Insurance Audits

You’ve been requested to complete a business insurance audit. Great, right? Just what you don’t have time to complete during your busy season, or know how to complete. We feel your pain. It’s not a great process! It’s painful and very time-consuming for all parties involved. That’s why we have put together a comprehensive blog to help you better understand the Insurance Audit Process.

What is a business insurance audit? Why am I getting this audit notice?

Carriers are verifying that proper risk transfer is in place.  Are you a general contractor who has sub-contractors that are being utilized for specialty trades?  The insurance carriers want to make sure you’re not responsible for your subcontractor’s work. This is a benefit that could protect assets and future insurance costs by making sure there is proper protection. By doing so with various additional insurance endorsements, primary and non-contributory endorsements, and verifying the proper waiver or subrogation, endorsements are being provided by all sub-contractors. This also results in verifying the limits of insurance for anyone working on the job site and verifying that the subcontractor agreement that is in place is being followed correctly.

Proper cost of general liability policies. Let’s face it. There are a lot of underperforming agents who don’t review policies on an annual basis. This is one reason for the audit process becoming more utilized by carriers.

However, the associated audit costs are a two-way street:

• If you’re properly reporting payrolls from year to year, this won’t affect you very much.
• If you’ve overreported your payrolls or sales from goods sold, you will receive a refund for the overage.
• If you’ve underreported your payrolls or sales, you will receive an invoice for the difference.
• If you’ve hired new employees mid-term or grown expediently, you may also inadvertently have a larger than normal audit expense due to the increased payrolls or sales for the prior insurance policy period.

General Tips

• Remember the auditor is human and just wants to complete their job task like anyone else.
  • They have no personal ties to your business and don’t want to make the process more difficult than it must be. They’re not vindictive nor do they have any skin in the game. They are strictly working on behalf of the carrier to collect the information needed to complete the audit.
• Try to respond in an ample amount of time. What happens if you ignore a business insurance audit?
  • If the auditor indicates that you’ve been unresponsive, it could lead to disruptions in your business.  Since the policy is likely an auditable one, they could proceed with a non-renewal notice for non-compliance with the plan. This will cause you significant time in finding a replacement solution.
  • The second thing they could do is include an automatic audit premium percentage that is predetermined in the policy endorsement section of your policy. We’ve seen up to 30% be applied to the general liability portion of the insurance plans for non-responsive audits.
• Always consult with your dedicated insurance agent prior to submitting your payrolls back to the carrier auditor.
  • We have experience with hundreds of these and understand how to properly analyze payroll breakdowns. The payroll analysis is one of the major items a commercial lines agent should be advocating for you. Why? There are real premium dollars on the line.
  • Let’s look at an example: HVAC contractor has clerical/office staff, sales staff, estimators, owners, and in-field technicians. The rating for clerical and office staff is SIGNIFICANTLY different from the in-field technicians. If you’re lumping all payrolls into the HVAC general liability code, you are flat-out overpaying for your general liability insurance. The same concept with ownership. You need to make sure the owner’s payroll is subtracted from the minimum allowable figure used by the insurance carrier. The way in which the owner’s compensation is figured could be costing the organization way more in premium than it legally owes.  Find an agent who knows how to properly analyze your payroll.
    • NOTE: This applies to sales-based operations as well. An analysis of goods sold or manufactured matters. A manufacturer, retail sales operation, or distributor has a different valuation method to their associated general liability pricing. An agent who understands the proper analysis of these reports is key.
• Maintain current records from sub-contractors.
  • It is good practice to request updated certificate of insurance documents prior to their renewal dates. Proactively, you can send out a reminder on the same date yearly to obtain the most recent copy of insurance certificates. This will eliminate having to track down 20+ certificates at one time and be at the mercy of your sub-contractors and their office staff to complete your audit.
• Provide ALL documents that are being requested.
  • The auditor is not going to leave you alone until they have EVERY document they need. They just don’t go away, so be prepared!

How long have insurance carriers been auditing commercial insurance policies?

Business insurance audits have been around forever. Depending on your tenure with a carrier, or individual carrier it could be a new process that is now required to complete. Don’t be alarmed. They are not picking on you or singling anyone out. It’s just becoming common practice that all commercial insurance property/casualty insurance policies are now audited. Even though your policy has likely been an auditable policy for years, it is becoming a more utilized process by insurance carriers.

Documents and information usually asked for during a business insurance audit

1. The name and detailed duties, which include gross wages for all employees (in order to properly classify employees) for policy period 01/01/XX-12/31/XX.
2. 941’s for 1st, 2nd, 3rd, and 4th quarters of 20XX.
3. Summarized overtime earnings by employees (if applicable).
4. Amount paid to temporary and/or casual labor (if applicable).
5. Names, duties, and amounts paid to subcontractors (if applicable).
6. Certificates of insurance for sub-contractors.
7. The dollar amount of materials purchased by you and installed by subcontractors (if applicable).
8. A description of operations for your business including the number of years in business.
9. The Subcontractor Agreement that is currently being used.
10. Sales figures for goods sold during policy period dates.

