brokers.
33
MANAGING GENERAL AGENTS
General
95. Managing general agents ("MGAs") are persons or organizations that
have authority to underwrite and bind risks on behalf of their client
underwriters. The function of MGAs in the underwriting of risks
generally requires the experience and ability to evaluate the
acceptability of risks and to determine the appropriate premiums. As
such, MGAs typically are more directly concerned with and have greater
knowledge of the underwriting results of the business written than do
retail brokers. Also, MGAs typically have relatively larger back office
functions to process and administer the business written than do retail
brokers, whose efforts are directed more toward prospecting and
marketing. Although MGAs operate in many respects as underwriters, the
client underwriters, and not the MGAs, bear the primary insurance risk.
However, some entities referred to as MGAs retain all or portions of the
insurance risks described in FASB Statement No. 60, "Accounting and
Reporting by Insurance Enterprises."
96. The structures and organizations of MGAs vary considerably. An MGA
may be an autonomous organization or may be part of the operations of an
insurance broker. MGAs may operate on behalf of one or more
underwriters, in particular geographical areas, or for given blocks of
business, including life insurance. MGAs may manage captive insurance
companies, insurance pools, or syndicates for groups of underwriters or
investors.
97. The services and obligations of MGAs vary depending on the terms of
the agreements with the client underwriters. For example, MGAs may be
responsible for or guarantee the earned premiums due the underwriter and
could be required to service the run-off of business on canceled managing
general agent agreements. In addition to underwriting and binding risks
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on behalf of the client underwriters, MGAs may also provide a broad range
of services to the client underwriters, including:
Administration of the affairs of the underwriters, including
the reinsurance program of the underwriters.
Investment of premium funds.
Adjusting and settling of claims.
Maintaining the books and records of the underwriting
companies, syndicates, or pools.
Preparation of reports and financial statements to be filed
with insurance regulatory authorities, including assistance
with rate filings.
Assistance with or preparation of reports for filing with
statistical agencies.
Comparison of MGAs and Brokers
98. Both MGAs and brokers operate in service industries, receive
commissions and fees for their services, and incur similar operating
costs. In many respects, MGAs and brokers perform similar services, with
some notable exceptions.
99. Generally, both MGAs and brokers provide underwriting and claims
expertise and services and act as conduits to the insurance market for
their clients. MGAs, however, represent the underwriters, while brokers
represent the insureds. MGAs, acting on behalf and within the authority
or guidelines established by the underwriters, bind and accept or reject
insurance risks on behalf of the underwriter and may perform significant
additional functions concerning the business written; in contrast,
brokers generally do not have such authority and do not provide such
extensive services after placement of coverage with the underwriters.
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100. MGAs and brokers both operate in a fiduciary capacity by processing
cash receipts and disbursements related to premiums and claims. However,
MGAs sometimes process and control all the funds on behalf of the
underwriters they represent, while brokers usually are required only to
collect, hold, and account for the client or underwriter funds.
101. MGAs, unlike brokers, are usually responsible for the future
servicing of claims, depending on the agreements between the parties.
Therefore, the functions and responsibilities of MGAs are significantly
greater than those of brokers, because MGAs are usually contractually
obligated, or may specifically agree with the underwriters, to continue
to settle and adjust claims even after the managing general agents'
agreements have terminated.
Revenue and Expense Recognition
102. Commissions and Fees. MGAs may receive compensation for services in
one or more of the following forms:
Commissions (or overrides) as a percentage of premiums written,
earned, or collected, which may also include a minimum fixed fee
amount and/or a sliding commission scale based on premium volume
produced.
Fees for services performed or cost-plus arrangements.
Fixed fees for a specified period or for specified services,
that is, an unbundled approach.
Reimbursement of certain expenses incurred, such as for data
processing services.
Profit participation in the underwriting results or in the net
income of the operation.
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103. Commissions and fees may be charged together or separately for
certain kinds of services, such as underwriting, administration, and
claims adjusting. MGAs may operate on behalf of several separate
underwriters and could be reimbursed for certain direct and indirect
costs associated with servicing each underwriter. MGAs may also act as
brokers or agents and obtain business for the underwriter or for the
entities that they manage, for which the MGAs would receive separate
commissions.
104. MGAs have adopted diverse revenue recognition practice as follows:
As the commissions are billed to the underwriters, based on the
premiums billed or collected on behalf of the underwriters,
which may include installment and deposit premiums.
As the premiums are billed on behalf of the underwriters.
As of the effective dates of the underlying policies.
On a pro rata basis over the policy period.
105. Historically, MGAs have recorded commission adjustments for
subsequent policy cancellations, audit adjustments, or premium volumes
when they occurred. Fixed fees generally have been recognized as earned
over the contract period.
106. Although brokers may perform other services before (marketing) and
after (subsequent servicing) placement of insurance coverage with
underwriters, the placement of insurance coverage is the predominant
function for which brokers receive commissions. The predominant function
of an MGA is the performance of a broad range of services relating to
underwriting and managing the business on behalf of the client
underwriters, not the placement of insurance coverage. Though an MGA's
compensation may be in the form of commissions, the nature of the
compensation is a fee for all services to be performed. Therefore,
commissions and fees of MGAs should be recognized in relation to the
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services performed but not before those revenues are realized or
realizable, which is ordinarily the effective date of the contracts. If
the services are performed relatively evenly over the terms of the
contract period, commissions and fee revenue should be recognized pro
rata over the contract period. However, commission adjustments should be
recorded as they occur or become known to the MGAs.
107. Contingent Profit Commissions. MGAs’ profit participation (the
contingent profit commissions) in the underwriting results or net income
of the businesses managed by the MGAs may be structured by agreement in
various ways. The contingent profit commissions generally are specified
percentages of the profits as defined in the agreements for a given year
or group of years, such as fiscal, calendar, syndicate, or pool years.
The defined profits may be based on results determined in accordance with
generally accepted accounting principles or in accordance with accounting
practices prescribed or permitted by insurance regulatory authorities.
The defined profits may contain arbitrary percentages or amounts for
unearned premiums, loss reserves, or specified expenses on each
calculation date. The contingent profit commission payments to the MGAs
may be payable within a short time after a particular year or may begin
only after a number of years have passed after the issurance was
written. In either case, the commission calculations may be subsequently
adjusted as actual loss experience develops. The experience of a
particular year may be carried back or forward for a number of years and,
accordingly, could potentially increase, reduce, or eliminate the
contingent profit commissions previously received or to be received.
