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Why Insurance Companies Do Annual Insurance Audits: Everything To Know

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Why Insurance Companies do Annual Insurance Audits: Everything to Know

For business owners and private citizens alike, the word “audit” tends to send a shiver down our spine.

The word tends to carry a negative connotation, often associated with IRS tax audits that can potentially land you in hot water.

However, annual insurance audits are much different—and can actually be beneficial to your business. They ensure you do not have too much (or too little) coverage.

There are various types of insurance, depending on the needs of your business. On average, eligible policies are audited yearly. But in actuality, they may occur more or less often than this.

To ensure you are getting the most of your insurance and not overpaying, audits can work in your favor.

Plus, keeping up on your insurance is key—you do not want to get into a situation where your business insurance lapses. This can have serious consequences, including loss of coverage, increase in rates down the line, and legal consequences.

To avoid this situation, and to learn more about how audits work for the different types of insurance, keep reading.

What Are Annual Insurance Audits?

Insurance audits exist to ensure you have paid the correct cost of insurance based on your level of risk—no more, no less. These audits make certain that your premium is appropriate and adjust it if not.

There are various types of insurance available to business owners. Some are required by law, and some are not. This depends on many factors, including the state in which you have registered your business, the industry in which you work, etc.

Annual insurance audits can be conducted by the insurance company or by a third-party independent auditing firm.

It’s important to note that all information discovered during the insurance auditing process is solely for the purpose of insurance rating. The information will not be passed to other entities, including the IRS.

The process of audits starts with your company’s examination under a microscope.

Information pertaining to operations, records, files, and other areas are reviewed to determine insurance exposure. The term “exposure” refers to the financial aspects of your business, including the number of employees, payroll, sales, and units.

Payroll is one of the most important figures in the insurance auditing process. It includes:

  • Hourly/salaried wages
  • Bonuses
  • Holiday, sick, and vacation pay
  • Commissions
  • Profit-sharing
  • Meals/housing provided for employees
  • Allowances for expenses without a receipt

Payroll does not include:

  • Tips
  • Overtime
  • Severance pay
  • Expense reimbursements with a receipt
  • Personal use of a company car
  • Incentives/rewards (gift cards, event tickets, etc.)

These numbers are used in the audit and thus determine the premium you will pay in the next year (out-of-pocket cost of insurance).

What Do They Mean for My Business?

The auditor reviews your records to review how much risk they insured last year and if this is appropriate for the next year or if it needs to be adjusted.

Insurance is based on estimates from the previous year. So if your payroll or sales numbers went way up, your insurance carrier was actually taking on more risk than what you had originally paid for.

If you did not have enough coverage, or if your circumstances have changed significantly over the past year, your premiums will likely increase in the next billing cycle. If you paid too much, you will usually receive a credit on your next term.

This is the difference between “one-way” and “two-way” business insurance. In a two-way relationship, the carrier will give you back the difference in the cost of insurance (premium) if the actual figures are lower than expected.

In a one-way relationship, they will not refund this difference.

What Are the Types of Annual Insurance Audits?

Each state has its own laws governing which businesses need specific types of insurance and the level of coverage. As such, the types of annual insurance audits will differ by type of insurance.

In Massachusetts, for example, the law requires any business to have workers’ compensation insurance. This regulation is true for all employees of the business. It does not matter how much or what type of work they do.

This law does exclude sole proprietorships, as they do not have employees.

The state also mandates all company-owned vehicles and their drivers to have commercial auto insurance.

In this state, commercial property insurance is not required. Although, the mortgage lender may require this if you are seeking a loan for business property.

There are also industry-specific policies required for certain companies and industries.

Plus, small businesses will have different insurance policies—and therefore, a different process of audits than larger companies.

Workers’ Compensation Insurance Audits

Workers’ comp insurance is required by law in all states but Texas.

Each state has its own laws governing this, but it is generally used to assist employees who are injured or become ill on the job and thus can’t work.

The insurance auditing process for this insurance really depends on the state. There are three categories of states and how they set their premiums.

