AT YOUR OWN RISK
You paid your
premium and received your new policy. You can relax, right? Well, not quite.
Most courier executives have
encountered insurance audits, at least with Workers Compensation. Less well-understood is the fact that several other common
insurance policies are also subject to an audit.
Furthermore, audits are not necessarily a bad thing. You can
actually benefit from having an audit. Not uncommonly it is the
audit that doesn't happen or the one that slips by without incident that can come back to haunt you later.
But what is an audit anyway, if not a bald-faced attempt by
insidious insurers to double-dip into your finances and make up
for what they may have had to pay out? Actually, audits have nothing to do with losses. A business with twenty claims will
pay the same audit premium as one that runs loss-free.
From the insurance company's perspective, audits simply let
them collect the full premium they charged when the policy began.
That's because "auditable" policies (i.e. policies that are subject to an audit) are priced according to how your business performs
during the year the policy is in effect.
For example, Workers Compensation policies charge according to
your company's payroll. Other policies base their charges on
your revenues or the number of drivers you use. Obviously this is impossible to know at the beginning of the policy term.
Why should insurance work this way? As the insurance company
sees it, the risk it takes in covering you is directly proportional
to the amount of activity you do. The more miles driven by your vehicles, the greater their risk. And the greater their risk, the more
they should charge.
If mileage is their true concern, however, why do they often
focus on private information like payroll and revenues? These do
not always accurately reflect the risks.
For example, a courier that prides itself on providing
exceptional service may pay its people more and take in more revenue per
delivery. This company could pay higher premiums than another whose margins are lower (resulting in lower revenues for the
same or even greater mileage). Such an outcome does not seem fair.
Since insurance companies rely heavily on audits, they need to
know as surely as possible that the information they collect is
accurate. Therefore they prefer data -- like payroll and revenues -- that also is reported to other authorities. This allows them to
cross-check and verify the figures and discourages cheating. Sometimes, as with workers compensation, laws and regulations
mandate how carriers must charge.
Still, no one can deny that the system can be unfair. An
audit's whole purpose is to produce accurate charges, but in so doing
it uses measurements of risk that are inexact and at times misleading. Your best defense is knowledge and awareness that will
allow you to challenge situations that seem unfair to your business.
How Audits Work
When your insurance policy begins, your insurer estimates your
business's annual performance. It charges a deposit premium
up front and also sets a rate, which is tied to a particular index (such as $1.00 per hundred dollars of payroll). In this example,
$1.00 is the rate and payroll is the index, also known as the "rating basis."
Some time after the policy year is over (usually 2-3 months
after expiration) the insurance company verifies your actual perform-
ance via either an onsite inspection of records or a mail-in survey. It then applies the rate to the audit results and calculates the
true policy premium. This adjusted premium is compared to your deposit premium.
If the adjusted premium is greater than the deposit premium,
you owe the difference. If, however, the deposit is greater, the carrier
owes you a refund. Imagine that -- the insurance company has to write you a check!
Audits really are not so complex or mysterious. Most problems
occur because your broker fails to share full information with
you (either out of ignorance or fearing a negative reaction on your part). As a result the audit takes you by surprise and seems
like double jeopardy.
Once properly informed, you can easily track the index that
will determine your audit charge (or refund!), you can budget funds
as necessary, you can have documentation available for the auditor to review, and you even can debate the fairness of the index
In some cases you may prefer a non-auditable policy, but as we
shall see it often makes better sense to have an audit -- so long
as you know about it and understand it from the beginning.
Identify Audits in Advance
The first step is knowing which of your policies are subject to an audit. Policies and coverages that are generally auditable are:
Other policies that may be auditable include:
If you were not aware of this, you are in the majority. A
substantial percentage of the owners and managers we speak with
are surprised to learn that several of their policies are auditable. Often they are skeptical at first until we show them their policy
provisions in black and white.
Do not assume that just because you have not been audited
before, that a policy is not auditable. This is a common mistake.
Actually, an insurance company has three years in which to audit a policy. This means that if your policy expires December 1,
1998 you can be audited at any time until December 2001!
In order to save money a carrier sometimes will do only spot
checks, which means they only audit a small percentage of their
policies each year. Sometimes they will send questionnaires in lieu of conducting onsite audits. None of this exempts you from
having a full audit later on.
Another practice is to forego annual audits on smaller
policies unless something raises a red flag. Often the trigger is a claim,
but it could also be a renewal application, a different policy audit, or even an internal memo warning that other similar businesses
have understated their figures.
The point is that, like they say in the investment business,
"past performance is no indication of future results." Know what
your policies say on the subject because that is what governs. If your broker's explanations leave you feeling unsure, get a
second opinion and have the broker provide respond in writing. If you receive incorrect information and can prove it, at least
you have a stronger case.
Understand your Rates
Most people when they purchase insurance naturally focus on
their premium charges. Certainly it is important to know how
much money you need to come up with to put coverage into effect. For auditable policies, however, the most important cost-
related item is not the initial premium but the policy rate.
Remember that the premium is just a deposit, which will be
adjusted after the policy audit. The key to properly calculating
the cost of your insurance is the rate. If your workers compensation driver rate is $5.00, then you will need to budget $5.00
for every $100 in driver compensation -- or 5%. If driver compensation increases during the year, you should set aside funds
Likewise if you should lose a big account or two and revenues
fall, then you should be able to anticipate a refund from
your cargo carrier (cargo policies are most often audited on the basis of gross revenues).