108. Contingent profit commissions are based on the results of business
underwritten by the MGA and generally are not determined and paid until
after the end of specified periods. Some contingent profit commissions
are based on only the results of the current underwriting year; however,
such contingent profit commissions generally are based on the results of
a number of years. Under some arrangements, adverse loss experience in
future years may require the MGA to pay back contingent profit
commissions already received.
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109. Unlike a typical retail broker, an MGA often administers the
underwriting and the claims functions of the business it writes. An MGA
may therefore have the information on profit experience of the subject
business needed to estimate its contingent profit commissions.
Historically, the recognition practices for contingent profit commissions
varied among MGAs and included the following practices:
- Some MGAs recognized contingent profit commissions when received
regardless of whether the commissions may be contingently returnable
to the underwriter, based either on business already written or for
business yet to be written. These MGAs have recognized adjustments
to contingent profit commissions already received when such
adjustments occurred.
- Some MGAs have recognized contingent profit commissions when they
were received but only if they were not returnable to the
underwriters should adverse loss experience develop for business
already written or for business yet to be written.
- Some MGAs have recognized contingent profit commissions using
accruals based on estimates of underwriting experience on the
business that had been written. The accruals have been adjusted as
actual experience became known. If MGAs have not had sufficient
information to reasonably estimate contingent profit commissions,
the MGAs have recognized such commissions when they received them or
when they have been notified by the underwriters as to the amount of
such commissions.
- Some MGAs have recognized contingent profit commissions using
accruals as described in the preceding description, but only to the
extent that the commissions would not be reduced or eliminated by
any carryback of adverse loss experience for business yet to be
written.
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110. Contingent profit commissions should be accrued and recognized as
revenue when such commissions are determined on the basis of the
underwriting results of current or past periods and if the MGAs can
reasonably estimate the amount of such commissions based on information
or experience with the business written. The timing of the payments of
such contingent profit commissions is a matter of negotiation between the
underwriters and the MGAs and should not necessarily determine the timing
of revenue recognition for the MGAs. The revenue should be recognized as
the services are performed that result in the commissions. Any future
paybacks of commissions caused by adverse experience of future periods
should be recognized as losses in those periods, and any subsequent
modifications or adjustments to prior contingent profit commission
revenue represent changes in estimates that should be accounted for in
those future periods.
111. The ability to reasonably estimate contingent profit commissions
varies depending on the stability of the business written and the
information available to the MGAs. If these commissions cannot be
reasonably estimated, the MGAs should recognize only that portion of the
provisional profit commissions that represents the guaranteed minimum
commission element. This practice is similar to the accounting by
underwriters for some of their premium revenues. Many underwriters
recognize premium adjustments using estimates of loss experience that has
occurred, and the kind of information on which those estimates are made
is generally available to the MGAs. The accounting by underwriters for
premium adjustments is described in FASB 60, paragraph 14, as follows:
If premiums are subject to adjustment (for example, retrospectively
rated or other experience-related insurance contracts for which the
premium is determined after the period of the contract based on
claim experience or reporting-form contracts for which the premium
is adjusted after the period of the contract based on the value of
insured property), premium revenue shall be recognized as follows:
- If, as is usually the case, the ultimate premium is reasonably
estimable, the estimated ultimate premium shall be recognized
as revenue over the period of the contract. The estimated
ultimate premium shall be revised to reflect current
experience.
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- If the ultimate premium cannot be reasonably estimated, the
cost recovery method or the deposit method may be used until
the ultimate premium becomes reasonably estimable.
112. Contingent profit commissions subject to future performance or
underwriting results of future periods should not be recognized as income
until the future performance requirements have been met or until future
underwriting periods have ended and the related profitability levels can
be reasonably estimated. Adjustments to reported contingent profit
commission revenues should be recognized as information on actual
experience becomes available.
113. Expense Recognition. An MGA’s costs, like those of a retail
broker, are primarily payroll and payroll-related costs, travel and
entertainment, rent, and other general and administrative costs. A
portion of the costs are incurred early, in prospecting and underwriting
new or renewal business before the policy effective dates. MGAs also
incur costs after the policies are issued for administrative, accounting,
and claims settlement services. Under the typical MGA agreement, the MGA
usually is obligated to continue to service run-off business, for
example, servicing claims after the managing general agent's agreement
with the underwriter has been terminated. MGAs could also incur losses
for uncollected premiums to the extent of any guarantee of premium
collections in such MGA agreements.
114. Historically, MGAs have expensed all of their costs when incurred.
MGAs have not deferred direct costs incurred to generate revenues in
future periods. Also, MGA's generally have not given current recognition
to future servicing costs, such as for the run-off of claims for which
the MGAs are responsible according to the management agreements, and they
have not separately identified fees for such services.
115. MGAs should continue to expense all of their costs as incurred.
However, a loss should be recognized currently if it is probable that
future expenses related to contracts in effect at the balance sheet date
will exceed any future revenues on those contracts that relate to periods
prior to the balance sheet date.
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116. Reimbursements to the MGAs for expenses, including those incurred in
connection with cost-plus arrangements, should be recognized as the
applicable costs are incurred.
117. When premiums due the underwriter that are guaranteed by an MGA are
deemed to be uncollectible, a loss should be recognized in the amount of
the earned portion of the premium and all related commissions.
Financial Statement Presentation
118. The conclusions on financial statement presentation for retail
brokers, as described in paragraphs 72 and 73, also apply to managing
general agents.
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LIFE INSURANCE AGENTS AND BROKERS
General
119. This section describes some unique considerations that relate to the
operations and accounting of life insurance agents and brokers (referred
to herein as brokers). In addition to dealing in life insurance, life
insurance brokers often deal in accident and health insurance, employee
benefit services, and related services. The discussion in the preceding
sections of this guide that focuses on retail property and casualty
insurance also applies to accident and health insurance, group insurance
plans, employee benefit services, and short-duration term life insurance,
because certain aspects of those policies and the related broker services
and commission arrangements are similar to those of retail property and
property insurance. However, because of their long duration, other kinds
of life insurance may present certain unique issues.
120. Substantial amounts of life insurance are sold by brokers who act as
independent agents. Independent agencies often are organized as
proprietorships or closely-held corporations. As such, they often do not
prepare general-purpose financial statements, and many of their reporting
practices are influenced by income tax considerations.
