What is an Audit?
A Business Insurance Audit is a review conducted by your insurance company to verify that the premium you're paying matches the level of risk and operations your business actually has. It ensures that you're neither underinsured, risking significant out-of-pocket expenses in case of a claim, nor overinsured, where you might be paying more in premiums than necessary.
Common Insurance Policies Impacted by Audits
- Workers Compensation
- General Liability
- Professional Liability
Workers Compensation Audits
Workers compensation audits are routine and required by governing bureaus such as NCCI or state-specific bureaus like WCIRB. These audits are typically performed after the expiration or cancellation of the policy. During the audit process, the auditor will collect information to verify that:
- The proper class codes are assigned to each employee.
- The correct “remuneration” (payroll plus bonus, commissions, etc.) is recorded for each classification.
If a classification is missing or payroll is not accurate, the audit will adjust the classification and correct the premiums accordingly. This can lead to an increase in premiums if payroll has grown during the policy period and was not updated. It’s crucial to assign correct class codes at the start of your policy and to update any payroll increases during the year to avoid unexpected premium adjustments.
How is Workers Compensation Premium Calculated?
Workers compensation premiums are calculated using the following formula:
Premium = (Payroll / 100) x Rate x Experience Modifier
- Payroll: The total remuneration paid to employees, including wages, bonuses, and commissions.
- Rate: A rate assigned by the governing bureau based on the classification of the work performed by employees.
- Experience Modifier (Mod): A factor that adjusts the premium based on the employer’s claim history and industry standards. New ventures typically do not have an experience modifier. It is assigned after a business has maintained coverage for a sufficient period and met specific premium thresholds. This factor reflects how your claims history compares to similar businesses in your industry.
For example, a construction company with $500,000 in payroll and a class rate of $5.00 per $100 of payroll and an experience modifier of 1.1 would calculate its premium as follows:
Premium = ($500,000 / 100) x $5.00 x 1.1 = $27,500
Example of a Workers Compensation Audit
Imagine a landscaping business that has 10 employees. Initially, the business estimated an annual payroll of $500,000 and assigned all employees to a general landscaping class code.
During the audit:
- The auditor reviews payroll summaries and notices that the actual payroll was $600,000.
- Additionally, it’s discovered that 3 employees were performing tree-trimming work, which has a higher-risk classification code than landscaping. The rate for tree trimming is $8.00 per $100 of payroll, compared to $4.00 for landscaping.
Outcome:
- The premium is adjusted based on the higher payroll ($600,000 instead of $500,000).
- The 3 employees are reclassified into the tree-trimming code, which carries a higher rate.
- As a result, the business is billed an additional $8,400:
- Landscaping: ($420,000 / 100) x $4.00 = $16,800
- Tree Trimming: ($180,000 / 100) x $8.00 = $14,400
- Total Premium: $31,200
- Difference from Initial Premium: $31,200 - $22,800 = $8,400
Tips to Avoid Surprises:
- Update your agent about payroll changes during the policy period.
- Assign proper class codes from the beginning and review them periodically.
Common Information Requested for Workers Compensation Audits
- Payroll Summaries or similar reports
- Quarterly State Unemployment Report
- Payroll Tax Reports
- Quarterly Federal Payroll Tax Reports (IRS Form 941)
- Employee Job Titles & Job Descriptions
General Liability Audits
General liability audits are performed after a policy’s expiration or cancellation, particularly in industries where risk factors fluctuate throughout the policy period. These audits are typically based on one or a combination of metrics such as gross revenue, payroll, subcontractor expenses, or square footage. Not all general liability policies are auditable; this depends on your industry and policy type. Any additional premium resulting from the audit is generally required to be paid in full.
How is General Liability Premium Calculated?
General liability premiums are calculated using this formula:
Premium = Base Rate x Exposure Basis
- Base Rate: The rate per unit of exposure (e.g., per $1,000 of revenue or payroll) determined by the insurance company.
- Exposure Basis: The measurement used for premium calculation, such as gross revenue, payroll, or subcontractor costs.
For example, a retail store with $1,000,000 in gross revenue and a base rate of $3.00 per $1,000 of revenue would calculate its premium as follows:
Premium = ($1,000,000 / 1,000) x $3.00 = $3,000
Example of a General Liability Audit
Consider a small construction company that estimated its annual gross revenue at $1 million. The general liability premium was initially calculated based on this estimate.
During the audit:
- The auditor requests financial records and discovers the actual gross revenue was $1.3 million.
- The company also hired subcontractors for $200,000 in expenses but did not provide certificates of insurance for them, resulting in an additional premium charge.
Outcome:
- The premium is recalculated to reflect the higher revenue:
- Revenue Premium: ($1,300,000 / 1,000) x $3.00 = $3,900
- A surcharge is applied for the uninsured subcontractor costs at a rate of $4.00 per $1,000:
- Subcontractor Premium: ($200,000 / 1,000) x $4.00 = $800
- Total Premium: $3,900 + $800 = $4,700
- The company receives an audit bill for an additional $1,700.
Tips to Avoid Surprises:
- Report revenue changes and subcontractor expenses to your agent during the policy term.
- Collect and provide Certificates of Insurance for all subcontractors.
Common Information Requested for General Liability Audits
- Profit & Loss Statements
- Balance Sheets
- Check Registers
- Cash Disbursement Journals
- Subcontractor Costs and Certificates of Insurance