Any time you identify a policy as being auditable, your next
move should be to ask for the rate -- or rates. Yes, sometimes
a policy sports more than one rate. Don't panic. Think about your workers compensation where every type of worker --
driver, sales, clerical, etc. -- has its own rate.
It's "Basis" Arithmetic!
Now that you know which of your policies are auditable and
what rates apply, you need to ascertain the rating basis --
or index -- being used. Is it payroll, revenues, driver count, or something else entirely? Are underwriters using accurate
figures to generate their premiums?
This last question has broad implications and is responsible
for most audit-related disputes. If underwriters are applying
rates to inaccurate business data, they will end up overcharging or undercharging. Neither alternative is good for you.
Let's say your rating basis is revenues. If you substantially overreport
and claim much greater revenues than you really
have, you may be entitled to a big refund upon audit. However, this means that your insurer was holding (and earning
interest on) a large sum of your money during the policy year. You are better off reporting more conservatively and
paying less up front while putting aside some money in case the audit generates an additional charge.
If on the other hand you underreport, you pay the price in several ways.
First, you simply delay the inevitable since the extra money
will be billed after the audit. While you have the use of the
money in the meantime, you may lose the ability to spread out your payments. Unlike deposit premiums, which can be
divided among several installments, audit premiums are due within 30 days as one lump sum.
Second, since you are presenting yourself as a smaller
business, you will not earn as many volume-related credits as you
could. In other words, your rate will be higher and a higher rate means higher premiums -- up-front and after the audit.
Have your broker show you where on your policy it specifies
the rating basis used and the figures on which the deposit
premium is based. This really is critical to avoiding nasty surprises down the road.
"If Any" Spells "Trouble"
Beware of policies where, instead of a figure, the phrase
"if any" appears. This means that underwriters do not believe that
you have anything they need to charge for at the moment. Perhaps there is a token, "minimum" charge, but no more. The
rate remains, however, and underwriters reserve the right to audit and charge fully in the future.
We see this most commonly on auto policies. You may may have
several owned or leased vehicles insured and are told
that your insurance company is "throwing in" coverage for non-owned & hired autos (such as contractor-drivers). There
is no extra charge or something quite minimal. Sure enough, when you check the policy you find the phrase "if any" in the
box that should contain your total "cost of hiring" drivers (i.e. your total payroll/1099's).
In fact you are not getting the Non-Owned and Hired Auto
coverage for free. You are simply putting off the charges until
audit time, when they will all be due at once. In addition, you would not have known this and would not have had an oppor-
tunity to prepare unless you checked your policy and questioned your broker. Is this really such a "bargain?"
One Pennsylvania courier refused to purchase a separate
Non-Owned & Hired Auto insurance policy because he "was
getting the coverage for free" with his fleet insurance and he did not want an auditable policy. He had 60 contractors.
Two years later he received a bill from his auto carrier for over $145,000 dollars!
It turned out that his policy was auditable all along. We
helped him to settle but the premiums plus the legal and consulting
fees he paid -- not to mention the time he invested in the dispute -- far exceeded what he would have paid by accepting a
better policy with a clear audit process.
Audits = Savings?!
The case for audits as a good thing begins and ends
with money. Since the hassle of an audit makes auditable policies
inherently less preferable, there needs to be a corresponding advantage to make them acceptable. Few of you hear about
these benefits since many brokers do not to talk about audits at all. Others choose to pander to your negative stereotypes,
"siding with you" against the greedy insurance companies.
Actually there are two ways in which audits let you pay less!
First, as we have already mentioned, auditable policies make
it possible for you to get money back if your business
suffers a setback. Why should you be stuck paying premiums on 40 vehicles-worth of deliveries when in fact your
business dropped off and you averaged only 33 vehicles? That's over 15% less! Unless you have an auditable policy,
your insurance company simply pockets the money for the extra risk. And don't expect a thank you note.
If your business does grow, you now know the score about
audits. You may pay proportionatey higher audit premiums,
but these are offset by your increased sales. Think of it as a small price to pay in return for which you get to "insure your
premiums" against a downturn in your business.
Second, auditable policies generally charge less up front. Put
yourself for a moment in the shoes of your underwriter. Two
businesses approach you for insurance. One says, "charge me a deposit now and if I grow you can collect more later." The
other says, "You must agree to accept whatever I pay now as final." To whom do you offer the lower price?
Underwriters can charge less when they know that their
downside is protected by an audit. If you feel like proving the point
to yourself, have your broker obtain two proposals from carriers: one with an audit and one without. Remember though that
workers compensation policies must be auditable as a matter of law.
Audits, therefore, are not impossible to understand and
predict, and they do not necessarily mean that you pay more.
They can be understood and anticipated and may even help you reduce your insurance costs. To avoid an audit, you
must be prepared to pay more up-front and sacrifice the potential for a refund.
Audits are fearsome only when poorly understood or when they
take you by surprise. As with many other things, to
know them is...well...to accept them as a reasonable and potentially beneficial part of your insurance program.
Having read this article, you should be able to make up your
own mind and direct your insurance brokers accordingly.
If they are not as responsive or knowledgable as you might like, you can always turn the tables and bring in someone
else to audit them!
Peter Schlactus, a Certified Insurance Counselor and Accredited Advisor in Insurance, is Co-President of KBS International Corp., which provides specialized insurance programs, benefits, and risk management services to courier companies and executives nationwide. Mr. Schlactus is available to answer inquiries at 1-888-KBS-4321 or via e-mail at firstname.lastname@example.org.
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