The word “audit” tends to trigger anxiety for small business owners. It brings up thoughts of investigations, financial scrutiny, and potential fines. When unsuspecting business owners receive a notice that their insurance policy is due for an audit, stress and worry quickly set in. The reality, however, is that audits are far less dramatic than they seem.
Insurance audits are a standard review process to keep premiums aligned with actual business operations. An audit is not looking for evidence of a problem; it is simply reconciling projections with hard data. Audits should never be a stress inducing nightmare. If you’re working with a communicative insurance agent, your audits should be straightforward administrative tasks. At Smyrl Insurance, we help our business clients in Montgomery and Bucks Counties prepare for routine audits so that they are simply a matter of business.
What Is an Insurance Audit Looking For?
Certain commercial insurance policies, particularly general liability and workers compensation, are issued based on exposure estimates. Basically, the more employees you have and the higher your sales are, the bigger your insurance exposure. As a business owner, you can only forecast or guess what you expect your payroll and sales to be for the coming year, so you provide that estimate to the insurance company. They calculate your monthly or quarterly premiums based on that estimate.
At the end of the year, it’s time to reconcile your original estimate with the real numbers. This is called an audit. Here are some examples of how things might change during the year, which is why audits are necessary:
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You land a huge new construction project for your electrical contracting business in Hilltown, resulting in several new employees and a huge revenue increase.
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Your wedding cake business in Harleysville just lost a major venue because they hired an in-house pastry chef, and now you have to lay off a few employees.
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Your small marketing firm has hit its stride and is steadily bringing on new clients, so you’re ready to transition your last remaining contractors into W-2 employees.
Your audit will ask for the genuine sales and payroll numbers, then compare them to your estimates from the beginning of the year (or policy date if it’s a new insurance plan). The correct premiums for insurance coverage will then be calculated based on the updated numbers. If you overpaid, you will receive a refund. If you underpaid, you will receive an invoice for the balance of what your premiums should have been.
Common Audit Pitfalls that Create Problems for Small Business Owners in Pennsylvania
Most of the time, audits do not need to cause too much stress. For most businesses, the discrepancy between estimate and actual numbers is small. There are a few situations, however, that make audits a bit more traumatic for business owners. In Pennsylvania, this happens most commonly with workers compensation audits.
Workers compensation requires an audit every year for Pennsylvania businesses. When it’s time for the audit, the insurance carrier will request financial statements, quarterly payroll tax statements, copies of 1099 reports, and payroll reports. If a business severely underestimates payroll, it will incur a substantial additional premium bill. That bill is payable as a lump sum invoice, which is rarely in the budget.
One way this happens is that a business hires multiple employees or a few highly paid employees during the year. Company growth is great, but that growth should be reported to your insurance agent as soon as possible so that your premiums can be adjusted in real time.
The other two common ways employers run into audit problems are a matter of employee classification:
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Every position in your business comes with a certain level of risk where workers compensation is concerned. Your office employees need to be classified one way, while your employees who work out on the road or with heavy machinery must be classified another way. Mis-classifying employees who have higher exposure to a work-related injury will show up on your audit.
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If your 1099 contractor employees don’t carry their own insurance policies, your workers compensation provider requires you to carry them on your policy. If you use contractors, require their proof of insurance, or include them in your payroll estimate.
Since a workers compensation audit is mandatory in Pennsylvania, a business that does not comply with the records request can face penalties of up to 100% of the original premium. Of course, the insurance carrier might also drop the policy, leaving the business uninsured and in much deeper trouble.
General liability audits work a bit differently. If you receive an official audit request, the carrier is typically looking for financial statements, copies of 1099 contractor reports, and business tax returns. Companies with small premiums might have the audit waived, especially if they have extremely small payroll or sales. Some carriers simply ask for a general report and skip the official audit. For larger companies, it varies by carrier. The wise choice is to check in with your commercial insurance agent a few times a year to run calculations, especially if you experience a sizable change in sales or workforce.
Making Insurance Audits Work for Your Business
Insurance audits serve an important purpose in both the business and insurance industries. They help to keep insurance risk and accountability fair for all policy holders. From the business perspective, it’s very important to work proactively with your insurance agent to make sure audits are a standard business task rather than a surprise event.
At Smyrl Insurance, we help our business clients prepare for and navigate annual audits so that they are as painless as possible. We work with many startups in Montgomery and Bucks Counties, so educating our clients about how audits work is a key aspect of getting them set up in their first policy. We know that the very first estimates might be a total guess, so we advise clients to check back with actual sales and payroll numbers once they get operations underway.
One option we offer clients is a quarterly phone call to collect payroll and year-to-date sales reports. We will review these numbers against the initial estimate and help them determine if it makes sense to spread the premium increase across the remainder of the policy or wait to receive an invoice at audit time. Either way, they know what the impact will be and can avoid surprises.
Some insurance carriers now offer a “pay-as-you-go” premium plan that collects monthly or pay period payroll information and invoices the policy holder for that period. There will still be an audit, but the premium adjustment should be minimal, if anything at all. This type of plan is especially beneficial to companies with seasonal operations or fluctuating payrolls.
Prepare for Insurance Audits with Confidence
The key to successful insurance audits is the same as the key to your general business success. Maintain accurate payroll and financial records, keep track of big swings in sales and employment, follow the law and best practices when it comes to record keeping, and rely on your professional service providers. Your insurance agent is your partner in protecting your business, so open communication is important to making sure audits run smoothly.
Whether you are facing your first insurance audit, or you’ve been through the process many times before, having a knowledgeable local insurance agent in your corner can eliminate a great deal of stress. Smyrl Insurance educates, nurtures, and empowers our business clients through insurance by helping them understand and prepare for the requirements associated with their business. We believe that regular communication prevents surprises and leads to managed expectations during insurance audits and renewals. If you have questions about your current policy, your upcoming audit, or one of our premium tracking options, please contact us. We are proud to serve many small, mid-sized, family, startup, and growing businesses for workers compensation, general liability, commercial property, and other types of business insurance in Hatfield, Lansdale, Souderton, Harleysville, and throughout the region in Montgomery County and Bucks County, Pennsylvania.