121. Life insurance is also sold by the direct sales forces of life
insurance underwriters. Because few direct sales forces are separate
entities, the discussions in this guide do not apply to direct sales
forces. Commissions paid to such forces and certain other costs are
capitalized by the underwriters as policy acquisition costs and are
amortized to match the recognition of premium revenues. Those costs
should be considered within the broader framework of accounting practices
of insurance enterprises, which are specified in FASB 60 and further
discussed in the AICPA Audit Guide, "Audits of Stock Life Insurance
Companies."
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122. Some stockbrokers have operated as independent insurance agents and
have marketed substantial amounts of certain kinds of life and annuity
products, particularly those that are believed to have inherent
policyholder tax savings, tax deferral, or investment features.
123. Life insurance may also be one of the personal lines of business of
brokers who also service the property and casualty insurance needs of
their commercial clients. For larger brokers, life insurance has been
less significant than their property and casualty business. Brokers may
also provide life insurance through group merchandising programs to
professional or trade associations or other large groups, using
techniques such as direct mailings and payroll deduction plans.
Services Provided by Life Insurance Brokers
124. One major difference between life insurance and property and
casualty insurance is that there can be only one claim under a life
policy but there can be more than one claim under a property and casualty
policy. Thus, a relatively smaller portion of a life insurance broker's
effort is devoted to providing services after the effective date of life
policies. The subsequent services may consist of maintaining contact
with the policyholders, billing and collecting premiums (although this
may be done directly by the underwriters), advising the policyholders on
benefit options, and so forth. Because a relatively smaller portion of a
life insurance broker's effort is expended after the effective date, a
relatively larger portion can be devoted to looking for new business and
designing and negotiating life insurance programs.
Revenue and Expense Recognition
125. Commissions. Most life insurance brokers are compensated by
commissions, which are either withheld by the brokers, who then remit the
net premium amounts to the underwriters, or which are transmitted to the
brokers by the underwriters if the premiums are billed directly by the
underwriters.
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126. Unlike most property and casualty insurance, which is usually
written under annual policies, a substantial portion of life insurance is
written under long-duration policies that provide for the payment of
periodic premiums over a period of several years. Brokers usually
receive relatively high commissions when the life policies are sold and
lower renewal commissions in later years as subsequent premiums are
collected. The terms of the commission arrangements between the broker
and the underwriter are individually negotiated and vary significantly.
A fairly typical arrangement for an ordinary life insurance policy is a
first-year commission equal to one year's premium, with renewal
commissions for the next nine years at five percent of the annual
premiums paid and a servicing commission for subsequent years at two
percent of the annual premiums. Another broker, however, might receive
commissions under a similar policy equal to forty percent of the annual
premium for the first three years with no subsequent renewal
commissions. Commission arrangements also vary with the kinds of
policies. For example, first-year commission rates under ordinary life
insurance policies with fixed premiums and benefits are ordinarily higher
than those for universal life insurance policies with variable premium
and benefit features. Under some arrangements, brokers' renewal
commissions may become vested, that is, the brokers maintain the right to
receive renewal commissions even if the brokers terminate their
relationships with the underwriters.
127. Historically, brokers have recognized commissions on life insurance
when the related premiums were collected by the broker or billed by the
underwriter.
128. First-Year Commissions. The annual premiums on long-duration life
insurance are not the same as installment billings for property and
casualty insurance, which cover only short durations. Therefore,
first-year commissions on long-duration life insurance policies should be
recognized as income when the first premium is paid by the insured and
accepted by the underwriter, regardless of whether the first-year premium
is paid as a single premium or as a series of monthly, quarterly, or
semi-annual premiums.
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129. Renewal Commissions. Though life insurance brokers may not be
obligated to provide significant future services to receive renewal
commissions, such renewal commissions are subject to the uncertainty that
the policyholders will terminate or not renew the policies. Thus,
recognizing renewal commissions when the policies are issued could result
in recognizing income that may never be realized. Therefore, renewal and
servicing commissions should be recognized by life insurance brokers as
revenue when renewal premiums are paid by the insureds or when premiums
are paid under an automatic premium loan option.
130. Persistency Bonus Commissions. In addition to regular commissions,
persistency bonus commissions may also be paid to life insurance
brokers. Such commissions typically are based on the amount of premiums
remaining in force for three or more years. For example, for a given
broker, a five percent persistency bonus would be paid if at least
seventy percent of the business written in a given year was still in
force after three years. Therefore, persistency bonus commissions should
be recognized by life insurance brokers in the same manner as contingent
profit commissions of MGAs are recognized, as described in paragraphs 110
through 112.
131. Commission Adjustments. The only commission adjustments generally
occurring after the effective date of life insurance policies are caused
by policy cancellations. Cancellations of policies sometimes require
brokers to return previously received commissions. This situation is
typical, for example, for policies in which the premiums are billed
monthly but the full first-year commission is paid to the broker when the
first monthly premium is paid by the policyholder. Therefore,
adjustments to commissions due to cancellations of policies should be
recognized when the broker is notified by the underwriter of such
cancellation. If annual commissions are paid to brokers in advance of
the collection of monthly or other installments of annual premiums, a
provision should be made for estimated adjustments due to cancellations,
if such a provision can be reasonably estimated.
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132. Expense Recognition. The costs of life insurance brokers are
similar to those of retail brokers. The relative proportions that may be
classified as initial direct, subsequent servicing, and indirect costs
may differ but the conclusions for retail brokers, as described in
paragraphs 66 and 67, nevertheless also apply to life insurance agents
and brokers.
Financial Statement Presentation
133. The conclusions on financial statement presentation for retail
brokers, as described in paragraphs 72 and 73, also apply to life
insurance agents and brokers.
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EXPENSE RECOGNITION BY BROKERS
AFFILIATED WITH INSURANCE UNDERWRITERS
134. Historically, various expense recognition methods have been used by
brokers who were directly or indirectly affiliated with insurance
underwriters, either as subsidiaries, parent companies, or brother-sister
corporations, collectively referred to herein as affiliated brokers.
135. Some affiliated brokers have expensed all the costs related to their
services as incurred. Other affiliated brokers have deferred only the
direct costs that were related to the acquisition of the insurance
business that was placed with their affiliated insurance underwriters.
Still other affiliated brokers have deferred the direct costs related to
the acquisition of all the insurance business that they produced,
regardless of whether that business was placed with their affiliated
insurance underwriters or with nonaffiliated insurance underwriters.
136. Affiliated brokers should follow the general authoritative guidance
on consolidated financial statements in Accounting Research Bulletin No.
