In today's business environment, every business owner, large or small, knows that one of the fastest growing items in the operating budget is the cost of commercial insurance.
As a construction business owner, time and money are a vital concern to your daily business life. Your knowledge about commercial insurance contracts and the role of the insurance premium audit professional will enable you to reduce the stress related to the commercial insurance transaction and ensure that you pay only the correct premium.
Insurance premium auditors are highly trained professionals who will work with you and your representatives in an effort to produce an accurate audit report. Your proper maintenance of business records is vital to produce an accurate audit report. Accurate premium audit reports can save your company time and money by assuring the audits are correct the first time, thereby eliminating the need for time consuming dispute communication and revisions or changes to the audit report.
What Is an Insurance Premium Audit and Why Is It an Essential Part of My Commercial Insurance Contract?
An insurance premium audit is a examination of the business owner's operations and accounting records. A premium audit is performed to determine the actual insurance exposure for the coverage provided by the insurance company.
While it is the contractual obligation within your insurance policy contract for your insurance carrier to conduct the premium audit, it is to your advantage to have the audit completed accurately and on time.
The results of your premium audits are shared with insurance regulatory agencies/bureaus that use this data along with that provided by similar businesses to develop a wide array of class data.
Insurance Regulatory Agencies/Bureaus
When conducting the insurance premium audit, all carriers are required to adopt rules established by the following:
- NCCI (National Council on Compensation Insurance)-The National Council on Compensation Insurance (NCCI), headquartered in Boca Raton, FL, is a voluntary, non-profit, statistical research and ratemaking organization. The NCCI's primary functions are the preparation and administration of rates, and classification systems for workers' compensation insurance in thirty-two states and the provision of similar assistance in about half of the remaining states. Members of the NCCI include insurance companies, mutual companies, and insurance departments' competitive state funds. Member companies provide the NCCI with extensive information, such as payroll and claims costs, used to calculate the loss costs and rates published in NCCI Basic Manual for Workers' Compensation and Employers Liability insurance. The NCCI Basic Manual also sets forth the rules and procedures for workers' compensation insurance audits. NCCI is the licensed rate-making organization for these states. The NCCI's rules and classifications are incorporated into these state's workers compensation laws.
- Independent States' Bureaus-The following states maintain their own rule and rate-making bureaus: Delaware, Pennsylvania, New Jersey, New York, California, Michigan, Texas and Massachusetts. Some of these states' bureaus use the services of NCCI while others calculate their own rates and issue their own rules and manuals. NCCI's rates and rules are not applicable in these independent states' bureaus.
- Monopolistic States-Monopolistic states are states where only the state may legally provide workers' compensation insurance to business owners. The monopolistic states include North Dakota, Ohio, Washington, West Virginia and Wyoming. For these monopolistic states, stop-gap coverage and employers' liability may not be provided.
- ISO (Insurance Services Office)-ISO is a nationwide organization that functions as an advisory and rating organization for non-compensation insurance coverages such as commercial general liability. ISO offers a wide range of services: provides statistical information to develop loss costs for several lines of insurance (excluding workers' compensation); acts as an agency for filing coverage forms; loss costs and rules with state insurance departments; publishes and distributes manuals; shares rules and loss costs; acts in an advisory capacity to independent state rating bureaus; creates and applies property rating schedules; and develops standard forms of policies and coverages.
What Types of Commercial Insurance Policies are Subject to Premium Audit?
