A criminal question: agent groups say a proposed model law that would criminalize misappropriation of premium funds is flawed.

Next month, a committee of the National Association of Insurance Commissioners is expected to consider the final draft of a controversial model act that would criminalize the misappropriation of premium funds by producers and establish new requirements for the handling of premium dollars. Problems arise when a producer collects a carrier's premium funds, which the producer holds in a fiduciary capacity, and uses them for personal benefit.

There's no dispute among agent groups that misappropriating premiums amounts to theft and should be punished accordingly. But from its earliest drafts, the measure, known as the Fiduciary Responsibility of Insurance Producers Model Act, initially raised concerns for these groups chiefly because, they said, the preliminary wording would have any producer who violates a key provision--even those who unintentionally miss a 24-hour deadline for depositing cash for premium payments--presumed guilty of a felony.

"A key clement to the prosecution of any crime is the intent of the alleged criminal," said Tim Kovac, director of business and compliance affairs for the National Association of Professional Insurance Agents Inc. "Early drafts of this model failed to recognize intent, and lumped those producers who have no intention of misappropriating funds but fail to meet certain timing standards due to real world business issues with those who intend to steal."

However, that particular concern seems to be lessening. The NAIC's Producer Licensing Working Group, which has been fine-tuning the measure, recently agreed to make clear in the model act's wording that the presumption of guilt would stem only from the ultimate failure to deposit fiduciary funds into the proper account and failing to meet the 24-hour deadline would not be considered a criminal violation.

"It's just the act of failing to deposit that would now trigger that presumption," said Jack Chaskey, vice chair of the working group. If insureds' complaints pile up at the door of state regulators about policies canceled for nonpayment and the carriers say they never received payments, the focus of the inquiry would shift to the agent, Chaskey said. "If we go to the agent with the insured's canceled checks and the agent is showing no money anywhere--none in his account and no records to show that he received the money--then that's going to be a failure to deposit," he said.

How Much Fraud?

At the core of this debate are differing views on the prevalence of agent fraud activity. Kovac said that his organization hasn't seen too many instances of misappropriation of premium funds. "In any industry, you are going to have some people who violate the law," he said. "But for the most part, all producers understand that they have a fiduciary obligation for funds that they collect for their carriers."

In Chaskey's experience, however, misappropriation of funds has, indeed, been a worry. Back in 1999, when discussion began on a possible model act to address this, the NAIC had asked representatives of various state insurance departments if they were witnessing agents diverting premium funds or inappropriately using these funds. "They got about 20 states to come back and give some detail as to the problems they were having," he said.

Both agent groups and NAIC officials expect a version of the model to be approved by the commissioners sometime in 2005. The process leading up to this has been fluid, and additional discussions were planned for early April and May between the NAIC and the agents' representatives. Presumably those talks could affect the wording of the final version. But as of press time, agent groups remained strongly critical of the model act both in its scope and for the criminalization provision.

For example, Wes Bissett, senior vice president of government affairs mad state relations for the Independent Insurance Agents & Brokers of America Inc., called the measure broader than any of the trust account requirements that exist in states today. "Frankly, it's cumbersome, it's impractical, it's expansive," he said. Fewer than half of the 50 states have trust account requirements and their laws cover a half page or one page saying that premium dollars coming to an agency are to be treated in a fiduciary manner, Bisett said.

"Generally, there are some basic requirements about how those funds have to be treated and transmitted ultimately to the insurance company," he said. "In states that have these laws, it's a very clear and simple requirement. The proposed NAIC model, though, is a five- or six-page document that's very excruciating in its level of detail and frankly, creates traps for even well-intentioned agents."

Proponents of the measure say it would foster much-needed uniformity and consistency in these requirements from state to state, if adopted by each state legislature. And Chaskey noted that in the past some states interested in adopting this type of statute have indicated that they would prefer to work with an NAIC model rather than start from scratch.

Howard Goldblatt, of the Coalition Against Consumer Fraud, sees the measure as preventive. "A model bill like this would shut the door on one way" that agents can embezzle or mishandle funds, he said. "What it will tend to do is prevent those agents who are on the brink of stealing from going "ahead."

Is a New Law Needed?

There are some other concerns that agent groups have with this model:

* They say it steps in between the carrier and the producer. "Through their business practices and their ongoing relationships, insurers and producers have well-established procedures detailing how premiums must be collected, recorded and transferred both to the carrier and to the customer" in the case of canceled policies and returned premiums, Kovac said. "So you already have established business practices with which both producers and carriers are satisfied."

The model was developed even though carriers and producers have not complained about this issue and have not asked for additional regulations, he said.

Chaskey acknowledged that in the contract between carrier and agent, certain duties and responsibilities are listed, but he said that he has never seen a contract specifically state a fiduciary duty or obligation for the producer.