51, "Consolidated Financial Statements," and on related party transaction
disclosures in FASB Statement No. 57, "Related Party Disclosures."
137. In separate financial statements, affiliated brokers should charge
their costs to expense, as described in paragraphs 64 and 65, regardless
of their relationships with insurance underwriters, because their
operations typically are similar to those of other brokers not directly
affiliated with insurance underwriters. Charging costs to expense as
described in these paragraphs will enable comparability of financial
statements among brokers.
138. Consolidated reporting entities comprised of affiliated brokers and
insurance underwriters should account for acquisition costs related to
the acquisition of insurance policies underwritten by the entities in
accordance with FASB 60, paragraphs 28 to 31, after elimination of
intercompany commissions paid by the insurance underwriters to the
affiliated brokers.
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139. Because their operations are similar to direct sales forces of
insurance underwriters, affiliated brokers should defer costs related to
the acquisition of the insurance business that is placed with their
affiliated insurance underwriters for purposes of consolidated financial
statements. The affiliated brokers should capitalize any unreimbursed
costs as a form of deferred policy acquisition costs and should amortize
those costs against either their related revenue or that of their
affiliated insurance underwriters.
140. An accounting policy of deferring acquisition costs of affiliated
brokers in consolidated financial statements is similar to many other
forms of purchase accounting in which subsidiaries adopt the parent
companies' accounting policies for the same or similar portions of their
operations.
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PURCHASE ACCOUNTING
Separately Identifiable Intangibles Other Than Goodwill
141. Historically, the kinds of separately identified intangibles and the
amounts assigned to them in accounting for the acquisition of brokers
accounted for by the purchase method have varied with the circumstances
of each such transaction. To some extent, specific identification and
valuation of separate intangible assets appears to have been a function
of the relative size of the transaction and the relationship of the total
consideration paid by the buyer to the net tangible assets of the
acquired entity.
142. Some acquirers, particularly in larger transactions or those in
which the purchase price significantly exceeded the net tangible assets
acquired, have tried to separately value specifically identifiable
intangible assets other than goodwill, such as the intangible assets
discussed herein, based on comprehensive studies. Others have concluded
that it is impractical to analyze any excess purchase price over net
tangible assets acquired beyond identifying that amount as goodwill.
143. Acquirers should separately identify and value the intangible assets
acquired to conform with the requirements of APB Opinion No. 17,
"Intangible Assets," paragraph 26. The separately identifiable
intangible assets should be amortized over their estimated useful lives;
however, the amortization period should not exceed forty years.
Intangibles— General
144. The principal intangibles of brokerage operations to which values
might be assigned could include the following:
- Renewal rights.
- Employment and management contracts and noncompete agreements.
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- Equity valuation of affiliates, foreign subsidiaries, and other
investments.
- Operational systems, for example, coded software and written
operational procedures and materials.
- Leasehold interests.
- Licenses.
- Goodwill.
Renewal Rights
145. A major portion of the cost paid to acquire an insurance broker is
incurred for the prospect of future renewal commission income from the
established customer base (known as policy expirations, books of
business, or renewal rights).
146. Renewal rights normally are evidenced by signed broker of record
letters, which authorize the brokers to negotiate directly with
underwriters to place insurance on behalf of the clients. Therefore,
even though insurance policies in force may expire, the brokers continue
to have the renewal rights to current policies until the clients rescind
the broker of record authorizations.
147. Appraisers generally value renewal rights at the present value
(i.e., the discounted amount) of the projected future earnings
attributable to such rights, as follows:
- Anticipated gross renewal commission income on an account-by-account
basis, assuming expected attrition rates based, for example, on each
account, broker, and industry historical experience, the current
economic and business environment, the kinds of coverage, and the
size and location of the clients.
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- Ongoing administrative and servicing costs, including income taxes,
for each account based on assumed inflation rates. Costs of new
account prospecting and development are not allocated to each
account.
- Appropriate interest rates are to be used in the discounting
process.
148. Amortization of Renewal Rights. An analysis of the anticipated
continuation of renewals related to particular customer bases or book of
business (lifing analysis) used should be consistent with the assumptions
used in determining the values assigned to renewal rights. APB 17
supports the straight-line method of amortization, unless another
systematic and rational method can be shown to be better in the
circumstances. Because renewal rights represent the value of future
renewal commission income, the assigned value generally should be
amortized in proportion to the ratio of annual renewal commission income
to the present value of the total commission income anticipated from the
purchased policy expirations. This approach should take into
consideration the declining cash flows and the time value of money.
149. Subsequent reviews of amortization, as required by APB 17, paragraph
31, may cause adjustments to the amortization if subsequent experience
differs significantly from the underlying assumptions used to initially
record the assets or to determine their amortization.
Employment and Management Contracts and Noncompete Agreements
150. Employment and management contracts and noncompete agreements,
though not unique to insurance brokers, may represent relatively
important assets obtained and obligations assumed under acquisition
agreements, because employee costs are typically the largest costs of
brokers. Noncompete agreements restrict former owners, employees, or
agents from competing against the acquiring company, in an attempt to
preserve the business environment it acquired and to alleviate the
potential for loss of future earnings.
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151. Assignments of values should reflect employment contract and
noncompete provisions. Obligations under noncancellable contracts should
be estimated and discounted in accordance with APB Opinion No. 16,
"Business Combinations," paragraph 88. The related assets should be
amortized in proportion to the benefits to be received under the
contracts. The amortization periods should be the periods over which
services are to be rendered to the broker under the contracts. The
amortization methods should reflect the ratios of periodic services
provided to the total services to be provided over the contract periods.
152. Cancellable contracts typically do not have unconditional
obligations that would establish the assignment of value. Consideration
should be given to management's intentions and its past record regarding
renewals of these otherwise short-term contracts.
153. Because noncompete agreements have no liquidation value and cannot
be sold, the value assigned to them could only be the cost to the
acquiring company, which amount should equal the obligations under the
noncompete agreements. Also, the value assigned should reflect the
difficulty of legally enforcing such agreements.
Affiliates and Other Investments .
154. Foreign and partially owned affiliates and investments generally are
valued using the discounted cash flow of net asset value approach. Such
values generally are not amortized or are amortized over forty years or
shorter periods, if warranted, e.g., in a joint venture agreement.
Operational Systems
155. Operational systems are intangible assets that provide the acquired
brokers with procedures for operating the business. Computer software
makes up a large part of these intangibles. Internally developed
software generally has been recorded at current cost, by determining the
person-days devoted to designing, coding, documenting, testing, and
debugging each software system.