  • National Council on Compensation Insurance (NCCI) states
    • These states rely on NCCI’s established codes and rates to determine workers’ comp regulations
    • Most states fall under this category
  • Independent bureau states
    • These states develop their own workers’ comp insurance ratings
    • CA, IN, MA, MI, MN, NC, NY, PA, WI
  • Monopolistic states
    • These states actually do not allow companies to obtain private workers’ comp insurance
    • Instead, they must go through a state fund to provide this coverage
    • ND, OH, WA, WY

 

Generally speaking, workers comp insurance is calculated by multiplying payroll costs by a class modifier. The latter half is where the risk factor comes into play.

The reason for these audits is the same across the board. Auditors check if the figures estimated for payroll and class codes accurately reflect the data for the policy period.

It also ensures subcontractors had their own coverage in place while they worked for you.

These annual insurance audits may occur more frequently than the yearly average. But, if your company keeps good records, it should be fairly straightforward. The process of audits may even be fully automated, depending on your industry and company’s technology.

General Liability Insurance Audits

General liability is one of the most common forms of insurance.

For the most part, if there is any risk that your company may be held accountable for causing harm to another person or business. If this is true in any of your business activities, then you might want to consider protecting yourself with general liability insurance.

There is quite a bit this insurance can cover. Some examples include:

  • Costs of litigation
  • Costs of restitution for injury
  • Court-awarded damages
  • Settlements
  • Medical costs
  • Slip and fall costs
  • Property damage
  • Damage to rented/leased space
  • Advertising injury
  • Personal injury
  • Products/completed operations injury
  • Fire damage
  • Liquor liability

 

It’s important to note this insurance covers someone who is injured or incurs property damage as a result (direct or indirect) of your business activities. But this is much different than an employee getting hurt on the job while working (workers’ comp).

The insurance auditing process for general liability coverage depends on your company and insurance carrier. The annual insurance audits process focuses mostly on business operations and the level of risk they may pose.

insurance audit

Contractors Liability Audits

Due to the nature of the work done on a job-by-job basis, annual insurance audits for contractors may look a little different than for other businesses.

Examples of the type of paperwork you are likely to be asked to provide include:

  • Journals
  • Ledgers
  • Tax filing records
  • Payroll records
  • Timecards
  • Company vehicle titles/registrations
  • Contracts with clients
  • Contracts with subcontractors
  • Balance sheets
  • Profit and loss statements

 

All of this information paints a better picture of your yearly business operations, all jobs considered.

 

Subcontractors and Insurance Audits

The insurance auditing process for independent contractors is a bit tricky.

Subcontractors are required to have their own workers’ comp and general liability insurance. This coverage must be in place at the time you hire them.

If, during an audit, you are found to have worked with subcontractors who did not have coverage, you may be charged for them on your own policy. In this case, they are treated as an employee—and charged as such.

Commercial Liability Audits

There are two types of commercial liability insurance: general and professional.

General liability is good for common business risks. It covers injuries or damage that may occur on the physical premises of your business or harm caused by your business operations.

One example of this is bodily injury claims and any associated medical payments. Another is the legal expenses resulting from slander lawsuits. The costs for this type of insurance can vary based on location, type of business, and industry experience.

Professional liability is more for businesses that offer specialized services. This type of insurance covers legal expenses and settlement fees that might arise for issues more applicable to certain industries. These industries include:

  • Real estate
  • Construction
  • Finance
  • Medicine

 

Negligence, incomplete, or incorrect work in these industries can cause a loss for your client. This can have serious consequences. As such, greater insurance coverage is required.

The numbers used to calculate these audits are typically based on sales figures. However, don’t be surprised if your insurance carrier asks for more information depending on your industry.

Audits for Specific Businesses

The insurance auditing process will vary by type of insurance required. Though many share similar components, an insurance auditor will look at each case individually.

Restaurant Insurance Audit time

Restaurants and Bars

As outlined above, this industry faces a lot of liability in their insurance coverage.

The actual types of insurance can vary widely by state. But even if not required by law in your town, it is a wise decision to obtain this insurance.

This is especially true for businesses in states governed by dram shop laws. 44 states plus Washington DC have implemented these regulations.

Dram shop laws pertain to the businesses who serve/sell alcohol at their establishment. It follows that these businesses are held responsible for the actions of the individuals they serve.

