Premium Audit – An Assessment of Insurance Policy's Exposure Basis
Business owners often need to manage more than their businesses alone. A term that frequently comes up and may cause some confusion is ‘premium audit.’ If you’re unaware of this element of business policies, you may encounter unexpected premium changes.
TL;DR
- A premium audit is a review conducted by insurance companies to make sure the exposure basis and premium of the insurance policy are accurate.
- It is vital in the agency work as it helps determine the final premium for the policy period.
- One common misunderstanding is that a premium audit is a governmental audit, it’s not. It’s an insurance audit process performed by your insurance carrier, which can significantly influence your insurance costs.
- A quick win for agencies is to keep the workflow transparent and educate the client about the premium audit process.
What Is a Premium Audit in Insurance?
Plain-language definition: A premium audit is a check-up done by your insurance company to make sure you’re paying the correct insurance premiums for your business.
Technical definition: A premium audit is the insurance audit process where carriers review the rating components of commercial insurance policies—a process that both business owner and insurance carrier will go through before the end of the policy period. This can depend on details such as payroll, sales, or square footage. The information helps the carrier to revise or confirm the estimated exposure basis provided at the beginning of the policy period and conclude the final premium amount.
Key Related Terms to Know
- Exposure Basis: This is the unit of measure (like payroll or gross sales) that the premium is based upon.
- Policy Period: This signifies the time frame in which the insurance policy remains effective.
- Classification Codes: These are codes that represent the type of work being performed by the business and employees. Each code has a specific rate used to calculate the premium.
- Estimated Payroll: It is an initial guess of how much a company will spend on salaries, which influences the premium.
- Audit Professional: This is the insurance expert responsible for conducting the premium audit, often called a premium auditor.
- Final Premium: The conclusive insurance costs that is determined after the premium audit.
Common Questions About Premium Audit
What is the primary purpose of a premium audit?
Premium audits primarily serve to verify the information used for developing the policy’s premium basis and ensuring that the insurance costs are suitably rated for the policyholder’s actual exposure.
How is the premium audit process conducted?
There are typically two methods that the premium audit process can be executed. A physical audit where the premium auditor visits the business location, and a voluntary audit where the business owner provides the necessary information via mail or online.
What happens after a premium audit?
Once an audit is completed, you will receive a ‘Statement of Audit.’ If the actual payroll was higher than the estimated payroll, then you will have a premium adjustment to pay additional premium. If it was lower, you may receive a return premium.
What can a business owner do to prepare for a premium audit?
Business owners can prepare for the audit by gathering financial records like payroll records, federal tax returns, and certificate of insurance for subcontractors, among other supporting documents.
Will the size of my workforce affect the premium audit?
Yes, it can affect your premium, since changes in the employee count will change your payroll, which is an exposure basis in workers compensation and some liability policies.
Premium Audit vs. Annual Premium Audits
There can be confusion between a premium audit and annual premium audits. While a premium audit is conducted at the end of a policy period to adjust the premium, annual premium audits occur yearly, as some businesses have policies that renew annually.
Comparison Area | Premium Audit | Annual Premium Audits
|
Primary use case | To accurately determine insurance premiums by confirming exposure basis. | Regular check and balance carried out yearly. |
Coverage / concept type | Audit process to finalize premium. | Routine audit for all policy periods. |
Typical exclusions | Audits can exclude certain cash expenses, non-payroll labor costs. | Rarely has exclusions if the policy is renewed annually. |
Who is most affected by errors | Both the business owner due to increased expenses and insurer due to miscalculations contributing to loss ratios. | Primarily the insurer due to the frequency of audits. |
Common mistakes | Providing incorrect payroll information, documentation errors. | Not completely understanding policy limits, incorrect projections of business operations. |
Real Claim Examples Involving Premium Audit
Scenario 1: A real estate company underestimated its estimated payroll during the application process for workers’ compensation insurance. During the premium audit, the insurance company discovered the discrepancy and adjusted the premium accordingly. This resulted in a sizable increase in the premium due to the higher payroll. The lesson learned is always to provide accurate estimates to avoid sudden premium increases.
Scenario 2: In another scenario, a small business owner failed to maintain and provide complete payroll records during the premium audit process. This delay led to the automatic application of higher rates, causing an increase in the insurance costs. The business owner could have prevented this increase by maintaining accurate and complete records.
Scenario 3: A general contractor underwent a premium audit, where it was found that a classification code for a risky type of work was missing in the policy, but the contractor’s employees were performing this work. The post-audit premium significantly increased due to this high-risk classification. Lesson learned: Ensure all job duties are included in your policy.
Limitations and Common Mistakes
- Premium audits don’t apply to personal insurance policies, only to commercial insurance.
- A misunderstanding is assuming the audit process will inevitably result in increased premiums. It can also lead to a lower premium.
- Failing to provide detailed business operations during the policy inception can lead to inaccurate classification codes and premium adjustments.
- Misclassification of employees as independent contractors to reduce premium is a frequent documentation error.
How to Explain Premium Audit to Clients
Personal Lines client: “Think of a premium audit like a yearly check-up for your policy costs based on the facts of your business.”
Small Business owner: “A premium audit ensures you’re paying the right amount for your insurance coverage. It’s like a year-end reconciliation comparing your actual payroll or sales to your estimates.”
CFO or Risk Manager: “A premium audit helps align your policy costs with your business reality. It’s an exit interview at the end of your policy period where your insurance carrier verifies the data and makes any necessary premium adjustments.”