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Published: July 14, 2011
Author: Robert Procter
The Wisconsin Builders Association Hot Line is a service provided for the Wisconsin Builders Association by the law firm of Axley Brynelson, LLP. Legal Hot Line Answers should be considered a general statement of applicable legal information. Given this format, it is impossible to fully address all potential legal issues which might apply in any particular situation. A determination of any individual's legal rights in a transaction can only be obtained after a complete analysis of the law and its applicability to the particular fact situation. Please contact the author of the article if additional information is needed, or private counsel, if legal advice is needed.
How do insurance companies determine premiums for general liability policies and what strategies exist for addressing the computation of premiums during a premium audit? Specifically, what is the definition of “subcontractor costs” for the purpose of determining a premium basis and are the subcontractor’s costs for materials included?
A: Most insurance carriers include the costs of materials in the total subcontractor costs when determining the insured's premium basis. However, every carrier determines its premiums differently. The actual basis for determining the premium will be included in the insurance carrier’s rules and rates – this document is generally not part of your policy documents. The problem is that most insurance carriers do not tell you how they determine the total subcontractor costs until you get to the audit.
To assist your understanding of your insurance premium, here is a general explanation of how premiums are determined for Commercial General Liability (CGL) policies.
Deposit (or Advanced) Premiums versus Earned Premiums
Many businesses misunderstand how most insurance carriers determine their CGL premiums. First, there is the deposit premium (also called advanced premium). When you purchase a CGL policy, you pay the deposit premium subject to a year end audit. The “deposit premium” you pay is really only an estimate of the total expected earned premium. The insurance carrier gets information from you relating to its different premium categories (your total payroll, subcontractor sales, etc…). It uses those numbers to estimate your premium basis in each category. It then uses your estimated premium basis for a period of coverage (for example, January 1, 2011 through December 31, 2011) to determine your deposit premium. The deposit premium is what you pay in advance of your coverage.
If we asked our clients the amount of their insurance premiums, most would answer by telling us the amount of their deposit premiums.
The Earned Premium
The "earned premium" is the portion of the insurance premium that applies to the expired portion of the policy. For example, if your coverage started on January 1, 2011 and is up for renewal on January 1, 2012, the earned premium as of today would be the portion of the premium that covers the policy from January 1, 2011 through today (as of May 13, 2011 -- approximately 45 percent of the premium is earned). The earned premium is the actual premium for the insurance coverage you are purchasing from the carrier, and will not be known until after the coverage period ends (in our example above, sometime after December 31, 2011).
At the end of the coverage period, the insurance carrier will conduct a premium audit to determine the amount of the earned premium for the coverage period. If the earned premium determined by the audit is greater than the deposit premium, then you will have to pay the difference. If the earned premium is less than the deposit premium, then you will receive the difference.
Determining Premiums
To simplify, CGL premiums for general contractors are usually based on a formula that takes into account the general contractor's total payroll and the total cost of subcontracted work. However, each carrier treats the information differently. A rate is generally applied to the per $1,000 of payroll for the owners, payroll of other employees of the GC, total costs of uninsured subcontractor work and total costs of insured subcontractor work. Other factors may also be used such as land acreage for builders that are developers. For example, a builder that develops land may be subject to additional charges based on acreage of vacant land or subdivided land for development. This is a generalization – we must stress that each carrier uses its own methods and information.
Important Point 1: The rates used to determine premiums are generally set forth in your Commercial General Classification Schedule Declaration. For example, it may say:
- Premium Basis: $1,036,200 -- Total Subcontractor Costs
- Per 1,000 Rate: 0.588
- Deposit Premium: $609
A similar line item would exist for each premium basis (employee payroll, total subcontractor costs, etc...). This document should be included with your policy documents.
However, the Schedule generally does not include how the carrier determines the premium basis for a specific category. For example, this document will not tell you whether subcontractor materials are included in total subcontractor costs. Whether or not the subcontractor's materials are included in the premium basis will directly impact your rate. Thus, you have to ask for the insurance carrier’s rules and rates to find how it determines each premium basis.
Important Point 2: When your insurance agent obtains an insurance quote for you, the insurance carrier is either using your historical information or estimates to determine a deposit premium amount. If the information given to the insurance carrier is not correct or varies from the actual numbers you expect for a coverage year, the audit will catch it and the earned premium will be more than the deposit premium.
It is very important to understand the rules and rates used by your insurance carrier to determine your deposit premium prior to purchasing the coverage. In other words, you need to know what information was used by the insurance carrier to determine your deposit premium to insure that the information is consistent with what you expect for the upcoming year. For example, if the deposit premium was determined based on information that your estimated payroll is $100,000 however you know your actual payroll for the year will be closer to $250,000, then you should expect or know that at the end of the year the premium audit will catch that difference and you will owe additional amounts at the end of the year. A consumer needs to be on guard against insurance agents that submit low ball estimates to the carrier. This is sometimes done to obtain a favorable quote in order to get the business, knowing that the difference will be caught during the premium audit.
Important Point 3: You must know at the time you purchase the coverage how each premium basis is determined. This will help you know what records and documents you will need regarding payroll, subcontractors, etc… to make sure you are treated correctly at the time of the premium audit. Once you know what records and documents you will need at the time of the audit, you can maintain and obtain those records and documents through the period of coverage.
Tips for analyzing your GCL policy prior to purchase and working through the audit:
- Find out from the carrier how it determines its premium basis for each category. For example, are materials included in subcontractor costs?
- Make sure your employees are not misclassified. Different employees may have different rates for determining premiums (i.e. an in-house clerk is treated differently than a laborer).
- Make sure you know what documentation you will need to give to the insurance carrier. For example, if you need to have certificates of insurance from your subcontractors, make sure you know exactly how your carrier wants the certificate completed to make sure they are classified as insured subcontractors.
- You can negotiate everything with an insurance carrier. You can negotiate the terms of the audit and whether there even needs to be an audit (if you are big enough). At the time of the audit, you can negotiate during the audit under the threat of moving your business. However, the best time to negotiate is before you purchase the coverage.
For more information about the Wisconsin Builders Association Hot Line, contact Robert Procter at 608.283.6762 or rprocter@axley.com.
Axley Brynelson is pleased to provide articles, legal alerts, podcasts and videos for informational purposes, but we are not giving legal advice or creating an attorney/client relationship by providing this information. The law constantly changes, and our publications may not be currently updated. Before relying on any legal information of a general nature, please consult legal counsel as to your particular situation. While our attorneys welcome your comments and questions, keep in mind that any information you provide us, unless you are now a client, will not be confidential.
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