Insurance policies, such as general liability and workers' compensation, often require a premium audit. This process involves reviewing and comparing the estimated exposures stated at the beginning of the policy term to the actual data collected at the end of that term. Premium audits are crucial for ensuring fair premiums based on accurate information. In this article, we will delve into why these audits are important, how they work, and provide tips on avoiding pitfalls or problems.
Most general liability policies, including some business owner's policies (BOP), as well as all workers' comp policies, are written on an auditable basis. This means that insurance companies collect data on various factors like payroll or sales – whichever serves as the rating basis for that particular policy – to determine premiums.
Example
Let's take workers' compensation insurance as an example. Whether you're renewing an existing policy or starting one from scratch, it is rated based on payroll estimates per class code specified in your policy. For instance, if you estimate clerical office payroll at Rs 100,000 and outside sales payroll at Rs 80,000 for a given term period when initiating coverage; accordingly, you pay premiums based on these exposures.
However, once your policy expires and gets renewed later on – usually annually –the insurance company will request either payroll records from you or conduct a physical audit of your books to verify these figures accurately. Insurers must physically inspect books at least once every three years regarding workers' compensation coverage.
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Purpose for Audits
The purpose behind conducting these audits is to determine actual exposures compared to earlier estimations made during inception so that proper adjustments can be made to ensure fairness in premium calculations going forward.
Continuing with our previous example: suppose during this renewal period you report actual clerical payroll of Rs 150 000 instead of Rs 100 000 initially estimated before; similarly outside sales payroll is now Rs 200 000 instead of Rs 80 000. This suggests that your company experienced growth, hired more workers, and had higher payroll expenses than estimated.
Consequently, the insurance company will bill you for additional premiums based on these revised figures minus what has already been paid during the prior term. If actual payrolls are less than initially anticipated, you may receive a return or premium credit.
But why are audits necessary in the first place? The answer lies in the fact that auditable policies rely on rates multiplied by rating exposures – such as payroll or sales – to determine premiums. Audits ensure accurate collection of premiums reflective of an insured company's real exposures while maintaining fairness across all policyholders.
To illustrate this point further: let's assume that after conducting an audit, it becomes apparent that your company's actual clerical payroll was Rs 1 million instead of the initial estimation of Rs 100 000; likewise, outside sales amounted to Rs 800 000 rather than just Rs 80 000. In this scenario, your company had ten times more payroll exposure than originally expected. Consequently, if we consider workers' compensation claims potential which correlates with payroll figures - theoretically speaking - now there could have been ten times more claims compared to earlier projections.
Henceforth, insurers require extra premium payments reflecting these increased exposures to maintain equitable practices for all their customers/insured parties. Neglecting this aspect would result in underpayment towards insurance coverage and potentially disrupt financial sustainability within insurance companies since rates are established based on actual rating exposures.
So what happens if you refuse or neglect paying audit bills? Occasionally some clients might find themselves unable or unwilling to pay significant audit bills due to rapid growth throughout a policy year resulting in larger-than-anticipated premiums from insurers.
However understandable such situations may seem from a business standpoint; they still pose problems because insurance companies enter into policy contracts with good faith assumptions about estimated exposures and associated premium charges. Thus, they will vigorously pursue any additional premiums resulting from audits.
