Simply the mention of the word “audit” makes the shoulders of many business owners slump. But a workers’ compensation or general liability audit is nothing like one from the IRS. Rather, because premiums for these policies are based on estimates of payroll and/or sales, when the policy ends the insurance company needs to know the actual figures to adjust billing accordingly. In it’s basic form, a policy begins based upon estimates and everyone settles up at the end. Thus, after each audit a business will receive either a bill or a refund check.
Why Are Audits Performed?
Insurance premiums are based upon the level of risk. For example, for property, the value of the building insured is a known limit. Since this doesn’t change throughout the year, no audit is needed. But for workers’ compensation and general liability insurance policies, the level of risk is based upon business activity. The more activity, the more risk the insurance company is exposed to, therefore the more money it costs the client. For workers’ compensation and general liability, this activity is measured by payroll and/or gross sales.
How Does an Audit Work?
Insurance companies will perform audits using the same general process. They request information on actual sales and/or payroll and the business replies. The request may come by letter, email, phone call, or even an old-fashioned in-person visit. If by letter, a reply may be as simple as completing a form and returning it. An audit may request backup records for the information supplied, such as a payroll report, income statement, or copy of a tax return. An auditor will review the information, compare it to the original estimates, then determine whether a bill or a return premium is appropriate.
One item to note here is the handling of subcontractors. If a subcontractor does not carry workers compensation, their payroll will be charged against your policy. For general liability, work performed by uninsured subcontractors will often be charged to a higher-cost classification. However, if the subcontractor has their own policies evidenced by a certificate of insurance, your business will not be penalized. See expert tips below.
How to Prepare
Audits are typically performed thirty to sixty days after the policy period ends. Ensure payroll/sales records are up to date, accurate, and broken out by activity (policy classification). For example, a residential general contractor should track payroll by general construction/remodeling jobs, painting-only jobs, masonry-only jobs, roofing-only jobs, etc. Likewise, an electronics manufacturer will want to track higher-risk aircraft radio sales separate from lower-risk car stereo sales. Ask your insurance agent what those categories are for your business. If reports are not broken down, an auditor will often charge all figures to the highest risk (highest cost) category for your business.
Disputing Audit Findings
Businesses are allowed to dispute audit findings. Auditors can make mistakes, charge against the wrong work category, or misunderstand reports provided. Each audit will include instructions on how to dispute the findings, and most misunderstandings are cleared up with follow up communication.
Common Audit Issues
- Failing to keep current copies of certificates of insurance for subcontractors on file. See expert tips below.
- Lack of category (policy classification) detail on payroll and sales records. Again, ask your agent what the appropriate policy classifications are for your business. Example: One of our commercial electrical contractor clients occasionally preformed work on cell phone towers. Understandably, workers compensation rates for tower work are much higher than normal electrical work. The client discovered the auditor had charged too much payroll to the tower classification, resulting in a large audit bill. Our client always tracked tower time and reflected that in his accounting system. After clarifying a few points with the auditor, the audit was adjusted to accurately reflect his work.
Obtain Subcontractor Certificates of Insurance
When using subcontractors, ensure they have their own general liability and workers compensation coverages. Obtain an updated certificate of insurance from them for each policy and keep it on file. This way, your business will not be charged for them unnecessarily.
Expect Subcontractor Charges
If a subcontractor does not carry insurance, expect them to be charged against your workers’ compensation and/or general liability policy. Talk to your insurance agent about the pros and cons of this (FYI, they are mainly cons).
Require subcontractors break out all invoices by labor and materials, and track them in your accounting system as such. This way, only labor costs will be charged against your policy. If not broken out, all subcontractor expenses will be charged against your policy and cause an artificially high audit bill.
Included in ``Payroll``
Workers compensation is based upon gross payroll including wages, salaries, commissions, bonuses, holiday pay…just about everything. Severance pay is not included. Ask your auditor any questions regarding what should be included in payroll reports.
Avoid The 1, 2, 3 Cash Flow Crunch
If sales or payrolls take a large turn up, be happy for the increase in business! But also set aside money to pay for the upcoming audit. Too often, when a business experiences high growth, they fail to plan and get hit by the 1, 2, 3, cash flow crunch. The issue goes like this: 1) business pays for the renewal policy, 2) soon thereafter the business pays for the audit on the expired policy, then finally 3) the insurance company automatically increases payroll/sales estimates for the renewal policy to match the audit, resulting in yet another bill!
Insurance audits should not be stressful. Accurate payroll and sales records, broken out by the appropriate policy classifications, along with maintaining current certificates of insurance for all subcontractors, will eliminate audit anxiety. Questions? Contact your Bankers Insurance agent. Not a client of ours? Let us compete for your business! Each client is assigned a personal agent in our office, given their email address, and provided a phone number that rings right on their desk.