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Economic obsolescence should be considered in the determination of the
estimated remaining lives of the software systems. Externally developed
software should be recorded at an appropriate value at the date of the
business combination.
156. Internally generated and prepared materials include, for example,
manuals, handbooks, video tapes, and sales kits, which are produced for
and by the brokers and which will continue to be used by the company for
several years before they are replaced. These items should be recorded
at an appropriate value at the date of the business combination.
Leasehold Interests
157. Leasehold intangible assets or liabilities are caused by the
brokers’ lease rents being favorable or unfavorable compared to current
market rents. Leasehold interests should be recorded by computing the
present value, after tax, of the economic advantage or disadvantage and
should be amortized over the life of the lease.
Licenses
158. The acquired broker, particularly if it has insurance underwriting
subsidiaries, may have various licenses or "approvals" to operate in
certain states. Since an underwriter cannot write business without these
licenses or approvals, these operating rights have inherent value. Such
licenses should be recorded at an appropriate value at the date of the
business combination.
Goodwill
159. Goodwill encompasses all other unidentified assets (i.e., the
residual method) and includes the "going-concern" value.
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GLOSSARY
Abstract - A form prepared containing basic data shown on a policy.
Account Current or Agent's Account - A statement usually prepared by the
agent for his or her month's business, showing for each premium
transaction the balance due either to the underwriter or to the agent.
Account Executive - The person who takes the overall responsibility for
management of all aspects of an insured's account.
Accounts Receivable - The amounts due the broker from clients for
insurance premiums or services charged on a fee basis.
Additional Premium - The premium due from the insured for an endorsement.
Advance Billing - A billing rendered to a client before the effective
date of the policy.
Advance of Premium to Underwriter on Behalf of Client - A payment by the
broker to the underwriter of the client's premium before the client pays
the premium to the broker.
Affiliated Broker - A broker directly or indirectly affiliated with an
underwriter either as a subsidiary, a parent, or a brother-sister
corporation.
Aged Accounts Receivable Trial Balance - A report indicating amounts
overdue over ninety days, sixty to ninety days, and thirty to sixty days
and indicating current items and the total account balance.
Agency Company - An insurance company (underwriter) whose business is
produced through a network of agents, in contrast to a direct writing
company, whose business is produced by company employees.
Agency System - The system of producing business through a network of
agents. Such agents have contracts to represent the company and are of
three classes, i.e., local, regional, and general. These agents are
compensated at differing rates of commission, and general agents have
much greater responsibilities and duties than local and regional agents.
Agent - A licensed representative of an insurance company in negotiating,
servicing, or effecting insurance contracts. An agent may, in fact,
represent several insurance companies. For purposes of this guide, all
references to agents are identical to brokers unless otherwise noted.
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Advance of Claim Settlement/Premium Refund - The payment by a broker to
an insured on behalf of the underwriter for settlement of a claim or
refund of premium before the broker receives the settlement or refund
payment from the underwriter.
Agent. General - An independent person or organization that operates the
way a branch office of an insurance company operates. The person or
organization usually performs the function of an insurance company in
selecting, writing, and servicing business for the insurance companies
represented. A general agent may use sub-agents and brokers to market
the products of the companies represented.
Anniversary Date - The date on which the next annual premium is due for
policies written for more than one year with premiums payable annually.
Assuming Company - An insurance underwriter that accepts all or part of
an insurance risk from another underwriter through reinsurance.
Assured or Insured - The person or entity in whose name the insurance
policy is issued and whose life, property, or liability exposure is
insured.
Audit - In certain kinds of insurance, a survey of the insured's records
during or at the end of the policy period to determine the earned premium
for the period that coverage was in force. An audit may also be defined
as a review of the client's insurance program to determine the adequacy
of its coverage or rates.
Audit Premiums - Earned premiums determined from data developed by
periodic audits of insureds' records or from periodic reports submitted
by insureds. Such audits are made and such reports are submitted either
monthly, quarterly, semiannually, or annually.
Billing Date - The date a billing is prepared. It does not necessarily
coincide with the effective, expiration, or term dates of the policy.
Binder - A temporary insurance contract created to confirm to the client
that coverage is in force pending creation of a formal policy contract.
In some instances, the broker may invoice the anticipated premium along
with the binder to expedite eventual collection of premiums. In these
situations, a "premium-bearing binder" is issued.
56
Bordereau - A detailed list of premiums and/or claim transactions,
usually prepared monthly, and rendered to interested parties. Such lists
are also frequently rendered by ceding companies to reinsurers and by
large general agents to underwriters.
Broad Form Cargo Policy - Insurance covering the value of cargo during a
specific voyage, commonly written on a reporting-form basis.
Broker - A representative of the client who places the client's insurance
with an underwriter. The compensation for his services generally
consists of a commission paid to the broker by the underwriter. The
broker is not an agent of the underwriter and the commission that the
broker receives is usually lower than that of an agent who represents the
underwriter. Brokers also may provide services other than the placement
of insurance.
Broker of Record - The broker who placed the current coverage and thus is
entitled to receive commissions related to the placement of that coverage
and has undertaken to service the coverage for the client.
Builders' Risk Policy - Insurance covering the increasing values of
property at various stages of construction, commonly written on a
reporting-form basis.
Bundled Transaction - A transaction in which the broker receives a single
fee for placing insurance coverage and for providing services that do not
relate to obtaining insurance coverage.
Cancellation - Termination of an insurance contract by the insured, the
insurer, or the broker before it expires.
Cancellation. Flat - Cancellation of an insurance contract with a full
return of the premium by the insurer.
Cancellation. Pro Rata - Cancellation of an insurance contract with a
refund of the portion of the premium that the remainder of the policy
period bears to the total policy period.
Cancellation. Short Rate - Cancellation of an insurance contract with a
return of premium of less than the amount of premium refundable on pro
rata cancellation.
Carrier - The bearer of the risk related to an insurance policy.
57
Casualty - A class of insurance that generally includes legal liability,
workers' compensation, automobile, and aviation insurance.
Ceding Company - An insurance underwriter that transfers all or part of
an insurance risk to another underwriter through reinsurance.
(Loss) - A demand by the insured for payment by the underwriter of
a policy benefit because of the occurrence of an insured event such as
death, injury, destruction, or damage.
Claim Settlement - The amount paid by an insurer to or on behalf of an
insured to discharge the insurer’s obligation under the terms of the
policy.
