Business Insurance Audit Letter, Why Did I Get One and Do I Have To Fill It Out?

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What is this commercial insurance audit letter I received in the mail, and do I have to complete it?

When a business general liability or professional liability policy is nearing renewal (generally about 10 or 11 months into a year policy), and sometimes when an insurance policy is written and put into place insurance carriers send an audit letter(s). Usually, in a typical contractor's insurance policy, an inspection is performed at the beginning and not an audit

I get questioned on this often, often from new clients that were taken by surprised by their previous policy and agent, and despite advising clients at the start of their policy, by my own clients from time to time. It's understandable, it's not an issue that is focused on by the client or admittedly, by myself, other than advising, and by that point in the process, a new business person is usually overwhelmed with various terms, words, concepts, procedures, requirements, and language that comes with operating a business and procuring business insurance coverage.

There are several reasons why insurance companies send audit letters, and in no particular order, other than my memory, here are the primary reasons.

Like all insurance, commercial business insurance coverage is forward-looking. One method of pricing a policy's premium to align with the business risk is measuring how much activity the firm is producing. There are two primary methods for measuring a small business level of activity. The first is to examine the payroll. This is also performed usually in one of two ways. The first is measuring how much is paid to employees and staff. The second is to measure the number of full-time equivalent employees working for the business. In a nutshell, more employees relative to others in the industry equates to greater activity.

The second is to measure the gross sales. When a business insurance general liability policy is quoted, I almost always ask what the expected gross sales will be for the next 12 months. About half the time, I get asked to confirm it's the gross sales and not the profit. Insurance companies generally don't care how much profit a business makes, only how much "activity" is happening because the profitability of a company isn't a good barometer of how much business any given company is doing.

For example, Tesla Motors hasn't made a profit as of this writing, Amazon makes relatively very little profit, and General Motors went bankrupt, albeit all three are large organizations with thousands of employees and a huge amount of risk relative to other profitable, albeit smaller firms.

Very few companies can state with any reasonable degree of certainty what their gross sales and payroll will be in the next 12 months.

This is especially true for companies with employees. So, when quoting business insurance, I ask business owners to provide their best reasonable "guess" what they think it will be. It's almost always met with anguish, so I have strategies I use to make it easier and to provide the most accurate estimate that can reasonably be produced.

Knowing that companies are guessing at their revenue, insurance carriers send audit forms to reconcile the "guess" or estimate with what really happened. This results normally in one of three things happening. The first is that the amount of business was much greater than expected, and a bill for additional premium is requested. The second is business was much less than expected, and a refund check is given to the business owner for a return of unused premium (much like workers' comp insurance), and the final most common for the smallest of businesses, is that it's a net wash and no premium is returned or required. For many one-person bands, including contractors, the estimated premium is the resulting premium, and the audit doesn't change anything.

Be on the lookout for agents playing games to win your insurance business

This brings me to a point I want to make with insurance agents that as an insurance buyer for your business or company, you want to be on the lookout for agents that artificially enter low gross sales, so their insurance quote is lower than others. I find the act highly nefarious, and if done intentionally, I think it rises to a level of fraud. 

The way it works is the agent presents a quote that's low because the number of employees or gross revenue is artificially low. The agent knows that the insurance carrier will audit the policy and he/she will receive a commission check at the end of the policy for much more premium after the audit is performed. Your key takeaway is to make sure when comparing business insurance quotes is to check how they are "rated." By rating, I mean address, revenue, payroll, and class codes of activities. These all play a factor in the insurance quoted premium.

The next reason is to make sure the agent is doing their job correctly and to weed, or at least call out agents that are writing policies within 15 minutes of speaking to business owners. For one, insurance carriers will start to question why any given agent is habitually high or low in their estimates if the numbers are consistently out of line and not reasonable for the clients. This is especially true because carriers aren't always able to collect the amount of premium they should given the company's risk profile.

If the business goes out of business and can't pay additional premium from an audit, the insurance carrier essentially has given the business a gift by not charging for the actual risk. So, insurance carriers aren't too keen on having the premium too low and making up for it during an audit. Likewise, the carrier doesn't want the premium too high, or they more likely risk the client will leave for a "lower" price, even though in the end, the carrier may have the better offer. Ideally, the premium estimated and originally charged is "Goldilocks," not too low, not too high, and just right.



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