What to Expect When You’re Expecting…an Audit

Often associated with the Internal Revenue Service (IRS), the word ‘audit’ usually elicits feelings of worry, stress, and impending doom.  However, not all audits are created equal. An insurance audit is simply the way for an insurer to determine your actual exposure for the policy term.  Not all policies are auditable.  Auditable polices can be based on a monetary exposure such as gross sales or payroll or possibly on the number of units. In short, an audit is a reconciliation of your estimated exposure versus your actual exposure.

Below is an overview of the audit process in order to help you prepare and set expectations.

What is an Insurance Audit and Why is it Needed?

An insurance audit is the insurer’s way of determining the actual exposure over the past year vs. the original estimate. An audit is conducted at the conclusion of the policy period and allows the insurer to make any necessary adjustments in final premium. Audits use documents and information such as actual sales and operations data to determine how accurate the initial estimate was regarding an insured’s exposures and premium.

What Insurance Coverages Frequently Require an Audit?

  • General Liability
  • Garage Liability or Auto Liability
  • Workers’ Compensation 

How Should I Prepare?

  • Have all necessary records and information prepared and available. This includes, but isn’t limited to, payroll records, employee records, remuneration records / cash disbursements, and certificates of insurance (yours and those of any subcontractors
  • Be ready to discuss record-keeping procedures in order to see how that impacts your premium
  • Prepare any questions you may have about what is needed or what is expected from you
  • Designate a primary contact to work with the insurer / auditor to make communication and the process overall go smoother and more efficient. It should be someone who is familiar with any prior audits and the entirety of your business.
  • Review the original policy to understand what was used to calculate the initial policy premiums. Be sure to consider payrolls, rates, and classification codes.
  • Analyze any publicly available information about your company. This includes, but isn’t limited to, your website, industry databases, association listings, and google search results. Your auditor will likely review all of this as well, so be sure to catch and change any inaccuracies.

Who Conducts the Audit?

  • Usually a third party auditing firm will conduct the audit. This ensures accuracy, timeliness, and objectiveness
  • The auditor should clearly identify themselves as a representative of the insurer and provide you with a checklist of the records they will review. 

How Often are Audits Conducted?

  • In general, a policy is audited every year.

May I Direct the Auditor to Contact my Accountant for the Audit Information?

  • Yes. As stated above, it is good to assign a primary contact to work with the auditor. As long as your accountant is familiar with your business and any past audits, has knowledge about the company’s owners/officers and their duties, then that is more than suitable.

What if my Estimates are Not Accurate?

  • Estimates should be as close as possible to the actual amount of exposure, such as payroll and receipts incurred during the policy period. If the estimate is too low, you’ll receive a bill for the additional premium for the audit period and the current year. If the estimate is too high, you could be eligible to receive a refund.
  • Remember to check your current policy exposures and adjust as needed during the policy term to avoid a large audit change.

What Records are frequently Reviewed During the Audit?

A. Payroll

(1) Payroll Journal and Summary showing:

  • Monthly and quarterly totals
  • Separate monthly and quarterly totals by each type of work performed
  • Overtime must be shown separated by employee and by type of work

(2) Individual Earning Records showing:

  • Type of work performed
  • Date hired and date terminated
  • Gross payroll: Monthly and quarterly totals
  • Overtime: Monthly and quarterly totals

B. Cash Disbursements

Cash Disbursement Journal showing:

  • Monthly totals by account
    • (a) Materials
    • (b) Subcontractors
    • (c) Casual labor
    • (d) Cash receipts

C. Cash Receipts

Cash Receipts/Sales Journal showing:

  • Monthly totals by source
  • Service and repair
  • Products
  • Installation

D. Certificates of Insurance

Certificates of Insurance for each subcontractor showing:

  • Workers’ Compensation and General Liability coverage
  • Limits of coverage (equal to or greater than your policy limits or the state’s statutory limit)
  • Coverage effective for the entire period work was performed during the audited policy period (This may require more than one certificate)
  • In many states a copy of an exemption form can be used for smaller companies, if the subcontractor does not have Workers’ Compensation coverage, then a signed contract will be required along with the general liability certificate and proof of independent contractor status.

Certificates of Insurance for any OCIP/CCIP/Wrap-up Work showing:

  • Workers’ Compensation and General Liability coverage
  • Coverage effective for the entire period work was performed during the audited policy period (This may require more than one certificate)
  • Separate Payroll and Sales records showing the exposure attributed to this job.

Why is it important to secure copies of Certificates of Insurance for subcontractors?

Subcontractors who do not have adequate insurance may become the responsibility of the individual who hires them. For subcontractors who do not have proper insurance, there may be an additional charge to your commercial general liability and/or workers’ compensation premiums.

What is Included as ‘Payroll’ when Payroll is the Premium Base for Workers’ Compensation Insurance or Commercial General Liability Insurance?

Common inclusions for workers’ compensation insurance, subject to state specific requirements:

  • Employee wages/salaries (including pay for overtime holidays, vacations, or sickness). What is included or excluded is dependent upon state regulation check with your agent if you have any questions.
  • Executive officers’ wages (minimum/maximum rules apply)
  • Commissions and bonuses
  • Wages paid for time not worked, idle time, and strike periods
  • Contributions or payments to IRS-qualified salary reduction plans
  • Employees Retirement Income Securities Act of 1974 (contributions to employee accounts)

Here are some of the most common inclusions in payroll for commercial general liability insurance:

  • Employee wages/salaries (including pay for holidays, vacations, or sickness)
  • Payroll of executive officers, individual insureds, and partners (usually a minimum flat amount)
  • Commissions and bonuses
  • Cash value of housing, lodging, and meals if furnished to employee as part of their wages
  • Piece-work wages
  • Employer’s payments on behalf of the employee to incentive plans or profit-sharing plans
  • Payments or allowances for tools.

What is Included as ‘Sales’ when Sales is the Premium Base for Commercial General Liability Insurance based on ISO Rules?

  • The gross amount charged by the insured
    • All Goods or products, sold or distributed
    • Operations performed during the policy period
    • Rentals; and
    • Dues or fees.
  • Inclusions (items that cannot be deducted from gross sales:
    • Foreign exchange discounts;
    • Freight allowance to customers;
    • Total sales of consigned goods and warehouse receipts;
    • Trade or cash discounts;
    • Bad debts; and
    • Repossession of items sold on installments
  • Exclusions (items you can exclude from gross sales:
    • Sales or excise taxes which are collected and submitted to a government division;
    • Credits for repossessed merchandise and products returned. Allowances for damaged and spoiled goods;
    • Finance charges for items sold on installments;
    • Freight charges on sales if freight is charged as a separate item on customers invoice;
    • Royalty income from patent rights or copyrights which are not product sales, and
    • Rental receipts for products liability coverage only

Why am I being charged differently from one carrier to another?

  • Audits are always based upon the policy terms which will vary from carrier to carrier. There are some standards called ISO rules that many carriers follow however there is always some interpretation and underwriting breadth on these rules.

What should I do if I disagree with the audit?

Contact your agent if you have any questions about the audit or audit procedure.