The following are examples of policies that your company may have with an insurance carrier that may be subject to premium audit:
- Commercial Automobile Liability Coverage
- Commercial General Liability Coverage
- Garage Liability Coverage
- Inland Marine Coverage
- Umbrella Liability Coverage
- Workers' Compensation
Generally, your commercial insurance policy is written with an auditable or adjustable exposure basis such as payroll, gross sales, total construction cost, or total units of equipments or vehicles. The premium audit department from your insurance company is required to conduct an audit after your policy expires. Due to insurance regulations, the premium audit report must be finalized within a specified time frame to determine the actual exposure covered during the policy period. In addition you may be required, on certain occasions, to participate in pre-audits or interim audits (during coverage period shortly after policy inception). These audits will include a review and discussion of operations, ownership, employee's duties, claims information, non-employee usage, classifications and an exposure comparative analysis. The data obtained from these audits will be used to adjust exposure estimates or update policy file information on ownership changes, if any, with the use of an endorsement. During the pre-audit, interim audit and the annual audits, the premium audit professional may offer record-keeping suggestions where needed or requested and classification changes where deemed appropriate to reflect the actual operations of the insured's business.
How Is my Premium Determined?
The price (premium) for most of your commercial insurance coverages (workers' compensation, general liability and garage liability) will be based on payroll or remuneration paid or payable to your employees. In most states, payroll or remuneration means money or substitute for money and this generally includes the following:
- Holiday pay
- Overtime pay (time and half and double time)
- Other money substitutes
- Payment for piece work
- Stock bonus plans
- Profit sharing plans and incentive plans
- Sick pay
- Store certificates and other substitutes for money
- Statutory payments (payments mandated by law)
- Tool allowances
- Value of boarding or lodging (Housing allowance payments)
- Vacation and holiday pay
- Davis-Bacon wages
- Value of meals provided to employees to the extent shown in the records of the insured
- Salary reduction plans, savings plans, retirement plans and cafeteria Plans
- Non-reimbursable expense payments to employees
During the course of the insurance audit, the audit professional will interview you about your business records, the business operations or projects. The audit professional may ask to personally observe the various operations of your organization by conducting a guided tour with you or your representative.
Accurate records, information about your operations and the results of personal observations will enable the audit professional to assign the proper classifications to your operations.
By maintaining your records in accordance with the following guidelines, your audit professional will be able to calculate the proper premium base amounts and assign these premium base amounts to the correct classifications. Furthermore, you should maintain accurate information about severance payments, moving expenses for your employees and other fringe benefits that were paid to your employees during the coverage period, as these items may be excluded. The following are payroll exclusions for workers' compensation insurance audits:
- Payments to group plans
- Special rewards
- Dismissal wages or severance pay
- Payments for active military duty
- Employee discounts on goods purchased from the employer
- Expenses reimbursements to employees to the extent shown in the accounting records
- Supper money
- Work uniform allowances
- Third party sick pay
- Company perks
- Overtime (the premium portion-one-third of time and half overtime and half of double overtime.) Note that an overtime test must be completed by the auditor in order to apply the overtime credit.
What Records Are Required for the Insurance Premium Audit?
The insurance premium auditor professional may ask to review some or all of the following records depending on the basis of premium contained in your policy (i.e., payroll, sales, construction value, units of equipments or vehicles, etc.):
- Payroll records with details (i.e., by employee, dept, gross, overtime, etc.), including individual earnings records
- Payroll tax returns, federal and state unemployment reports
- General ledger/financial statements
- Cash disbursements journals, check registers, bank statements
- Business checkbooks
- Certificates of insurance for sub-contractors
- Job cost reports
- Sales journals
- Federal 1099's/1096 forms
- Vehicle registrations, titles or ownership tax receipts
- EDP system reports
The premium audit professional will use a combination of these records, depending on the type of policy requiring an audit, to determine the proper auditable exposure for the audit period in question. If some or all of your business records are maintained at your accountant's office, then you must inform the audit professional of the name, address, fax and phone number of the accounting firm during the audit appointment process.
After the audit is completed at your accountant's office, the audit professional will discuss with you the audit results and may ask further questions pertaining to personnel or the business operations to justify your business classification on the policy.
What Is My Role in the Premium Audit Process?
As a construction business owner, you need to become involved with the audit process from the day you contact your agent/broker to secure a policy, all the way to policy expiration and until the premium audit is conducted.
