I Owe More Insurance Premium?!

Contributing Author: Mark Rogina, CPCU

One of the most misunderstood topics I frequently field questions for is the insurance premium audit. Most business owners tend to not understand the reason for their premium audits and the process often appears to be convoluted at best.  Premium audit issues can be costly to businesses and certainly are unexpected surprises detrimental to cash flow.

There are two major insurance coverages that most business owners will have purchased that are usually auditable: general liability insurance and worker’s compensation insurance.

Each of the respective policies are priced based on class codes, or descriptions of what it is the business does or what their employees do for the business.  Multiple class codes can be used on one policy.  Each class code comes with a rate, and what is known as an “exposure basis”.  Depending on the type of business, an exposure basis is either payroll, revenue, building SQFT, number of units, etc.  In its simplest terms, the exposures basis is divided by 100 for a worker’s compensation policy or 1,000 for a general liability policy and then multiplied by the predetermined rate to develop an insurance premium.

For example, let’s assume a particular type of business has an exposure basis of revenue and when setting up their general liability policy at the beginning of the policy year they anticipate $10M in revenue.  Based on their operations, the class code they are assigned to carries a rate of $5 dollars per $1,000 dollars in revenue.  This company’s general liability premium would be calculated as: $10,000,000 divided by 1,000 X $5.00 (rate) and their annual general liability premium would be estimated at $50,000 dollars.

The key word here is “estimated”.  At the end of the policy term, the company will be audited on its sales volume. Regardless of whether or not the company remains with the same insurance company or switches companies, the insurance company who just provided a year of general liability insurance will request a survey be completed and the business provide actual sales figures for the year as well as tax documentation back-up for these figures.  If the business had more revenue than expected at the onset of the policy, they will owe additional premium to the insurance company.  If they had less than expected revenue, the insurance company will owe the business money back.

Below are potential simplified audit scenarios for the business described above.

If the business was audited and found to have only $8M in sales, they could expect to receive $10,000 dollars back.  Conversely, if they were audited and found to have $12M in sales, they could expect to owe their insurance company an extra $10,000 dollars.  The rate itself is never increased or decreased.  The only change is the company’s sales figures for the year – projected vs. actual.

While it may look appealing to have a return premium at the end of the year, I always tell my clients that neither scenario is ideal.  If you owe additional premium it represents money you weren’t necessarily expecting to pay and need to come up with, while if you are owed premium back it represents money the business had tied up all year in insurance premiums that could have been used elsewhere.

Worker’s compensation audits work the same way, the major difference is the exposure basis is always annual payroll and payrolls are divided by 100 on a worker’s compensation policy rather than 1,000 on a general liability policy.

This process is completed annually on all auditable policies to ensure the premium the insurance company is charging is adequate for the amount of risk they are taking on for a particular business.  

Frequently asked audit questions:

Q: Do I need to complete the audit?

A: Yes, if the general liability or worker’s compensation policy purchased is auditable and the insurance company requests an audit, you will need to complete their audit.

Q: What if I don’t complete the audit?

A: Most insurance companies will send multiple requests.  If multiple attempts to audit the policy are unsuccessful, insurance companies may assign an arbitrary audit figure which always equates to an additional premium.  If that amount is not paid, the insurance company will send the uncollected premium to a collections company.

Q: How will the insurance company audit me?

A: either by a phone interview, self-interview, or in person interview, depending usually on the size of the business

Q: Are any policies non-auditable?

A: Yes, some general liability policies may be non-auditable.  Policies that have class code with an exposure basis of SQFT are usually non-auditable as well as other specific variations of the general liability policy, depending on the type of business

Q: Can I avoid an audit?

A: While it may be impossible to totally avoid an audit, you may have options available to minimize the potentially large annual premium variations and improve cash flow for your business.  Please contacts us if you’d like to discuss some of these options.

For more information on Commercial Insurance please contact us.

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