This means that victims of crimes committed by these intoxicated individuals will have standing in court to file a civil suit against the establishment. This is in addition to action against the intoxicated perpetrator.

As such, restaurants and bars in these states face even greater liability and thus require more risk coverage. This is important information to consider when undergoing annual insurance audits.

Liquor Liability Insurance Audits

How audits work for the liquor industry can be more complicated, as the risk is of a different nature.

Liquor liability insurance coverage is a type of insurance designed to protect those in the alcohol industry. This includes those who manufacture, sell, or serve beer, wine, and liquor.

Common examples are bars, breweries, wineries, restaurants, and stores that sell alcohol.

This insurance covers costs associated with injury/damage that an intoxicated person may cause. These costs may be in legal fees, settlements, or medical costs. If the intoxicated person was served/sold liquor by your establishment, you may be liable.

Coverage can really vary by company and by the insurance carrier. Again, the legal requirement for this insurance will depend on your state. But even if it is not required, it is certainly a smart idea to protect your business.

Plus, some municipalities might require this insurance before they will issue a city liquor license.

Unfortunately, liquor liability insurance tends to be one-way policies more often than not. This protects the carriers against those who underestimate gross sales and fail to pay the difference in the next term.

Annual insurance audits are key in this industry, as the liability can be severe.

The insurance premium is usually calculated by gross sales. From there, the total is broken down into categories for gross sales, including alcoholic beverages, non-alcoholic beverages, and food sales.

Although, your insurance carrier may ask for other operational information when conducting an audit as well. In addition to the typical information provided during an audit, you may be asked to also include:

  • A separate register of tips earned by employees
  • Free meals provided to employees
  • Subcontractor information
  • Liquor sales
  • Total sales

Retail Stores Gross Sales Audits

Insurance for retail stores can aim at things that might happen to your store—like a customer slip and fall or an employee injury/illness. But this insurance is also for what is in your store—namely, protection against property damage and theft.

Common types of insurance found for retail stores start with general liability coverage. Business owners’ policy (which protects your commercial building/storefront) and workers’ comp are two other common types.

You may also consider commercial automobile insurance if you employ a company-owned vehicle.

Again, these types of insurance are not always required by law but are certainly beneficial to have.

Gross Sales Audits

The total amount charged for goods/products sold as well as services performed makes up the gross sales. This amount does not include tax, returns, and allowances. However, cash discounts are considered part of this number.

Gross sales are used to calculate premiums. They are most often used with commercial general liability and liquor liability annual insurance audits.

 

Man walking in front of storage containers at a rented facility in need of landlord insurance
Inland Marine Insurance – Massachusetts Independent Insurance Agent

Cargo/Freight Insurance Audits

These types of insurance are to protect against the risk of physical damage or loss from any external cause during the shipping process. The cost of insurance is usually calculated by shipping volume. The overall valuation of goods shipped may also be used to determine coverage.

There are two main categories of freight insurance.

One is open coverage. In this case, you pay a premium every year to cover multiple shipments traveling at the same time. This continues until the plan is terminated. This is ideal for large-volume freight companies.

The other is single coverage. This is pretty self-explanatory—it covers smaller businesses who ship freight infrequently.

The actual cost of insurance can also depend on the mode of transportation for this freight—between rail, truck, sea, or air. Some transportation methods are riskier than others.

This insurance is usually not required by law, though it is very risky to go without. It is more common than you may think for shipping containers to fall overboard the ship while underway, for example.

You could self-insure the cargo, but this is very dangerous. Even if you are the most careful company in the world, there may be factors beyond your control that cause serious loss to property. In the event of these “acts of God,” you have no recourse.

In terms of annual insurance audits, only the open coverage policies would be audited. These audits may be more complicated as there are a variety of factors that go into freight insurance. These include:

  • Value of goods
  • Origin and destination points
  • Loss history
  • Mode of transportation (ocean travel is more expensive than air, more risk and longer time span in the risk zone)
  • Risk of theft
  • Method of packaging

Information Needed for an Insurance Audit

The type of information needed for annual insurance audits will vary based on the type and scope of coverage. However, there is some common information that will be required for most types of insurance.

General Information

Your auditor will need some basic information to get an idea of how the company does business. This starts with a description of company operations.

