Viewpoint: Premium Audits Help Insurers Navigate Regulatory Compliance

By Robert Sherman | July 10, 2024

Leading carriers and managing general agents (MGAs) are increasingly seeking to assess their premium income via audits to ensure exposures are reported accurately, while tackling potential premium leakage and addressing possible non-compliance with state regulatory and rating bureau guidelines.

How can the industry effectively navigate this regulatory minefield?

Ensuring Accurate Exposure Reporting

Accurate reporting of exposures is the cornerstone of premium audits, which are conducted in order to determine the exposure basis for an insurance policy – such as payroll, sales, or vehicle count – at the end of a policy period in order make a final calculation of premium and premium taxes, according to a definition from the International Risk Management Institute. The Rating Bureau requires yearly audits, and while some carriers may waive them, the threshold for estimated or waived audits is low in the industry.

Agents also stand to gain from accurate reporting, as their commissions are often adjusted based on the revised exposures calculated during the audit.

The audits ensure that the right premiums are charged, reflecting the actual risk insured. This accuracy benefits not only the insurers but also the policyholders and their agents. For the policyholders, paying the correct premium means they are not overcharged and can potentially benefit from downstream cost savings through appropriate experience modification adjustments.

Agents also stand to gain from accurate reporting, as their commissions are often adjusted based on the revised exposures calculated during the audit. Moreover, accurate exposure reporting informs the future rate-making process of states and helps carriers apply appropriate loss cost modifiers. This, in turn, affects the earned premium, influencing loss ratios and combined ratios, which are vital for larger enterprise-wide decision-making.

The importance of accurate exposure reporting is underscored by data from the National Council on Compensation Insurance (NCCI), which shows that incorrect classifications and underreported payrolls can lead to significant discrepancies in premium calculations.

A study by the Century Foundation found that worker misclassification has a direct impact on higher workers’ compensation insurance premiums, stating: “As misclassification is fundamentally a process to evade required taxes and insurance, it is revealing that the three Northeast states (Vermont, Connecticut, and New Jersey) with the highest estimated rates of misclassification are also in the top five in the country in terms of the cost of workers’ compensation insurance premiums.”

Tackling Potential Premium Leakage

Premium leakage remains a significant challenge in the insurance industry. It often occurs due to misclassification of workers, underreporting of payroll, and the use of uninsured subcontractors. A common issue is the misclassification of subcontractors and independent contractors, particularly in states with stringent classification tests like California’s ABC test, which is used to determine whether a person is an employee or an independent contractor. Ensuring subcontractors have proper workers’ compensation coverage and validating their levels of independence is crucial.

Another area of concern is the interchange of labor, where employees are classified incorrectly according to state manual rules. Detailed interviews with business owners and officers to understand their duties and levels of management can help apply the correct classification codes. Accurate documentation of job duties and the defense of all classifications is essential. Additionally, understanding temporary staffing and labor broker agreements is crucial for assigning appropriate classifications.

Data from the Coalition Against Insurance Fraud indicates that workers’ compensation premium fraud costs insurers an estimated $25 billion annually. Addressing premium leakage through thorough audits can significantly reduce this financial burden. For example, substantial financial gains are achievable through productive audit practices, which can help transform a negative return premium – where a carrier is at risk of missing critical information at the time of audit (hidden exposure, subcontractors etc.), which in turn decreases the premium amount. This could have adverse effects on expense and loss ratios, thus having a direct impact on combined ratios and overall profitability.

Addressing Non-Compliance Issues

Non-compliance with state and regulatory bureau guidelines is a pervasive issue that can lead to severe penalties and financial losses for insurers. Proactive measures are essential to address non-compliance, starting with educating policyholders throughout the lifecycle of the policy. Premium audits often serve as one of the few touchpoints with customers, making it crucial to communicate the benefits of compliance clearly.

This is a time where the customer works directly with the carrier auditor or third-party audit firm. They will receive electronic or physical mail requests for information, requests to upload material to portals and fill out worksheets etc. Therefore, it is important that the carrier thinks of the process through a lens of customer experience and success as it could be the only time they are talking with a customer through the life of the policy.

While non-compliance surcharges and potential non-renewal or cancellation are traditional tactics, focusing on the customer’s experience and showcasing the benefits of compliance can be more effective. Customer journey mapping can identify critical touchpoints, ensuring that the premium audit process enhances rather than detracts from the customer relationship.

Engaging with state bureaus and industry associations such as the National Society of Insurance Premium Auditors (NSIPA) can provide valuable insights into best practices and regulatory updates. Being part of these networks helps insurers stay ahead of potential compliance issues and adopt industry-leading practices.

A proactive approach to compliance can also involve leveraging technology. Remote and AI-powered auditing solutions are becoming more prevalent, offering increased accuracy and efficiency. These tools can analyze large datasets to detect patterns and anomalies, providing a robust defense against non-compliance and fraud.

Ensuring Best Practice

The role of premium audits in the U.S. insurance industry is more critical than ever – a yearly audit is recommended and a substantial requirement at the rating bureau level. Ensuring accurate exposure reporting, tackling premium leakage, and addressing non-compliance are fundamental to maintaining financial stability and fostering trust with policyholders. By adopting thorough and proactive audit practices, insurers can mitigate risks, enhance accuracy, and ultimately drive better financial outcomes.

However, the path forward requires decisive action. Insurers must be proactive in implementing rigorous premium audits and maintaining stringent checks and balances to prevent non-compliance and financial losses. This proactive stance involves investing in advanced auditing technologies, engaging in continuous education for policyholders and agents, and fostering strong relationships with regulatory bodies and industry associations.

The stakes are high: inaccurate reporting, unchecked premium leakage, and non-compliance can lead to significant financial and regulatory repercussions. Conversely, a robust premium audit framework can not only protect against these risks but also unlock substantial financial gains, as evidenced by operational transformations seen by Pro Global that yielded up to 18% additional premium on productive audits.

Insurers can set higher standards for their premium audits by adopting the following practices:

  1. Investing in technology: Leveraging AI-powered auditing solutions to enhance accuracy and efficiency.
  2. Educating stakeholders: Providing ongoing education to policyholders and agents about the benefits of accurate reporting and compliance.
  3. Engaging with regulators: Building strong relationships with state bureaus and industry associations to stay ahead of regulatory changes and best practices.
  4. Implementing rigorous checks: Establishing comprehensive audit processes to detect and prevent premium leakage and non-compliance.

The time to act is now. By prioritizing these measures, insurers can safeguard their financial health, improve customer satisfaction, and strengthen the integrity of the insurance industry. The commitment to proactive premium audits and stringent checks and balances will not only prevent financial loss but also ensure a more resilient and trustworthy insurance ecosystem.

Topics Carriers Legislation

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