Depending on who you ask, the reaction to insurance audits vary from “it was no big deal” to ”mildly annoying” to “frustrating”. As an agent, we wish that every audit fell in the “no big deal” category. By having a clear understanding of why audits are conducted, being as accurate as possible upfront with policy applications and maintaining proper documentation, businesses can make the audit process easier and avoid surprises.
Why audits are necessary
Insurance audits are common with general liability, workers’ compensation, marine and some other policies. When these policies are issued, the level of protection to cover a business for potential claims and the corresponding premium are based on rating factors that may not be known with certainty at the beginning of the policy term.
A general liability policy may be based in part on a company’s gross revenues. A workers’ comp policy is based on payroll amount and job classification codes of workers. Using such factors, a best estimate of claim exposures during the policy term is established based on historical information or predictions. However, a company’s actual numbers for these factors can change dramatically within a year.
The insurance company makes a commitment to cover the business’ risks during the policy term even though it can’t determine the exact level of risk. In exchange, the business agrees that the insurance company can verify (audit) the actual revenues, payroll, etc. and retroactively adjust the premium. Generally, if an audit identifies that actuals are higher than the initial estimate, then a bill is issued for the additional premium owed. Likewise, if the actuals are lower, the business typically receives a premium refund usually in the form of a credit on your current policy.
It’s similar to a contractor hired to repaint the interior walls and trim of a house. He estimates the work and supplies and sets a price of $3,000 to do the job and is hired. During the job, the owner decides to also have the ceilings painted. Given the expanded scope, the contractor has to adjust his pricing and adds an additional $1,000 to the job for the extra work provided. When the specs change, so does the price.
Audits make sure that a business isn’t over or underpaying for the protection it receives. They also help to avoid a business having deficiencies in its coverage that can expose the organization financially if faced with a lawsuit and high settlement costs.
Preparing for an audit
Audits are typically a simple process of providing evidence of sales or payroll. Businesses can make the audit process smoother by having their insurance documentation ready before an auditor arrives. Some insurance companies ask the insured business to complete a self-audit by submitting documentation in advance, which may be followed up by an auditor if there are questions. Keeping accurate records throughout the year can makes it easier to gather the needed documentation at audit time.
For a workers’ comp audit, a company’s federal tax return payroll information and job descriptions typically allow the auditor to compare if the amount and classifications of work match the exposures outlined when the policy was first issued. If a company uses subcontractors, it should have available documentation to show that the subcontractors purchased their own workers’ comp coverage. For a general liability audit, the documentation varies by company and metric basis used to set the premium. The insurance company will indicate what documentation it needs such as general ledger, income statement or tax forms. When payroll is the metric, it includes records for any subcontractors.