Individual Employee Type Breakdown for Insurance Audit

If you’re in the construction business, you know your general liability pricing is based on employee payrolls. Not all employees are created equal as far as insurance pricing goes. We recommend keeping accurate records for each class of employee. Below are the 4 main categories we look at.

• Clerical Staff
  • Any office staff member including estimators, salesman, and relationship managers. The clerical staff general liability class code is significantly less than any type of construction class code. It makes sense if you think about it. Someone who is in the office has a different risk profile than someone operating heavy equipment, and it is rated as such.
• Executives
  • Anyone who is “C Suite” and above should have a different class code. This could be any employee who is tasked with high-level sales, customer relationships, CFO, CIO, COO, CEO, or something similar. There is a specific general liability class code for these employees. Again, this class is significantly less than in-field construction employees.
• On-site Construction Employees
  • This is where the construction class codes are needed. Whether you’re a general contractor, masonry contractor, concrete contractor, or plumbing contractor, all in-field staff need to fall under the correct construction code on your general liability schedule. (See the section Proper Breakdown of Employee Payrolls by Job Type (Class Code) below.)
• Owner Payroll
  • Any actual partner or owner of the company needs split out from the organization’s payroll. Each owner is assigned a nominal “minimum” payroll rating that varies by each individual insurance carrier. Owners could make up a significant amount of payroll. You don’t want to pay premium on this class, as it’s not required (other than the minimum amount required).

Sales-based organizations: This could be any retail sales operation, distributor, or even manufacturer. The general liability cost analysis is much easier to understand than complex payroll-based operations. You just need to assess that your agents are properly classing your organization for what you do.  There are over 700 individual class codes that are used. Each one has a different pricing model associated with it. In sales-based organizations, the correct class code is key to accurate pricing.

Real Life Example

We had a Self-Performing General Contractor that lumped ALL company payrolls into various construction codes. Codes such as excavation, concrete construction, prefab building erection, carpentry. Total payroll of the company excluding sub-contractors was approximately $2,200,000. Of that total, over $715,000 was made up of office staff payroll.  There was substantial savings by properly classing the office staff instead of using a construction general liability class code. This resulted in a savings of over nearly $8,000 passed onto the customer.

Proper Breakdown of Employee Payrolls by Job Type (Class Code)

This was briefly touched on in the previous real-life example. Each general liability class code has a slightly different cost associated with it. It’s based on the overall risk profile of the class of business. In simple terms, the more hazardous a class of business is, the more it will cost to insure. Insurance carriers price each class code per $1,000 of sales, manufactured goods, or payrolls.

Here are some current examples from one of our carriers:

• Carpentry is $11.81 per $1,000 of payroll.
• Grading of land is $8.06 per $1,000 of payroll.
• Excavation is $16.96 per $1,000 of payroll.
• Plastics Manufacturing has a cost of $0.61 per $1,000 of goods manufactured.

You can clearly see that excavation is higher than the other construction classes, because it has a higher risk associated and a higher likelihood of a claim to occur.

Improper classing is a very common mistake in all sorts of construction organizations. They want to get the audit off of their plate as soon as possible and just lump all of the payrolls into one class. Unfortunately, this is not great practice and could cost the consumer thousands more in insurance premiums as each class has a different rating. Make sure these classes are completed correctly from the onset of the insurance plan. This ensures no large out-of-cycle audit invoices to throw off your company’s budgets.

Real Life Example

A pool installation contractor also plows a very minimal amount of snow in the off-season. 98% of their revenue is in pool installations. However, when they completed their audit, a significant amount of their payroll got reported on the snow plowing general liability class code. This then created an invoice of over $6,000. We were able to jump in and properly advise the auditor of the mistake and reverse the audit invoice. Had we not caught the mistake, the insured would have legally owed the difference. Therefore, we always recommend consulting your agent first before finalizing your submission to the insurance auditor.

Subcontractor Payroll versus Material Cost

This is a common problem we see. It all relates to the ease of doing business on the front end.  Subcontractor estimates don’t always break out the labor versus the hard cost of materials. More times than not they submit the estimate with one lump sum of the entire job cost. While this is nice and clean for estimating, it’s a nightmare to split off the material costs when the audit comes around. If the material and labor costs from subcontractors are lumped together on your books, you’re likely paying premium on the material you purchased indirectly from the subcontractors as a general liability expense.

Real Life Example

A large concrete construction organization had submitted a subcontractor payroll report of approximately $6,400,000. There were 2 significant issues with their report as it relates to the insurance costs. Every subcontractor on their report had all their invoices lumped together and had NO breakout of construction material costs. This included the hard cost of aggregates, concrete, blacktop, lumber, mechanicals, along with other items. The second main issue with their report was professional services utilized by the concrete company were also included. Costs like attorney fees, CPA costs, architects’ fees, and consultant charges were part of the subcontractor report. After a long analysis by our agency, we were able to get the subcontractor costs down to their true number, which was around $2,900,000. This saved the customer over $16,000 in general liability costs from the prior year’s plan.

We’re glad you found us and hope this information is valuable to your business. We’d love to work together and become your trusted insurance advisor, especially at the time when you need help with an insurance audit. Start the conversation today by clicking on the image below!