Why are Audits Necessary on Liability and Workers Comp Policies
Today I want to talk about premium audits for general liability, workers’ compensation, and some other policy forms.
What they are, why they’re important and how to avoid pitfalls and problems.
Most general liability policies, including some BOP or business owner policies as well as all workers comp policies, are written on what’s called an “auditable basis”.
That means that at the end of the policy term the insurance company will collect data on payroll, sales, or whatever the rating basis is for that policy and compare that to what was stated as the estimated exposures when the policy started.
Let’s take workers comp as an example.
Whether you’re renewing an existing policy or starting one off from scratch the policy is rated on the amount of payroll for each given classification code on the policy.
So let’s say you started the policy with clerical office payroll estimated at $100,000 and outside sales payroll estimated to be $80,000.
For the policy term, you paid premiums based on these exposures.
Shortly after the policy expires and is renewed, the insurance company will either ask for payroll records to be sent to them, or they will do a physical inspection of your records.
In NY insurers must physically inspect books and records at least once every three years on workers comp.
The purpose of the audit is to determine the ACTUAL payroll exposures and compare them to the estimates at the beginning of the year.
Continuing with the example above, you report that the actual clerical payroll is $150,000 and the outside sales payroll was $200,000.
The company grew, hired more workers, and had more payroll.
The insurance company now bills you for the premium based on actual payroll exposures less what has already been paid in the prior term resulting in an additional premium. If payrolls are less, then the insured would receive a return or premium credit.
So why are audits necessary?
For any form of insurance that’s auditable and starts off with estimates like workers comp or liability, the reason for audits is that the premiums you pay are predicated on rates (Rates X Exposure – like payroll) times the rating exposure.
As I mentioned payroll, sales, or some other exposure characteristic.
The audit is necessary for the insurer to collect the accurate sum of premium reflective of the actual exposures of the insured company.
Put another way let’s take this same example and say the actual company payrolls were $1,000,000 for clerical and $800,000 for outside sales.
The company had ten times the amount of payroll than originally anticipated which means they theoretically could have had ten times the potential amount of workers comp claims.
Therefore, the insurance company “needs” that extra premium so that the system works fairly for all the insureds or customers of the insurance company.
Not collecting that extra premium means that the insured pays one-tenth the amount they should have.
If everyone did that, it would bankrupt the insurance company because rates are actuarially based on the actual rating exposures.
Now, what happens if you refuse to pay the audit?
Occasionally we’ll have a client that did grow very significantly during the policy year and they get a huge bill from their insurer and they say – “I can’t afford to pay that”, or “I refuse to pay that amount!”
This of course is a problem.
The insurer entered into the policy contract in good faith to provide insurance based on certain estimates and they believe they are due the additional premium reflected in the audit.
So, they will pursue that premium in an unrelenting manner.
Now, if that audit is incorrect, which sometimes happens.
Or the audit is based on an estimate, which I’ll discuss in a minute, then you’ve got a valid dispute.
But, disputes need to be made within 20 days of the original billing of the audit.
If you wait a couple of months to dispute an audit, you’ll have a tough time changing the insurance company’s mind. It can happen, but it’s not easy.
So, let’s talk about Estimated Audits
Sometimes when an insured does not comply with an audit request or they ignore their insurer’s request for payroll or sales data, the insurer will issue what is known as an estimated audit.
Often that audit will be two times the policy’s original premium.
It’s shocking and it’s meant to get your attention.
The State Insurance Fund in NY is famous for doing this, and they will not back down until they get the info they’re looking for.
The moral to the story, when you get a request for audit information, comply and provide it to your insurer asap.
Another moral to the story is that if your company goes through some rapid growth during a policy term it makes sense to inform your broker that you’d like to adjust payroll and or sales to reflect new anticipated figures based on your growth.
This gives you the remaining policy term to pay that additional premium – usually in installments – rather than getting hit in one lump sum at audit.
I know that was a bit lengthy, but if you have questions on audits or estimated charges, please reach out to us so we can go over your particular circumstances.