Introduction to Premium Audits

In the world of casualty insurance, particularly for Workers' Compensation and Commercial General Liability (CGL), the risk exposure is often tied to business activity that fluctuates. Because an insurer cannot predict exactly how much payroll a company will issue or how many sales it will generate in the future, they use a mechanism called a Premium Audit.

A premium audit is the process where an insurance company reviews a policyholder's records at the end of a policy period to determine the actual exposure that existed. This ensures that the premium charged accurately reflects the risk the insurer assumed. This is a critical concept for anyone preparing for the casualty exam, as it dictates how final costs are calculated for commercial clients.

Standard Exposure Bases

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Workers' Comp
Payroll (Remuneration)
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General Liability
Gross Sales
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Premises Liability
Total Square Footage
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Specialty Risks
Number of Units

The Deposit Premium and Estimated Exposure

When a policy is first issued, the insurer calculates a Deposit Premium (also known as an advance premium). This is based on an estimate provided by the insured. For example, a construction company might estimate that their total payroll for the upcoming period will be a specific dollar amount.

The insurer applies the manual rate to this estimate to arrive at the initial payment. However, this is not the final cost. The policy document includes a condition stating that the final premium will be determined after the policy period ends based on an audit of the actual figures. You can practice identifying these policy conditions in our practice Casualty questions.

Deposit Premium vs. Final Premium

FeatureDeposit PremiumFinal Premium
TimingPaid at the start of the policyCalculated after the policy expires
BasisEstimates and projectionsActual verified records
PurposeProvides immediate coverageTrue-up of actual risk exposure
AdjustmentSubject to changeResults in bill or refund

The Audit Process and Record Keeping

During a premium audit, the insurer has the right to examine the insured's books and records. This is a standard policy condition. The auditor typically looks at:

  • Payroll Records: Tax filings, individual earnings, and overtime (often overtime is handled differently in premium calculations).
  • Ledgers: To verify gross sales or receipts for CGL policies.
  • Subcontractor Records: To ensure that subcontractors have their own insurance; if they don't, the primary insured may be charged premium for that exposure.
  • Job Descriptions: To ensure employees are classified correctly under the proper NCCI or state-specific class codes.

If the audit reveals that the actual exposure was higher than the estimate, the insured receives an Additional Premium bill. If the exposure was lower, the insurer may issue a Return Premium (refund), subject to any minimum premium requirements stated in the policy.

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Exam Tip: The Right to Audit

On the Casualty exam, remember that the insurer's right to audit is a contractual condition. The insurer typically has the right to audit the records during the policy period and for a specific duration after the policy has expired (usually 36 months). Failure to comply with an audit can lead to heavy penalties or non-renewal of coverage.

Frequently Asked Questions

If an insured refuses an audit, the insurer may issue an 'Estimated Audit' which often includes a significant penalty increase (sometimes up to 200% of the original premium) and may lead to policy cancellation or non-renewal.
Generally, while the total pay is reviewed, the 'overtime premium' (the extra half-time paid for hours over forty) is often excluded from the payroll calculation, provided the employer's records clearly separate regular pay from overtime pay.
In casualty insurance, if a subcontractor is uninsured, the law often treats them as an employee of the general contractor for liability purposes. Therefore, the insurer will charge the general contractor a premium for that subcontractor's payroll unless certificates of insurance are provided.
No. Premium audits are primarily a feature of commercial casualty lines like Workers' Comp and General Liability where the exposure base is variable. Personal lines usually use fixed characteristics (like vehicle type and driver history) that do not require post-period auditing.