Several years ago a client of mine complained to me that his cousin, who also had a business insurance policy, never had any audits while my client got audited every year! My client wanted to know, why the difference? Believe it or not, there are logical reasons for this as explained below.
Not all insurance policies are rated or, have their premiums based on the same criteria. Insurance policies such as Workers’ Compensation are based on future estimated payroll while policies such as General Liability are based on future estimated payroll, or sales, depending on the type of business being insured. Yet, other policies calculate premiums based on the square footage owned or occupied by the insured. Such calculations don’t involve any estimating at all. At the end of the policy period, the insured/customer whose policy is based on estimated sales or payroll is required to provide the “actual payrolls and/or sales figures” so that the carrier can adjust their policies accordingly. Adjustments are made via audit and they are a contractual obligation of the policyholder. However, the insured whose policy is based on actual square footage, owned or occupied, has no reason to be audited because square footage doesn’t change.
Regardless of whether the premium bases are payroll or sales, at the time a policy is issued, the insured/customer can only “estimate” anticipated payrolls and or sales. Such estimates can be in the form of educated guesses such as in the case of a new venture, or approximations based on prior payroll or sales information for the year immediately preceding. A job description and an estimated annual salary for each employee are both needed for Workers’ Compensation and General Liability policies based on payroll. An anticipated sales figure is needed in the case of General Liability policies. For a new venture, a guess in terms of the number of employees that will be needed, their job descriptions and their total annual salaries, together with anticipated sales, are all required if both Workers’ Compensation and General Liability policies are to be written. In the case of an existing business, payroll and or sales information can be gleaned from expiring policies, but may need to be adjusted based on changes in the business which have recently taken place.
At the end of the policy period, the insured is asked to report the actual payrolls and/or sales developed during the policy period to see how they match up with the estimates used at inception. If the insured has had more payroll or higher sales than anticipated, they may have to pay an additional premium. If payrolls and/or sales were overstated the carrier might have to return money to the insured.
Regardless of the actual method used to procure the payrolls and or sales, the important point to remember is that auditable policies are subject to review at expiration. Often a carrier may send the insured a form on which to report their payrolls or sales. This is often termed a self-audit where the insured goes through his/her books for the actual payrolls and sales recorded during the year and returns the form back to the company. Sometimes carriers send out auditors to review an insured’s books. An appointment is made and the auditor usually visits with the insured at their place of business or with the insured’s accountant. Sometimes, carriers will simply estimate the information. If you receive an audit from your insurance carrier, you should always check the figures used by the insurer. When you receive an “estimated” audit it is also best to check the figures since the carrier’s estimates may unfairly penalize you into paying additional monies that don’t adequately reflect your actual information. Even if you are eligible for a return premium from the carrier, you should always check an estimated audit. Very often an insured can do much better than anticipated during a policy period and, as a consequence, they are hit with a very high additional premium at audit. That is why we strongly recommend that if there are any significant changes to your business during the year, make sure to contact your agent and make him or her aware of what is going on. You will be glad you did when your policy comes up for audit.
By Karen Skoler, CPCU and Ray Alvarez, AAI