It also requires a list of the company’s owners’/officers’ names and job duties. The same information is needed for all employees. The auditor will also want to know how many employees work at each location.

Payroll Records

You will be required to self-report payroll records.

The key here is gross pay. Your auditor will look for information on wages, of course. But they will also want to know about any bonuses, commissions, holiday/vacation pay, sick pay, and retirement account contributions. They will also need a record of overtime, though it must be listed separately.

These are especially important for the workers’ comp insurance auditing process.

These records play a role in calculating the risk that employees undertake on the job. A company with 200 employees in the construction industry is not quite the same as an office of the same size.

Essentially, this risk is known as a “class modifier” that is multiplied by the total payroll for these employees.

Subcontractor Information

For annual insurance audits, the names of subcontractors are required.

But your auditor will also want to see their insurance certificates, as well.

Furthermore, your auditor is likely to ask for a general ledger, cash disbursements book, and/or checkbook register. These records help verify payments and work with subcontractors.

Tax Documents

Tax documents are essential for annual insurance audits. These documents help verify payroll and sales records, as well as confirm your federal ID number.

Example of these documents include:

  • 941
  • 940
  • 1099
  • W-2
  • W-3
  • Income tax return

Sales

This information is also self-reported to insurance carriers for auditing purposes. For most general liability policies, sales are used as the primary “rating factor.”

When estimating data to form an insurance policy, your sales data is projected. This means an educated guess is made based on history and forecasts.

During an audit, the sales data is reviewed and compared to the projected figures. Any discrepancies are adjusted for in the following billing cycle.

The gross sales for each type of service provided/work performed by location contribute to this figure.

Additional sales information your auditor may ask for could be a profit and loss statement or a general ledger.

Additional Industry-Specific Information

Due to the nature of the restaurant and bar industry, annual insurance audits are a little different.

In addition to the aforementioned information, to complete the process of audits, your auditor may ask for tips employees earned, shown separately. They may also inquire about the number of free meals given to employees.

Subcontractor information is required here, as well. This is typically for live entertainment or other associated groups.

Finally, this industry is unique in its heightened liability when alcohol is involved. As such, the auditor will likely want to see liquor sales data in addition to total sales.

 

Frequently Asked Questions

Frequently Asked Questions

With so many different types of insurance, there are consequentially various costs of insurance associated. While some insurance levels are flat, most high-stakes premium levels are adjusted each year by an annual insurance audit.

With so many moving parts, there are many questions often asked.

What Is the Timeline of an Insurance Audit?

An audit’s timeline really depends on the type of insurance in question. This will determine how audits work, and thus how long they take.

The process begins with your application for insurance, where you provide the key information outlined above. This includes the number of employees, their positions, and payroll information for each worker.

After you submit these, you choose a quote from the company you think is the best fit. You pay the estimated premium, which will cover you for one year based on the sales and payroll data you provided.

After a year, this policy will expire, and it will be time to re-up.

Within three months of this expiration date (though usually sooner), you should receive an audit worksheet in the mail.

You review your data from the previous year and report your actual payroll and sales data.

Your insurance carrier reviews this information and amends the policy based on your actual data. They charge an additional premium if needed (as compared to your estimated figures). In some cases, they will credit you for an overpayment.

If you find these numbers satisfactory, you can move on and pay any additional premium.

The process will repeat the following year again.

If you do not agree, you can contest the audit. The carrier will recalculate and, if needed, conduct an on-site audit.

What Is the Purpose of an Insurance Premium Audit?

Premium audits are designed to ensure the premiums each company pays are accurate.

Again, though the thought of annual insurance audits can be stressful—this can be beneficial to your business.

In these situations, an auditor looks back over your records and establishes what the actual exposure is. This includes the correct classification codes (associated with risk levels) and rates.

These are then compared to your previous estimated figures and adjusted as necessary. Any leftover amount is issued into your premiums for the next billing cycle.

What Policies Are Subject to aa Insurance Premium Audit?

The most common types of insurance that are subject to a premium audit include general liability, liquor liability, and workers’ comp insurance.

The information uncovered in these audits is used to adjust your insurance premium.

But in addition, this information can actually provide valuable insights about your business relating to operations that you may not have considered.

