Insurance 101: What is an audit?

Written By Wade Millward (Super Administrator)

Updated at January 11th, 2025

Table of Contents

What is an Audit? Common Insurance Policies Impacted by Audits Workers Compensation Audits How is Workers Compensation Premium Calculated? Example of a Workers Compensation Audit Common Information Requested for Workers Compensation Audits General Liability Audits How is General Liability Premium Calculated? Example of a General Liability Audit Common Information Requested for General Liability Audits

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.