One of the least understood things about product liability audits is the perceived unfairness of why there is no refund of premium at the end of the policy period from the insurance carrier, if actual sales fall short of projected sales.

An important point with product liability insurance is – the more sales you have the lower rate per $1000 of sales you deserve. In other words, if you have two distributors that sold the exact same products and one distributor had $1M in sales and the other distributor had $10M in sales, the distributor with $10M in sales should receive a lower rate per $1000 of sales than the distributor with $1M in sales.

The primary reason product liability insurance carriers do not offer full refunds, if actual sales fall short of projected sales, is it opens up to much of an opportunity for abuse by the policy holder by over estimating their projected sales and therefore, causing the insurance carriers to not earn a fair rate of return for the overall risk.

To better understand this point, see the two hypothetical illustrations below:

Illustration 1 – Based on current system in which no refund is provided if actual sales are less than projected sales.

• Projected sales are $15M
• Based on this projection, the insurance company provide you with a $8.00 per $1,000 of sales
• Annual premium or Minimum and Deposit Premium is $120,000

Illustration 2 – Insurance Carrier provides a full refund if actual sales are less than projected sales.

• Projected sales are $35M.
• Based on this projected sales, your insurance carrier provided you with a $6.00 rate per $1,000 of sales.
• Annual premium is $210,000
• At the end of policy period your actual audited sales are $15M.
• Because you receive $120,000 refund from the insurance carrier, actual paid premium is $90,000.

If the insurance carriers would offer full refunds when actual sales fall short of projected sales, there is not a business person alive today that would not invest $90,000, if they could guarantee a return of $30,000 at the end of twelve months.

Of course, the information above is an oversimplification and applies almost exclusively to Excess/Surplus product liability policies.  Excess/Surplus insurance carriers are responsible for providing product liability policies for most of the high risk products on the market and those products that may be unique or new to the market and not insurable by the admitted market insurance carriers. 

I am not completely sure, but I have a pretty good idea why business owners hate insurance premium audits so much. It has to do with a combination of feeling they are being taxed for their success, imposition on valuable time and privacy being invaded. 

But be warned, if you are a business owner reading this blog, not cooperating with an insurance auditor rarely works in your favor.

The first thing every business owner or officer should realize is, the auditor assigned to conduct the audit for the insurance carrier is typically paid by the job and not by the hour. So the longer you put off the auditor, the more likely the auditor will simply declare your account “uncollectible or uncooperative”. Once this happens, your frustion level is now guaranteed go up by about 1000% and the following four things are likely to happen:

1. If you are lucky and can convince the auditor to come back out to perform the audit, you may find an auditor with little patience and unwillingness to hash out the small details that could save you money.
2. The insurance company performing the audit may multiply your previously projected sales by two and send you a bill for the additional premium.
3. If you renewed your insurance with the same insurance carrier that tried to unsuccessfully audit your business, the insurance carrier may elect to cancel your existing insurance policy.
4. The insurance carrier will turn he the debt over to a collections agency.

If you are thinking – “I will just get my insurance from another insurance company”, be aware that most insurance carriers will not want to work with a business that has been non-renewed because of a year end audit. This is a ‘red flag” that you are a problem client and will likely have the same problems with them, since sales audits are standard operating procedure in the product liability industry.