Cash Balances Are Up – Now What?

For an independent insurance agency, strong cash reserves can be a double-edged sword. Having an influx of cash is certainly a positive, but effectively managing the balance between liquidity and returns requires careful strategy and disciplined financial management. With the right know-how, tools and banking partner, agencies can navigate this financial situation to maximize returns.

By Patricia Smith

Your independent insurance agency is flush with cash. Great! Now what?

While having strong cash reserves is certainly a positive, effectively managing the balance between liquidity and returns requires careful strategy and disciplined financial management. With the right insights, tools and banking partner, independent agencies can navigate these financial challenges in a way that optimizes returns without sacrificing liquidity or taking on unnecessary risk.

Some of the challenges agencies face when they have an influx of cash include the temptation to overspend, focusing on short-term investment strategies, and complacency by letting the funds sit idle. Through it all, the importance of finding and communicating with a trusted banking partner is essential for getting the right guidance no matter where the agency and the economy stand.

 

Challenges with strong cash reserves

One of the first challenges agencies face when flush with cash is the temptation to overspend. A surplus can create a false sense of security, leading to less disciplined financial management. It’s natural to feel more confident with a cushion in the bank; however, this can sometimes lead to poor decision-making if not managed properly.

It’s important to lay out clear financial guidelines and stick to them — even when the bank account is overflowing. By implementing strict budget controls and regularly reviewing spending against these controls, agencies can maintain the discipline necessary to ensure their cash reserves are being used wisely and effectively.

Although overspending is one of the main challenges agencies confront when cash reserves are strong, complacency is equally as challenging. Agencies face the risk of becoming too comfortable with their current financial situation, leading to missed opportunities and idle funds. It’s vital to remain proactive in seeking ways to reinvest those reserves into growth opportunities.

Whether it’s acquiring a new book of business, expanding services or investing in new technologies, agencies should always look for ways to put their cash to work. Regular financial reviews with their banking partner can help identify these opportunities, ensuring that agencies are not leaving money on the table.

 

Long-term focus

Another challenge that arises is a lack of focus on long-term investment strategies. With an excess of cash flow, agencies may not feel the urgency to plan and execute investment strategies that will yield high returns over time. Instead, they might opt for short-term gains, which don’t contribute to sustainable growth.

Just as with complacency, to develop a robust investment strategy, it’s crucial for agencies to work with a knowledgeable banking partner that understands the insurance industry. For example, utilizing products like overnight sweep accounts can be highly effective. These accounts automatically transfer excess funds into higher-yielding investments overnight, ensuring that cash isn’t sitting idle without generating returns.

In today’s age, technology plays an important role in optimizing cash management. Online banking platforms and other cash management tools allow agencies to monitor accounts, transfer funds and track financial transactions in real time. These tools make it easier to manage cash effectively and minimize the risk of missing out on investment opportunities.

In general, automated sweep accounts can transfer excess funds into high-yielding accounts daily, ensuring that an agency’s extra cash is always generating returns. By leveraging these technologies, agencies can reduce the manual effort required to manage their cash and ensure that their reserves are being optimized.

Between the challenges of overspending and letting cash sit idle, another big challenge for agencies in cash management is finding the right balance between liquidity and returns. Investing cash in high-yield, longer-term investments can potentially generate greater returns, but it also ties up the cash and reduces liquidity. Striking the right balance between liquidity and returns is crucial for managing risk and ensuring financial stability.

 

Cash sweep example

A cash management sweep product linked to the agency’s operating account is an effective method for maximizing returns on idle funds while ensuring liquidity. Here is an example involving excess funds of $100,000 sitting idle in an operating account. With an initial interest rate of 5.04%, the agency has the potential for earning significant interest, even amid fluctuating rates.

Assume in the first three months the rate remains at 5.04%. However, the next three months rates begin to dip to 4.04%, then 2.04% for the next quarter, and finally rates decline once again to 1.04% for the last three months of the year.

The calculation of the total interest earned from this investment example is broken down as follows:

1. First Three Months:

Interest = $100,000 x 5.04% x (3/12) = $1,260

2. Second Three Months:

Interest = $100,000 x 4.04% x (3/12) = $1,010

3. Third Three Months:

Interest = $100,000 x 2.04% x (3/12) = $510

4. Final Three Months:

Interest = $100,000 x 1.04% x (3/12) = $260

The total interest earned throughout the year would be approximately $3,040.

This illustration underlines the value of cash management sweep products; they allow agencies to generate returns on excess funds without sacrificing access to capital. Even as rates decline, a disciplined approach to managing idle cash can lead to substantial annual earnings, highlighting the importance of strategic financial planning in today’s fluctuating interest rate environment.

When rates are rising, there are other strategies to consider such as laddering certificates of deposit (CDs). CD ladders involve spreading investments across multiple CDs with different maturity dates, allowing agencies to access their funds at regular intervals while still earning higher returns. This approach provides both liquidity and the potential for increased earnings, making it an attractive option for agencies with excess cash.

 

Value of financial reviews

Having a reliable banking partner that not only provides essential financial services but also comprehensively understands the unique operational needs of an independent agency is invaluable. Such a partner recognizes the distinct cash flow patterns associated with independent agencies, including the inflows of commissions, as well as contingencies, and the outflows of carrier payments. This understanding is crucial, as it allows the bank to offer tailored financial solutions that accommodate the timing of claims and renewals, thereby ensuring seamless liquidity management. A comprehensive financial review with a banking partner can uncover opportunities to save costs, improve efficiencies and maximize returns. It’s important to conduct these reviews annually, even without an immediate lending need.

A financial review should encompass deposits, services and internal operations, as a good banking partner can provide ways to reduce costs and improve efficiencies through simple cash management solutions. Regular check-ins with its banking partner ensure that the agency’s financial strategy remains aligned with current market conditions and its long-term goals.

When managing large cash reserves, it’s important to be aware of the risks involved. High-yield investments can be tempting, but they often come with the risk of losing principal or encountering hidden fees. It’s essential for agency owners to fully understand these risks and to work closely with their banking partner to assess the true cost of any investment.

Transparency and open communication with the agency’s banking partner are key. By discussing the agency’s goals and plans, the partner can help the agency owners identify the best investment opportunities that align with their objectives. This collaboration ensures that the cash reserves are being managed in a way that maximizes returns while minimizing risks.

 

Strategic cash management

Being flush with cash requires a strategic approach to ensure that these reserves are working for the agency. By focusing on disciplined spending, long-term investment strategies, balancing liquidity and returns, leveraging technology, and maintaining a strong relationship with a knowledgeable banking partner, agencies can optimize their cash reserves for maximum benefit.

In today’s volatile economic environment, agencies that actively manage their cash are better positioned to navigate challenges and capitalize on growth opportunities. By taking a proactive and strategic approach to cash management, agencies can ensure they remain financially healthy and ready to take advantage of whatever opportunities the market may present.

Reprinted by permission of Standard Publishing Corp. © 2024.

 

Patricia Smith is vice president director of cash management and business development officer of InsurBanc. A division of Connecticut Community Bank, N.A., InsurBanc is a community-focused commercial bank specializing in products and services for independent insurance agencies.