What Is an Estimated Insurance Audit?

If you do not provide the proper information that was requested in the insurance auditing process, your carrier may not be able to determine a calculable audit.

In this case, they can estimate your information, which leads to an estimated audit. This, however, can result in a higher-than-necessary premium, as your carrier has to overestimate your risk (rather than underestimate).

Are All Business Insurance Policies Auditable?

The short answer is no, and not all policies are auditable. But this really depends on your state and your carrier/policy.

Across the board, general liability and workers’ comp are two examples of policies very like to be subject to the process of audits.

What Does a Business Insurance Audit Look Like?

This depends on the type of insurance that is undergoing the insurance auditing process. There are three ways it tends to happen:

  1. By mail (for smaller companies, or those who have not had problems in the past)
  2. By phone
  3. In-person (for larger companies or those with prior incidents)

Will My Business Insurance Be Audited Every Year?

Typically, yes. The insurance auditing process will occur yearly.

The exact answer depends on the industry and your individual carrier/policy. Generally speaking, the more risk—the more often you will be audited.

They sometimes may occur more than once per year. The exception is if you purchase a “pay-as-you-go” plan as detailed below.

What Can You Do to Avoid Surprises?

The most important thing you can do to make the insurance auditing process go as smoothly as possible is to keep detailed, accurate records.

It can also help to designate someone to be the point person for contact with the auditor. This way, one person can answer all of the auditor’s questions and keep communication as streamlined as possible.

These tips make the process of audits easier for everyone involved.

It’s best to try not to hide from it but rather to prepare for it. The more prepared you are, the smoother annual insurance audits tend to go.

Plus, keeping detailed records might allow you to lower your insurance premiums and save you money. So keeping timely and accurate business records is extremely beneficial.

This information is especially true when subcontractors are hired. It is essential to retain the proof of insurance for them. This way, you don’t get stuck with the bill for their insurance coverage.

Even if they had their own insurance at the time, if you fail to keep a record of it, you may end up paying the price.

What Can I Do to Save Money on My Insurance Premium Audits?

The best way to save money on your insurance premiums is to come well-prepared for the process of audits. The best way to be prepared is, of course, maintaining detailed records.

Also, you can get credits in some industries for things like overtime, tips, and severance pay, among other things. But to get this credit, you must have this information on your records summarized by employee and department.

For contractors, you may be able to split an employee’s wages between different jobs. But again, this relies on keeping as accurate and detailed records as possible.

What Is a Pay-as-You-Go Business Insurance Plan?

These plans are an option for workers’ comp coverage. If you choose this option, it takes away the need for annual insurance audits.

You still pay a monthly premium, but it is based on the actual payroll data you provide (rather than estimated like in a yearly plan).

This option can be beneficial, as it ensures you do not overpay on your insurance. In the case of one-way policies, this can prove very costly.

How Are the Owners Classified in the Insurance Audit?

These rules vary by state. But generally, owners, officers, partners, and members may be able to nonelect coverage.

Owners and officers are classified by their actual performances—so each company will have to provide a description of each person’s role and the duties they perform in their role.

This also varies by industry.

Can You Tell Me Specifically Which Files I Need for My Audit?

This will depend mostly on which type of audit, for which type of insurance you are receiving. Read the aforementioned information, or contact your insurance agent for the most accurate information.

Generally speaking, if you keep diligent records, it will not be difficult to pull these files when requested. But the auditor will let you know exactly which documents you need.

Will I See the Results of the Audit?

Yes, you will see the results of the annual insurance audits.

These typically come by mail. They should be reviewed carefully, as you have the right to dispute them if found inaccurate.

Will My Business Insurance Premium Go up After an Audit?

Your cost of insurance may go up or down, depending on the result of the audit.

Unless you have one-way insurance, in this case, you will not be credited for the overpayment.

Understanding How Audits Work

With any insurance policy, you want to make sure you are getting the most for your money. Be sure to contact an experienced carrier who are experts in the laws and regulations for your state and industry.

Especially given the COVID crisis, normal audit processes may be disrupted. So it is good to contact an insurance agent you can trust to get the most accurate information.

If you are in Massachusetts, contact an experienced insurance agent today to be sure you are prepared for your next annual insurance audits.

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