The following steps may help you to eliminate the stress associated with lack of planning before and during the conduct of your insurance audit:
- Provide your agent/broker with a complete description of operations or business, which will be used to determine applicable classifications.
- Provide your agent/broker with realistic estimated payroll, sales/receipts, vehicle or equipment unit count and other applicable exposures. A realistic exposure estimate will reduce the chance of large variation in audited versus estimated exposure at policy expiration.
- Provide your agent/broker with updates regarding any change in operations including ownership changes, large changes in your labor force, establishment of another operation in another state, etc.; this will ensure the issuance of applicable coverage endorsements prior to policy expiration.
- Properly maintain records required for audit with details about job categories, department breakdowns and information about key employees including their actual duties to allow for applicable adjustments to gross payroll.
- Upon contact by your insurance audit professional for an audit appointment, provide contact information for your accountant if you do not maintain your business records so as to facilitate the timely completion of your audit. Be prepared to answer additional questions with respect to personnel and job categories after the audit is completed with your accountant.
- Actively participate in the audit process or delegate to a responsible party when your insurance premium audit professional contacts you for an appointment.
Frequently Asked Questions
Q. Why are foremen/supervisors and/or managers classified the same as direct laborers?
A. Foremen, supervisors and or managers who have direct supervisory responsibility over a unit or a group of workers are exposed to the same risk to injury as the employees they supervise. As such supervisors, foremen and or managers with direct supervisory responsibility are subject to the same classification as the employees they supervise.
Q. Why do I owe additional premium?
A. There are several factors which can contribute to an additional premium invoice and the most common are as follows
- Estimated exposure set too low
- Audited exposure is distributed differently than estimated exposure on the policy due to changes that may not have been reported or endorsed on the policy
- Classifications not allowed at final audit and or different but applicable classifications added at final audit
- Increase in staff that may not have been anticipated, payroll increase due to pay raises, overtime wages paid out, bonuses/commissions paid out during the audit period, thus increasing the auditable exposure
- Changes in your Experience Modification Factor after the inception date of your Insurance policy
Q. Why am I required to pay premiums for uninsured subcontractors?
A. Your insurance carrier may be required legally to pay a claim as a result of injury to uninsured "non-employee" or subcontractor, based on the courts determination of an employer/employee relationship that may have existed at time of injury. Therefore, your carrier must collect the proper premiums to cover a loss if one should occur. One way to eliminate these additional premiums is to ensure that you hire only adequately insured subcontractors and maintain their updated certificates of insurance on file.
Q. Why does my Experience Modification factor fluctuate?
A. Your Experience Modification Factor will fluctuate based on several factors
- Your years in business
- Years in business without a claim
- Severity, frequency and the number of claims filed
- Time since your last claim
Q. Why am I required to authorize my insurance carrier to release the audit worksheets to my agent/broker who represents my business?
A. The audit worksheets and the audit report contain sensitive personal and financial information that all insurance carriers are required to keep confidential and it is only released to third parties, including your agent/broker with the expressed authorization of the insured or business owner.
Q. What is the difference between the insurance carrier auditor and a vendor auditor?
A. Both the insurance company employee auditor and the vendor auditor are highly trained professionals who know the NCCI's and independent states' bureaus rules and are classification experts who will work with you diligently during the conduct of the premium audit. The only difference is the carrier auditor is a direct employee and the vendor auditor is an employee of the vendor company. Insurance carriers, large and small, find it necessary to contract with vendor business partners to fulfill their obligations under the insurance contract with respect to the completion of the premium audit. It is important call your agent/broker for clarifications if you have any question or concerns relating to the identity of a vendor auditor.
The premium audit professional is a resource to the construction business owner at no additional cost who will assist in saving you time and money on your insurance program.
Keep in mind that the guidelines above follow general commercial insurance principles. Furthermore, it must be noted that these guidelines do not supersede conditions, definitions or endorsements contained in your insurance policy. It is recommended that you contact your agent or broker for any question relating to insurance coverage.
Construction Business Owner, March 2007