Chapter 9: Brokerage Financial Management Flashcards
What is the ethos of profit maximization?
The more profit the better.
What is a multiple of commission?
A simple approach that does not take into consideration the profitability of a brokerage in the value calculation.
What are the components included on a balance sheet? (2)
- Assets - cash, short-term investments, account receivables, other assets (facilities, softwares, equipment, etc.).
- Liabilities - current liabilities, long-term liabilities.
What is included on an income statement? (2)
- Revenues - commissions and possibly contingent commissions/profit sharing (though, due to the inherent unpredictability around any contingent incomes, they are not used in the valuation of the brokerage), investment income, all other incomes (fees-for-service, rental income, real estate commissions, etc.).
- Expenses
What are included in other financial items (brokerage valuation)? (3)
- Cash flow - large amounts of cash are naturally preferable, and receivables that are over 60 days old will have a reduced value due to the increased risk of bad debts.
- Billings - fewer billings based on premium volumes is considered to be better.
- Tax impact
When it comes to brokerage valuation, how could a brokerage’s location be important?
Larger brokerage organizations may pay high prices for brokerages in geographic areas where they are looking for representation.
What would be evaluated about the nature of a brokerage’s business operation? (4)
- Companies represented - good brokerage relationships with insurers that the buyer is keen on.
- Type of billings - a preference of the potential buyers, whether it be predominantly direct bill or agency bill.
- Relationships with clients - strong client relationships and a correlating rate of retention are sought after intangibles.
- Business mix - purchaser may have preferences as to the lines of business they are familiar/comfortable with, predominantly personal-lines or commercial-lines.
What are some other factors that go into the value of a brokerage? (5)
- Quality of employees
- New business potential - single-policy clients represent potential cross-selling of other products, and developing areas that are to see population growth in the near future.
- Loss ratio - affects relations with insurers as well as the potential/size of contingent profits received by the brokerage.
- Errors & omissions claims - E&O claims as a percentage of commission income.
- Market conditions
What are the components of the financial management cycle? (3)
- Budgeting
- Classifying financial information
- Making comparisons
When evaluating revenue/income, what information should be considered about commissions? (4)
- Retention rate
- Changing insurance rates
- Up-selling & cross-selling
- New business obtained
What does it mean to classify financial information? Why is this important?
Segmenting income and expenses by type. For example, commission income vs fee income, or personal-lines vs commercial-lines.
This allows for a consistent basis to compare financial results between quarters/years.
In the event of a variance in actual operations, what should take place, and why?
A variance, whether positive or negative, should trigger an investigation. Negative variances should be rectified with changes in operations, while positive variances would be investigated with an objective to replicate the success.
What is involved in income management? (4)
- Trust fund regulations
- Commission reserve accounts
- Internal cash controls
- Accounts receivable
What are trust fund regulations?
Manner in which monies from premiums are handled. Typically, funds are required to be deposited into a trust account, pending transfer to the insurance companies. Agreements allow for commission balances to then be moved in to an operating account.
What is a commission reserve account?
A separate account from the operating account, where the probable amounts of commissions that may have to be refunded are held.
What factors contribute to the amount of reserve that should be maintained? (3)
- Total of unearned commissions indicates maximum exposure.
- Ratio of returned commissions to total commissions over time demonstrates what the average returned commission experience has been.
- Commissions on large premiums/accounts should be considered, as they are susceptible to competition and represent a greater exposure as far as unearned commission is concerned.
Why is it important to pay attention to internal cash controls?
Controlling and handling of cash, cash equivalents, and other securities aids in the mitigation of employee dishonesty.
What factors contribute to increased costs of accounts receivable costs? (5)
- Surrendered opportunity cost of funds
- Increased cost of collection activities
- Cost of borrowing
- Reduced bad debt expense
- Commission losses from failure to extend credit
What are the factors important in an accounts receivable policy? (4)
- Payment arrangements
- Credit checks
- Payment methods
- Responsibility for follow-up
What is brokerage financing?
A brokerage’s own system of premium financing. If service charges are not applied, the brokerage will be overlooking the time value of money due to having less cash on hand for investment opportunities.
Some brokerages push these financing options because they see such service fees as a significant source of income.
What are the premium financing options available to brokerages? (6)
- Brokerage financing (in-house)
- Financial institution financing
- Insurance company financing
- Premium finance companies
- Captive finance companies
- Cash only financing
What are the means for controlling expenses? (4)
- Communicating
- Identifying areas for cost control
- Classifying costs
- Analyzing expenses - developing expense standards and making comparisons
What are the employee incentive plans employed by brokerages? (5)
- Bonus plan
- Stock option plan
- Performance plans - profit sharing, stock purchase
- Deferred compensation
- Pension plans
How do lease arrangements come into play when a brokerage is making income tax considerations?
If the firm were to lease equipment rather than purchasing they would accrue a number of tax benefits.
- Lease agreements often do not require a significant down payment, or do not require a down payment, allowing the firm to utilize cash elsewhere.
- Mitigates obsolescence risk as equipment is to be returned at or before expiry.
- Deduction of full lease payments from taxable income.
- Acceleration of lease payments (if permitted) can increase deductions.
- Flexibility; lease agreements are less restrictive than debt/financing agreements.
- Leasing does not add debt to brokerage’s balance sheet, increasing brokerage’s borrowing capacity.
