The audit is the final word on the true cost of your Workers’ Compensation and General Liability. It’s critical that you understand the mechanics of the audit and that you prepare for it throughout the entire policy year so that you don’t make costly mistakes that can result in your getting slammed with a huge audit bill that can be thousands of dollars and even higher. I’ve seen builders get hit with unexpected audit bills exceeding $20,000.
Lets cover some of the basics. Both your Work Comp and General Liability polices are subject to audit. You may also have a Builders Risk policy that’s subject to audit but that’s a topic that we’ll take up on a different article.
Under both Work Comp and General Liability, the risk of loss fluctuates with the amount of work that’s performed by a builder. The more work, the greater the risk of a claim and the corresponding need for your insurance carrier to collect more premium. The insurance industry figured out that the best way to account for the risk of claims and the corresponding need to collect premium is to tie them both to payrolls paid to employees and amounts paid to uninsured subs. In addition to these factors, the General Liability policy also tracks amounts paid to insured subs as well as number of rental dwellings and acreage of vacant land and real estate development property.
Because no builder knows for sure the amount of work that he’ll perform over a 12 month policy year, the Work Comp and General Liability policy premiums were designed to expand and shrink to take into account the actual work that ended up being performed during the 12 month policy year. This way, both the insurance carrier and builder get the exactly what they deserve in terms of matching the risk of loss with the premiums that are paid to offset such risk of loss.
When you meet with your insurance agent to either start a new policy or to get a renewal quote, he’ll ask you to estimate your payrolls, amounts paid to uninsured subs, amounts paid to insured subs, and so forth. Based on your estimates, the agent provides a quote and when you accept the quote, your policies are issued based on the work estimates that you provided.
After the policy year ends, you’re audited to determine your actual payrolls, amounts paid to uninsured subs, amounts paid to insured subs and so forth. Next, you’re presented with a Final Audit Bill which compares the estimates that you’ve already paid for against the actual figures. You’ll either get a refund if you overestimated or you’ll owe an additional premium if you underestimated.
Just a word of caution here. Some builders like to intentionally underestimate their work projections on policy set up to play a cash flow game. However, this is dangerous because such builder may not be able to pay a large audit bill that will be due in full within 30 days of receipt. This will result in cancellation of the existing policy as well as dealing with collection agencies. Once you’ve been cancelled for non payment of premium with one carrier, it’s unlikely that any other carriers will want to voluntarily insure you. Taking a risk to gain a cash flow advantage doesn’t make sense in my opinion because almost all carriers offer low or no interest payment plans that will allow the builder to spread the insurance costs over many months. Also, many Work Comp carriers now offer a monthly self reporting form so that premium payments can be matched to the exact amount of work that’s performed on a monthly basis.