Chapter 1 - The Legal Environment and Licensing Flashcards
Sole Proprietorship
A business owned by a single individual.
It may consist of the owner alone or may employ others.
+ Profits belong to owner
+ Control
+ Inexpensive to operate
- Unlimited personal liability for debts, losses, and judgements
- Owner relies on personal capital to finance business
- Owner’s expertise may be limited
- Business lacks continuity and may be difficult to sell because it will not automatically continue after the death, disability, or retirement of the owner
- Attracting and retaining employees, see above
Partnerships
A partnership is a voluntary association of two or more persons who are co-owners of a business operating for profit.
+ Increased Expertise compared to SP
+ Enhanced ability to raise capital compared to SP
+ Strategic and operational plans are based on the partner’s position.
- Unlimited personal liability for all debts, losses and obligations of the company.
- Discord regarding compensation
- the partnership is dissolved on death, disability, or retirement of one of the partners and there is therefore a lack of future certainty for employees.
- While the corporate intelligence of a partnership may exceed that of a sole proprietorship, it is still limited to that of the partners and paid external expertise.
- Partnerships are subject to more government regulation than sole proprietorships.
General Partnership - All rights and obligations of the partnership fall on all partners equally.
Limited Partnership - In a limited partnership (which is usually preceded by a general partnership), the limited partner is not active in running the business and has only limited liability, whereas the other, active partners are subject to unlimited liability.
Shareholders Agreements
Agreement sets out rights and obligations of the shareholders that go beyond the basic ownership of shares.
Shareholders’ agreements can set rules for the transfer and valuation of shares when certain other events occur, such as the death, resignation, dismissal, personal bankruptcy, or divorce of a shareholder.
Set rules directing how the future obligations of the company will be shared or divided.
“Shotgun Clause” - This clause sets out the conditions under which one or more shareholders would buy out another shareholder.
Other provisions can include non-competition clauses and confidentiality agreements; dispute resolution mechanisms; and details respecting how the shareholder agreement itself is to be amended or terminated.
Corporations
A legal entity whose incorporators are granted a charter by either the provincial or federal government, depending on where the business is registered.
A corporation’s name generally includes the words limited, corporation, incorporated.
Ownership of the corporation is evidenced by shares that can be transferred or sold.
A corporation may be privately or publicly held.
Fiduciary Duties (LORAD)
Loyalty Obedience Reasonable Care Accounting Disclosing Information
Fiduciary Duties - Loyalty
Broker has duty to act primarily for the benefit of his or her principal and to deal fairly with both principals in every way
This principle is complicated by the fact that the broker has DUAL RESPONSIBILITIES to two principals
Fiduciary Duties - Obedience
Duty to obey lawful instructions of the principal
If the agent fails to obey, the principal may bring action against the agent for any damages that result, and may terminate the relationship
Always consider whether obeying the lawful instructions of one principal will run counter acting for the benefit of the other.
Fiduciary Duties - Reasonable Care
Duty to exercise the degree of care that a reasonable, prudent person (with similar training) would use in the same or similar circumstances
Fiduciary Duties - Accounting
Broker owes a duty to his or her principal to account for all property and money of the principal in the agent’s possession.
The agent must keep such money and property separate from the agent’s own and may only use it for purposes authorized by the principal.
In addition to being entitled to a financial report, the principal has the right to examine the agent’s books of account.
Due to the special nature of insurance, brokers are required to keep premiums and operating funds separate.
Fiduciary Duties - Disclosing Information
The agent is responsible for providing the principal with all information that materially affects the principal’s interests; all information that is relevant to the affairs entrusted to the agent.
The duty to inform is strengthened by the legal principle of Utmost Good Faith, which governs all insurance transactions, and requires brokers to disclose all material information to insurers.
Affiliations
Careful assessment and wise selection can assist a brokerage in achieving its financial and production goals. Operating affiliations include a brokerage’s relationship with other brokers, its insurers, and other groupings outside its own legal structure.
Informal Affiliations
Networking Groups
Could comprise a group of brokerage managers who meet for coffee, lunch, or a regular game of golf.