Claims Incurred But Not Reported ("IBNR”) - Claims relating to insured
events that have occurred but have not yet been reported to the
underwriter as of the reporting date of the financial statements.
Client - A person or organization, such as the policyholder or insured,
for whom insurance is placed or other services are performed by the
broker or reinsurance intermediary.
Client Advance - A payment by the broker to the client of claim
settlement or return premium amounts before payment of those amounts to
the broker by the underwriter.
Commercial Lines - Coverage for business enterprises, rather than for
persons. Commercial lines include, for example, insurance for damage to
property, liability indemnity insurance, workers' compensation insurance,
and group life and health insurance.
Commission - A portion of the premium paid to a broker or handled by a
reinsurance intermediary. Generally, the broker or the reinsurance
intermediary collects the total premium from the client, retains his
commission, and remits the net premium amount to the insurer or reinsurer.
Commission Adjustment - Changes in the amount of commissions on discovery
of errors made in calculating commissions or premiums or on audit of
retrospective basis coverage.
Commission, Contingent - A profit-sharing commission the amount of which
depends on the profitability of the business written by a broker with a
particular underwriter. Contingent commissions are subject to the
provisions in agreements that the broker has with its underwriters.
58
Commission, Contingent Profit - A commission paid to a managing general
agent based on the profits, as defined in the MGA's agreement, of the
business managed by the MGA.
Commission. Negotiated - A commission determined by agreement between the
broker and the client at a rate different from that for regular
commissions.
Commission. Provisional - A commission paid to a broker that may be
subject to subsequent adjustment, such as under a contingent profit
commission arrangement.
Commission, Regular - A commission at a rate specified by the underwriter
or determined by agreement between the broker and the underwriter.
Credit Risk - The risk relating to the ability to collect money that will
come due.
Customer Refund - A return of all or part of a premium paid by a client,
usually as a result of a cancellation or overpayment.
Daily Report ("Daily") - A copy of the parts of an insurance contract
that apply to a particular risk kept by the broker’s office as its record
of a policy in force for a client. The daily contains all the necessary
premium billing information to create an invoice for the client. It is
retained in the client's file indicating in-force coverage.
Deposit Premium - The initial premium payment under an insurance contract
where the total premium is yet to be determined by audit.
Differences - A term applied to the differences developed as a result of
comparisons made of accounts current rendered by an agent with
transactions shown on the underwriter's records. Such differences are
common because the agent and the underwriter each use different cutoff
dates and because of errors and omissions by either the underwriter or
the agent.
Direct Bill - Policies billed directly to the insured by the underwriter,
with the broker assuming no responsibility for premium collection.
Direct Commissions - Commissions received directly from the underwriter
on coverages for which the client has paid the premium directly to the
underwriter. Direct commissions are most common with personal lines
coverages, employee benefits coverages, and life insurance.
59
Dividend - A payment by an underwriter to a policyholder based on surplus
or earnings on a participating policy.
Earned Premium - The portion of a premium applicable to the expired
period of a policy, usually determined on a pro rata basis.
Effective Date - The date from which protection is afforded under an
insurance policy. Also, the date from which an endorsement to a policy
amends the existing insurance coverage.
Employee Benefits/Life - A class of insurance that generally includes
personal life, annuity, health, and disability insurance,
employer-sponsored fringe benefits, including life, accidental death,
travel, medical, dental, disability, and retirement, and related
actuarial and administrative services.
Endorsement - Documentary evidence of a change in an existing policy
which may result in either an additional premium, a return premium, or no
premium adjustment.
Exclusive Agent - An agent who represents a single insurer, has little or
no ownership rights in the policies sold, and generally receives a lower
rate of commission than the independent broker because the insurer
performs services such as policy-writing, billing, and collecting.
Expiration Date - The date on which an insurance contract terminates.
Expirations - In a business combination, the value of future renewal
commissions related to an acquired customer base or book of business.
Facultative Reinsurance - Arrangements under which each risk to be
reinsured is offered to and is either accepted or rejected by the
reinsurer. (See also Treaty Reinsurance.)
Fee in Lieu of Commission - A payment by a client to a broker in an
amount agreed to between them in return for the broker’s services
relating to a client's insurance program.
Fees - Charges to clients in lieu of or in addition to commissions for
placement of coverage or charges for services other than placement of
coverage.
Fiduciary Funds - Funds collected and held by a broker from clients and
underwriters until remitted to the other party.
Handler - The person responsible for placement or handling of a
particular portion of an insured account.
60
Independent Agent - An agent who represents a number of underwriters,
bills the policyholders, collects premiums, and generally is considered
to own the renewal rights on the policies he or she has written. Most
major stock insurance companies use independent agents.
Industry Class Code - A code used to identify commercial accounts as to
kind of business. The numbers, which range from 1 to 99, are the United
States Government’s standard commercial classifications.
Installment Premiums - Premiums payable periodically rather than in a
lump sum at the inception or effective date of the policy.
Insured or Assured - The person or entity in whose name the insurance
policy is issued and whose life, property, or liability exposure is
insured.
Invoice - A document forwarded to an insured reflecting premium or fees
due.
Item Basis Payable ("IBP") - The procedure in which the broker defers
payment to an insurance company on a given item until the client has paid
the broker and the contract terms have expired. No legal liability to
the broker can be incurred until those events occur.
Lifing Analysis - An analysis of the anticipated continuation of renewals
related to a particular client base or book of business.
Long-Tail Business - A line of insurance for which losses are expected to
continue to be reported and settled over a long period after the coverage
term. Examples of long-tail business include medical malpractice
insurance and many kinds of liability insurance.
Loss Ratios - Relationships between claims amounts and premiums. Two
ratios commonly used are
- Paid loss ratio - paid claims divided by written premiums or
earned premiums.
- Incurred loss ratio - incurred claims divided by earned
premiums.
Managing General Agent ("MGA") - A person or organization that is
authorized by an insurer to underwrite and bind risks on the insurer's
behalf and who may perform other services in connection with the business
written.
61
Marketing - Services by a broker related to negotiating and placing
insurance coverage with an underwriter.
Mass Marketing or Mass Merchandising - The marketing of standardized
personal lines insurance package to individual members of an association,
organization, or employer. Insurance coverages are sold to members of an
organization by first securing the endorsement of the sponsoring
organization for a special program and then approaching each member with
the organization's especially tailored policy.