The NAIC model act does not add a responsibility or an obligation to a contract already in effect, he noted. "It really identifies that there is this fiduciary nature that exists when you're holding funds for others and you're the conduit for those funds," Chaskey said. "The fiduciary obligation is spelled out and these steps are created in statute as a standard of conduct to meet that obligation."

* It's already easy for state regulators to discover premium theft and crack down on it because there is always a trail, agent groups said. When a customer writes a check, the agent is supposed to pass that money on to the carrier, Kovac noted. "When an agent has bound coverage for that carrier and the carrier doesn't receive the funds, they're going to want to know where they are," he said. "When checks are deposited or cashed, there's always a record, so that's why when you do see premium theft it's always caught and prosecuted almost immediately."

Bissett also said that the model act may not be necessary because every state already considers misappropriation of funds, especially premiums, a felony, and regulators also have the authority to take action against agents' licenses when the need arises.

But after the many audits he has carried out, Chaskey has his doubts about the ease of collaring these wrongdoers, especially among smaller agencies. "I've gone into abandoned agencies, agencies that were in total disarray, agencies that had virtually no organized record-keeping system, that worked out of a cigar box using money orders and things like that, and not a separate account," he said. "As many personalities as you have out there running an agency, you had systems. There was no organized approach."

That likely would differ with larger, more sophisticated agencies having established internal mechanisms. "There, you would have a better infrastructure built into tracking the money coming in the door, but it's by no means universal," Chaskey said.

* The model act fails to understand how different producers work, Kovac said. For instance, in the independent agency system, there is the business entity itself, and those individual producers who work for the entity, he said. The model sets requirements for individual producers but does not clarify that it is the producer entity in certain cases, not the individual producers that work for that agency, that have the compliance obligation. Without making this distinction, the model is truly flawed, Kovac added.

"We've continually asserted that it's the business entity itself that's responsible for complying with these laws, that has the fiduciary obligation," Kovac said. "The entity will have specific personnel on staff who are responsible for recording and depositing premium funds in the proper account. That's their responsibility, that's their job. It's not the individual producer, who may be out on the road, trying to get new clients or servicing clients' accounts who goes back and writes all the records, deposits the funds and makes sure that the carders get the money in the proper time period."

Some modifications are in the works to clear that issue up, Chaskey said, adding that his working group took that concern pretty seriously. "We're trying to fine-tune that so the person who has the obligation to remit--the designated officer of the corporation who has a responsibility to have the corporation comply with the laws of the particular states--is the one that we are putting this requirement on."

A producer won't automatically be required to set up a fiduciary's fund account and structure, he said. "It will depend on how he relates to the insured and how he relates to the carrier that's going to determine that requirement" Chaskey said.

Despite some of the changes made in the wording of the model act, Bissett still feels it "is not quite ready for prime time" he said. He thinks it's possible to develop an efficient, workable model to address this issue, but finds that the NAIC draft so far does not accomplish that. "If it were to be adopted by the NAIC in its current form, we would be very surprised if many legislatures would take action on it," Bissett said. "We will continue to seek changes that will make this a workable proposal and make it more consistent with existing state commingling laws. But if it's adopted by the NAIC in its current form, we will oppose it or seek revisions at the legislative level."

The PIA does not endorse the model act in its current form either. While the organization has concerns with the model, its board has not voted on its official position.

But Kovac was complimentary about the attention that Chaskey has shown to agents' concerns. The PIA, which has 12,000 agency members with an average of seven to nine producers per agency, is committed to working to improve the model, he said. "I'm hopeful that things will get turned around, but it's up in the air at this point," he said.

Chaskey said the model act, fashioned from a consumer protection standpoint, also would benefit agents. If agents were to follow this model act, with its record-keeping and separate account requirements, they would be able to avail themselves and their customers of all the protections afforded by the Federal Deposit Insurance Corp., he said.

"We also think that if you have good records and then complaints arise with your clients about payment of premiums, you get to discuss this with your client and your carrier and resolve it before it ever becomes a regulatory issue," he said.

Key Points

* Next month, a committee of the National Association of Insurance Commissioners could take up the final draft of a controversial model act that would criminalize the misappropriation of premium funds by producers.

* Initially, the measure had agent groups concerned over a provision that would presume agents are guilty of a felony if they fail to meet premium-payment deposit deadlines. An NAIC working group says it is changing that wording.

* But agent concerns remain that the proposed model act is impractical and expansive.

Draft Language

Two key provisions of the Fiduciary Responsibility of Insurance Producers Model Act in its current form

* An insurance producer or other person who knowingly receives fiduciary funds to which the insurance producer or other person is not lawfully entitled, or who knowingly withholds, diverts or appropriates fiduciary funds for a purpose not prescribed by this Act, or who knowingly facilitates the withholding, diversion or appropriation of fiduciary funds by another person, is guilty of theft and punishable for theft as provided by law.

* Failure by an insurance producer to deposit fiduciary funds into a fiduciary account ... shall give rise to a presumption that the insurance producer is in violation (of the above section).