As insurance advisors, we come across a very common question in the underwriting process: Why does an insurance company need financial statements and what impact does it have on the ability to obtain a quote?
Depending on the type of workers’ compensation (WC) program you’re pursuing, the requirement for financials varies. Guaranteed cost programs may not require any financials; whereas, a loss sensitive program usually always requires audited statements. Here’s a quick rundown on the three levels of financial statements and the purpose of the carrier’s financial review:
1. Internal Statements
Internal statements are generated in-house with no formal external review for accuracy.
To secure a guaranteed cost program above a certain premium threshold (typically around $300,000), carriers usually will require, at minimum, an income statement and balance sheet for the past two years. Carriers take on the financial risk by providing an installment payment plan and need to see your ability to pay premium during the policy year and during an audit should the policy yield a significant additional premium.
All loss sensitive programs require, at minimum, internal financial statements. To offer a quote, the carrier needs to see financial security in your ability to pay not only premium, but also claim expenses, retro adjustments or to post collateral depending on the type of loss sensitive program you’re seeking.
2. Reviewed Financials
Reviewed financials are financial statements for which accuracy has been verified. A CPA reviewed the statements and verified it has been correctly prepared.
Reviewed financials could be required for a guaranteed cost or loss sensitive program. The requirement for reviewed financials depends on the carrier.
3. Audited Financials
Audited financials have the highest level of credibility. An independent certified auditor examines an entity’s financial statements and accompanying documentation. The results are compiled in a report that certifies the fairness of the statements and disclosures.
When seeking loss sensitive programs, carriers prefer audited financials. However, there’s significant time and cost that goes into audited financials, so it’s important to discuss the need with your broker prior to undergoing an audit (if a WC quote is your sole purpose for obtaining one). Because of the credibility with audited financials, it’s possible the same statements audited will yield a better financial rating from the carrier than internal versions.
When a carrier performs their review, some elements that determine your financial rating are:
- Current Ratio: a liquidity ratio that measures a company’s ability to pay short-term and long-term obligations. This is important when a carrier is determining your ability to pay premium, audits or claims.
- Cost of Goods Sold (COGS): the direct costs attributable to the production of “goods sold” by a company, also referred to as the cost of sales. For a staffing company, this is direct labor – payroll, WC, health insurance, etc.
- Operating Expenses: expenses other than direct labor – office staff, rent, administrative expenses, professional fees, etc. Carriers will review operating expenses to see how these stand in relation to similar businesses and how efficiently the company operates.
- Net Income as a % of Sales: indicates your ultimate profit margin and impacts cash flow.
- Lines of Credit or Outstanding Loans: may have an influence on your ability to post collateral.
Comparing these figures from one year to the next helps the carrier analyze what direction your financials are trending and whether they’re willing to make a long-term commitment by offering a quote. Although policies are written on an annual basis, carriers ultimately want to write a program with potential to continue for many years, which should also be a consideration, especially when there’s collateral involved.
For more information on requested financial statements, contact a Marsh McLennan Agency (MMA) advisor today.