Personal Lines - Coverage for persons rather than businesses. Personal
lines include, for example, automobile and homeowners’ insurance and
individual life insurance.
Policy Period - The period for which a policy contract provides
insurance.
Policy Year - The calendar year in which a policy became effective.
Premium - The money paid for insurance coverage.
Premium. Earned - See Earned Premium.
Premium Finance - Financing of premiums by a financial institution or
insurance company.
Premium, Net - The amount of the premium due the underwriter after
deduction of commission.
Premium Rate - The price per unit of insured exposure.
Pr emium Return - The premiums due to a policyholder on cancellation of a
contract, for a rate adjustment on audit, or for a reduction of coverage.
Premium Taxes - Taxes levied by various states on premiums written by
insurance companies.
Premium, Unearned - The portion of the premium for insurance in force
that applies to the unexpired period of the policy term, usually
determined on a pro rata basis.
Producer - The person responsible for bringing the insurance account to a
broker. A producer may be one person or a team of persons responsible
for initially producing the account. A single person may from time to
time be a producer and an account executive.
Property - A class of insurance that covers loss of property or loss of
use of property caused by fire and other perils, such as homeowners’
insurance and commercial package policies.
62
Pro specting - Efforts by a broker to obtain new clients or new or renewal
business from existing clients.
Reinsurance - Indemnification by an underwriter (called a reinsurer or
assuming company) of all or part of a risk originally undertaken by
another underwriter (called the reinsured or ceding company).
Reinsurance Intermediary - A middleman between underwriters in the
transfer of insurance risks.
Remittance Advice - A bordereau transmittal form used in paying an
underwriter for items due.
Renewal - Continuation of an insurance contract beyond the original date
of expiration by endorsement, certificate, or a new contract.
Renewal Right - A right of a life insurance agent to continue to receive
renewal commissions even though the relationship between the agent and
the underwriter has terminated. In a business combination, renewal
rights are tied to the value of future renewal commissions related to an
acquired client base or book of business.
Reporting-Form Policy - Insurance coverage for which variable periodic
premiums are charged based on predetermined rates applied to values that
change throughout the policy period. The premiums for reporting-form
policies generally are calculated, reported, and remitted by the insured
to the broker, usually on a monthly basis.
Retail Broker - An intermediary between clients seeking insurance
coverage and underwriters. Retail brokers include certain financial
institutions, such as banks and securities brokers, that also are active
in marketing certain kinds of insurance coverages.
Revenue Recognition Date - The date on which all of the following
criteria are met: protection is afforded under the insurance policy, the
premium due under the policy can be reasonably estimated, and the premium
is billable to the client.
Rewrite - A new policy issued to replace one or more existing policies
accompanied by a cancellation of the existing policies.
Risk Management - The coverage or protection achieved through a
systematic combination of risk retention and risk transfer.
63
Run-Off - The eventual settlement of losses from a group of policies that
occurs over a period of years following the expiration of the policies.
Self-Insurance - The portion of a risk to loss or liability that an
entity retains, either voluntarily as part of a risk management program
or involuntarily due to the unavailability of coverage at an acceptable
price. Self-insurance may involve the setting aside, or the reserving,
of funds by a person or organization to meet losses and accumulation of a
fund to absorb fluctuations in the amount of loss, with the losses
charged against the fund or reserve.
Treaty Reinsurance - Arrangements that provide for automatic reinsurance
of an agreed portion of business written. Treaty reinsurance avoids the
need for submitting each risk to the insurer for acceptance or
rejection. (Also see Facultative Reinsurance.)
Underwriter - An entity that accepts an insurance risk from a
policyholder in return for a premium.
Underwriting - The assumption of risk for designated loss or damage on
consideration of receiving a premium; usually also considered to cover
the determination as to the acceptability of risks to be insured and of
the amount of premium to be charged.
Unearned Premium - The pro rata portion of the premium in force that
applies to the unexpired period of the policy term.
Wholesale Broker - An intermediary between retail brokers and
underwriters. Wholesale brokers include excess and surplus lines brokers
and brokers that place insurance in international insurance markets, such
as Lloyd's of London.
64
Accounting By Insurance Agents and Brokers (File 3165.IA)
File 1400
AcSEC Minutes
October 29 to 30, 1987
Mr. Kauth, Chairman of the Insurance Agents and Brokers Task
Force, led a discussion of the task force's draft issues paper,
"Accounting by Insurance Agents and Brokers." He stated that
advisory conclusions have been added to the task force's paper
since the last time AcSEC discussed it a year ago. The task
force was formed because there was an absence of guidance in the
accounting literature for insurance agents and brokers. Four of
the largest public insurance brokers are represented on the task
force, which unanimously agrees with the conclusions in the pa
per. The U.S. insurance brokerage community as well as their
U.K. counterparts, also favor the paper.
Mr. Kauth said that not all conclusions in the paper are consis
tent with current accounting practice for the insurance agents
and brokers industry. If the advisory conclusions in the paper
were to become effective, all brokers would have to change one or
more facets of their accounting for revenue recognition or finan
cial statement presentation.
The majority of the paper deals with revenue and expense recogni
tion for retail brokers who place commercial risks, such as pro
perty and liability coverage. The paper discusses other kinds of
brokers, but the advisory conclusions presented for them are
consistent with those described for retail brokers in paragraph
84 of the paper. The task force believes the conclusions in the
paper provide a practical solution for accounting by insurance
agents and brokers and believe that the paper should be published
in one form or another.
• The sain change would be in financial statements presen
tation.
• Expense recognition would not change.
• For large public brokerage firms there would be little
change in revenue recognition practice. In this area the
paper basically recommends what is current practice for
those firms.
20
Mr. Schuetze asked if the changes to practice caused by the advi
sory conclusions in the paper would be material. The task force
members responded as follows:
File 1400
__
AcSEC Minutes
October 29 to 30, 1987
• Cash basis revenue recognition, which is prevalent in the
industry for nonpublicly held firms, would be eliminated.
Mr. Schuetze asked if the paper had at one time contained advi
sory conclusions that would materially change practice by requir
ing a significant accrual of revenue. Mr. Kauth responded that
the last tine the task force net with AcSEC, the paper did not
have advisory conclusions. The task force had previously re
quested that the Planning Subcommittee allow the paper to be
presented to AcSEC without advisory conclusions. So the adviso
ry conclusions originally in the paper were removed before the
paper was presented to AcSEC for initial discussion at its Decem
ber 1986 meeting.
