As insurance advisors, we frequently encounter a common question during the underwriting process: Why do insurance companies require financial statements, and how do these documents impact the ability to obtain a quote? The need for financial statements varies depending on the type of workers’ compensation (WC) program you are pursuing. For instance, guaranteed cost programs may not require any financial documentation, while loss-sensitive programs typically mandate audited statements. Below is a brief overview of the three levels of financial statements and the purpose of the carrier’s financial review:
- Internal statements: Internal statements are generated in-house without formal external verification of their accuracy. To qualify for a guaranteed cost program above a certain premium threshold (typically around $300,000), carriers generally require, at a minimum, an income statement and balance sheet from the past two years. Since carriers assume financial risk by offering installment payment plans, they need to assess your ability to pay premiums during the policy year and during an audit, especially if the policy results in a significant additional premium. All loss-sensitive programs require, at a minimum, internal financial statements. To provide a quote, the carrier must evaluate your financial stability to ensure you can cover not only premiums but also claim expenses, retroactive adjustments, or collateral, depending on the specific loss-sensitive program you are seeking.
- Reviewed financials: Reviewed financials are statements that have undergone verification for accuracy by a Certified Public Accountant (CPA) and confirm that the financials have been correctly prepared. Reviewed financials may be required for both guaranteed cost and loss-sensitive programs, depending on the carrier’s policies.
- Audited financials: Audited financials carry the highest level of credibility. An independent certified auditor examines an entity’s financial statements and supporting documentation, compiling the results into a report that certifies the fairness of the statements and disclosures. When pursuing loss-sensitive programs, carriers typically prefer audited financials. However, the process of obtaining audited financials can be time-consuming and costly, so it’s essential to discuss the necessity of an audit with your broker beforehand, especially if obtaining a WC quote is your primary goal. Due to the credibility associated with audited financials, these statements may yield a better financial rating from the carrier compared to internal versions.
When carriers conduct their review, several factors influence your financial rating, including:
- Current ratio: A liquidity ratio that measures a company’s ability to meet short-term and long-term obligations. This is crucial for carriers assessing your capacity to pay premiums, audits, or claims.
- Cost of goods sold (COGS): The direct costs associated with producing the goods sold by a company, also known as the cost of sales. For staffing companies, this includes direct labor costs such as payroll, workers’ compensation, and health insurance.
- Operating expenses: Expenses beyond direct labor, including office staff salaries, rent, administrative costs, and professional fees. Carriers will evaluate operating expenses to compare them with similar businesses and assess the efficiency of your operations.
- Net income as a percentage of sales: This metric indicates your profit margin and impacts cash flow.
- Lines of credit or outstanding loans: These may affect your ability to post collateral.
By comparing these figures year over year, carriers can analyze trends in your financials and determine whether they are willing to make a long-term commitment by offering a quote. Although policies are typically written on an annual basis, carriers prefer to establish programs with the potential for longevity, especially when collateral is involved. For more information on the financial statements required for your workers’ compensation insurance, contact Marsh McLennan Agency today.