Other groups of brokers might hold meetings to discuss common industry problems or to network.
Neither of these types of affiliation places members under any formal obligations to other members or to attend regular meetings.
Formal Affiliations
Generally involve some type of contractual relationship and/or obligation. Clusters Joint Ventures Common Identity Groups Franchises Insurer Investment in the brokerage
Clusters
A group of independent brokers or brokerages who agree to share certain expenses, to make unified volume commitments to their insurers, and to conduct specified aspects of their financial affairs in an agreed-upon manner.
Joint Ventures
Someone who owns his or her book of business goes into partnership with a larger broker to obtain access to markets and to gain marketing and administrative services in exchange for a percentage ownership of the book.
Common Identity Groups
Marketing organizations established to give participating firms the image and resources of national or international-strength organizations.
Franchises
Affiliated with a franchisor to which it pays a percentage of its revenues in return for various services.
Insurer Investment in the brokerage
Insurers invest in a brokerage by purchasing shares in the business, thus providing the brokerage with an infusion of cash to use to operate the business, to finance growth in the book of business, or to expand operations.
Agency Contract
Granting Authority Ownership of Expirations Billing Procedures Commission Schedules Agency Expenses Cancellation Rehabilitation Profit Sharing and Bonus Commission Agreements
Granting Authority
This clause authorizes the broker to act as an agent (in the legal sense) to the insurer.
It sets out what the broker can do without asking the insurer’s permission;
indicates any limitation in the relationship (for example, the authority may be terminated if the brokerage’s license is suspended or terminated);
and specifies the types of business a broker can bind.
Ownership of Expirations
This clause specifies whether the broker or the insurer owns the expirations, and therefore, who has the right to sell the book of business. Ownership of expirations lies at the heart of a broker’s financial position. It is a key element in the valuation of the brokerage, generally combined with other criteria (such as key employees and the quality of management) to determine the brokerage’s selling price. For instance, the selling price can be expressed as a multiple of the commissions earned on the book of business. If the insurer owns the expirations, it can transfer the book to another broker, seriously reducing the value of the brokerage as an asset.
Also establishes who has control of documents, such as inspections, surveys, applications, and rate books, among others.
Billing Procedures
Specifies the methods of invoicing clients. Two of the major methods used are broker bill and direct bill.
Broker Bill - The broker invoices the insured, collects payment, and sends the policy premium less commissions to the insurer. The records of transaction are generated either by the insurer or the brokerage, with periodic adjustments made to the calculations. In general, accounts are payable at the end of 30, 45, or 60 days from the end of the month in which the premium was generated.
+ Brokerage has control over billing
+ Able to invest premiums between collection and remittance to the insurer.
- Costs of bookkeeping and collection
- Potential for bad debts.
Direct Bill - Insurer bills the insured directly and submits the commissions to the broker periodically as agreed.
+ Broker is not responsible for collection of premiums
+ Broker has less work
+ Broker has less need to employ accounts receivable staff
- Loss of interest on premiums since the broker cannot invest them
- Loss of control of accounts
- Broker out of communication loop
* Contract should include a hold harmless agreement where the insurer agrees to hold your brokerage harmless for errors in accounting, including failure to collect premiums. Also, ensure the contract obliges the insurer to refer to the client to you if the agency contract is cancelled.
Commission Schedules
Usually attached to the agency contract as an addendum, lists the lines of insurance written and the rates of commission payable by line. Since commissions are generally negotiable and vary from insurer to insurer, review each offering carefully.
Most contracts specify a notice period, which is usually 60 or 90 days from the notice date, during which the insurer may adjust commissions. A shorter notice period may be specified for changing the commission payable on new policies than for changing commission on endorsements to existing policies.
Most brokerages are paid mainly through commissions, the commission schedule affects the profitability of the brokerage.
Agency Expenses
With some exceptions, most agency contracts oblige brokerages to pay their own operating expenses. In practice, although not required to do so under the contract, insurers often assist brokers with expenses by, for example, placing joint advertisements in local newspapers and telephone directories, providing financial support for the broker’s Web site, and offering training courses of the brokerage.