Mr. Kauth said the original advisory conclusions that were
removed from the paper differ from those now currently in the
paper. The original advisory conclusions were derived from a
conceptual point of view and recommended deferral of some of the
policy service costs before the issuance of a policy and a provi
sion for those costs that extend throughout the policy period or
subsequent to the policy period. These conclusions have never
been tried in practice or field tested, so there is no way to
know whether they are practical.
At the December 1986 AcSEC meeting, the task force was asked to
put advisory conclusions back into the paper. While doing that,
the task force reviewed the basis for those conclusions and de
cided that until the area of accounting for service industries in
general is acted on by the accounting authorities, the task force
should simply recommend practices that are practical and likely
to be durable, and not recommend substantial change.
Mr. Kenny said that the insurance broker industry is unusual
because there are six thousand brokerages in the U.S. but only
around eight of them are public companies. Unlike the savings
and loan industry or the insurance industry itself, no regulatory
authority, other than the tax authorities, require the brokers to
produce financial statements, so their financial reporting is
diverse.
The paper provides guidance to practitioners and bankers who
become associated with the industry for the first time. Mr.
Rosenfield said that for that reason, publication as a guide
might be best.
21
File 1400
AcSEC Minutes
October 29 to 30, 1 9 8 7
Mr. Crooch asked if there is a practice problem in the industry,
such as brokerages going bankrupt or a clamor from outside
parties that they are being mislead by the brokers' current fi
nancial reporting. Mr. Kenny said there is no such problem but
that there is an information gap, which the paper is trying to
Many members of AcSEC agreed that the information in the paper
should be made available to the AICPA membership in some form and
discussed what kind of form it should take.
One proposal was to make the paper a descriptive guide of prac
tice without advisory conclusions, such as the airline guide.
Mr. Strauss said that even if descriptive, it would still have to
present some accounting policies. Mr. Kauth said he believes
that whatever its form, the paper should contain conclusions,
because it deals with broad issues for the industry and without
them, diversity of practice would continue.
Mr. Schuetze pointed out that accounting in the airline industry
originated from a regulated environment and therefore had less
diversity than the insurance agents and brokers industry. Mr.
Ball said both the Airline Guide and the Casino Guide, though
primarily descriptive, did label a couple of practices as not
sound. Mr. Kauth said the task force's paper does recommend
conclusions that differ from current practice, such as the finan
cial statement presentation conclusions, and asked for further
clarification on how to present the paper as a descriptive guide.
pa r a g r a p h 72 .
AcSEC discussed paragraphs 85 and 86 on revenue recognition and
made the following comments:
Consider eliminating one of the two revenue recognition
methods. Paragraph 35.
Issue one asks when revenue and expenses should be recog
nized in a retail insurance brokerage. The discussion
following the question deals with only revenue and not
expenses, but it should also deal with expenses.
If it is uncertain when a cost is to be incurred, nor
mally the recognition of the related revenue is deferred
until the cost is incurred, instead of accelerated as
recommended in the paper, to achieve the matching of
revenues and expenses. Only if the service cost is in
consequential could the method recommended in the paper
be acceptable. Paragraph 67
22
File 1400
AcSEC Minutes
October 29 to 30, 1987
• Paragraph 86 refers to a theoretical basis as opposed to
the practical method that is recommended by the paper.
There is no need to refer to a theoretical basis if that
is not the method to be recommended. Delete the para
graph. Deleted.
The paper needs additional arguments to better support
its position of not accruing cost incurred to service the
policy after the revenue recognition date.
• The rationale for current practice should be strength
ened.
AcSEC discussed paragraph 95 on the balance sheet and made the
following comments:
. If the entity is only an agent for collecting the fiduci
ary cash, the cash is not an asset of that entity and
should not be on the balance sheet.
• Remove the alternative accounting from the paper. The
reporting of fiduciary cash and premiums due from clients
should be required either in the balance sheet, in a
note, or both, but not as a free choice.
• The fiduciary cash, if reported on the balance sheet, is
not regular cash but restricted cash.
• The fiduciary cash, if reported on the balance sheet,
should be shown on a separate line if required by law to
be kept separate.
The task force said the fiduciary cash is often commingled with
the company's own cash and cannot be separated dollar for dollar.
The asset is not necessarily always in the form of cash. The
company holds a receivable for a period of time before receiving
cash. The broker has the risk of collecting the receivable end
is liable to the underwriter for it. The task force therefore
believes it is better to present both the receivable and the
payable to the underwriter on the balance sheet rather than * net
ting them. As to the broker, because it is allowed to earn
interest income on the cash it collects to remit to the under
writer, that interest is a part of its total compensation. If it
was not allowed to earn that interest income, higher commission
rates would be charged.
23
File 1400
ACSEC Minutes
October 29 to 30, 1987
Mr. Strauss said the section on business combinations deals with
issues that do not apply specifically to brokers and interprets
general provisions of APB Opinion 16. He believes the section
should therefore be deleted. Any kind of company could have
those kinds of transactions, not just brokers. Mr. Schuetze
agreed.
Mr. Kauth said the task force did not intend for the section to
provide accounting guidance on business combinations but rather
to operate as a checklist for helping companies determine what
they were selling. He said he prefers to revise the chapter
rather than delete it.
Members of AcSEC made the following comments about the section of
the paper on business combinations:
Pages 84 and 85 list two methods for determining good
will, but only one of them is permitted by APB Opinion
P a r a g r a p h s 1 4 3 a n d 1 5 9
• Paragraph 195 on page 78 refers to a FASB discussion
memorandum on business combinations. It should instead
refer to APB Opinion 16. Paragraph 151
Mr. Strauss proposed that the paper be redrafted, though the
specific kind of document is not yet decided, to include the
arguments in the discussion expressed by the task force that
AcSEC believes are not clearly expressed in the current draft of
the paper and to provide conclusions. Mr. Kauth said the task
force will revise the document and address the revenue recogni
tion alternatives as well as the overall format of the paper.
Mr. Schuetze encouraged the task force to keep in mind when it
rewrites the paper that the FASB will have to review it and that
some FASB members do not like "either.. . or" kind of language.
AcSEC discussed that if the document is to be a guide, whether it
should also contain auditing guidance. Mr. Kauth said that audit
guidance could be developed by the task force, but it would pre
fer not to include auditing matters. Once someone understands
the industry, through the descriptive guidance in the paper, the
auditing would not be difficult, because it involves the same
auditing knowledge as any other service industry.
24
