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Surprise Audits and Financial Burden Disrupting Your Franchisees' Business?

Imagine this: your franchisee  , who has been diligently following your guidelines and growing their business, receives a notice of a large carrier audit. The result? A hefty, unexpected payment that they didn't plan for. The financial strain is immense, leading to frustration and tension within your network. Unfortunately, this scenario is all too common in the world of franchising insurance.

As a franchisor, you feel the immense frustration when your franchisees are blindsided by these audits. The financial burden can be overwhelming, creating distrust and potentially jeopardizing the stability of your network. This blog will delve into the specific challenges and foreseeable pitfalls associated with insurance audits, offering expert advice and real-world scenarios to help you navigate these turbulent waters.

By reading this blog, you'll gain valuable insights into the complexities of insurance audits, understand how to better prepare your franchisees, and learn strategies to mitigate the financial impact. Our goal is to provide you with practical advice and expert guidance to strengthen your network and build trust with your franchisees.

One common scenario involves a franchisee in the home services sector, such as plumbing, painting, or roofing. These industries often face unpredictable variables, from fluctuating material costs to varying labor rates. When an audit reveals discrepancies between estimated and actual payroll, the resulting financial adjustment can be staggering. This unexpected cost can disrupt cash flow, strain relationships, and even threaten the viability of the business.

The key to accurate payroll estimations is critical. One major area of concern is the use of subcontractors. Franchise owners must be firm and consistent with:

  1. Requiring Subcontractors to Have Insurance in Place: Ensure that all subcontractors working on a project have their own insurance. This protects the franchisee from being held liable for any incidents that may occur and prevents the need to include the subcontractor’s payroll in their own insurance calculations.

  2. Collecting Proof of Insurance: Franchise owners should collect a certificate of insurance from every subcontractor and keep it on file. This certificate serves as proof that the subcontractor has the necessary coverage. If a subcontractor does not have insurance, the franchise owner will need to include the subcontractor's payroll in their insurance estimations. This common issue often leads to franchise owners paying thousands of dollars in unexpected audit adjustments.

  3. Responsibility for Uninsured Subcontractors: If you do decide to use a subcontractor that doesn’t have insurance, be aware that you are then responsible for them as well as any additional premiums. This can significantly increase your costs and the risk of financial strain during audits.

Real-World Case Study: Failed to Collect Subcontractor Proof of Insurance 

Consider the case of a franchisee in the roofing industry. This franchisee hired several subcontractors to complete a large project but failed to collect proof of insurance from them. At the end of the year, during a routine carrier audit, it was discovered that these subcontractors did not have their own insurance. As a result, the franchise owner was required to list the subcontractor's expenses as part of their 1099 payroll.

Because the subcontractors' payroll was not originally included in the estimated payroll for the insurance policy, the audit revealed a significant discrepancy. The risk associated with the uninsured subcontractors was passed along to the franchise owner's policy, resulting in an additional premium of several thousand dollars. This unexpected financial burden created a cash flow crisis, strained relationships with the subcontractors, and added stress to the franchise owner's operations.

Insurance policy premiums are based on one of the following factors:

  • Annual Revenue

  • Annual Payroll, broken down by job type (e.g., Installer vs. Sales vs. Clerical)

  • Subcontractor Cost (including material cost purchased by the subcontractor)

The policy premium is determined by an estimated dollar amount for each of these categories for the next 12 months, so it's crucial to get these estimates as accurate as possible. Inaccurate estimates can lead to substantial adjustments during audits, causing financial strain and operational disruption.Real-World Case Study: Verifying Subcontractor Insurance

Consider the case of a franchisee in the construction industry who followed best practices for verifying subcontractor insurance. Before beginning any project, the franchisee implemented a standardized process for collecting and verifying insurance documentation.

When to Collect Proof: The franchisee required proof of insurance before any subcontractor began work. This proactive approach ensured that all necessary documentation was in place and verified well in advance of project commencement. This makes completing a carrier audit far easier than having to chase down COI’s after-the-fact. Not to mention, avoiding unfortunate scenarios where a subcontractor turned out to be uninsured, underinsured, or lapsed in coverage.

What Information to Verify: The franchisee checked the following details on the certificate of insurance:

  • Coverage dates to ensure the policy was active for the duration of the project.

  • Policy limits to confirm they met the minimum requirements specified in the contract.

  • Types of coverage, including general liability, workers' compensation, and automobile liability.

  • The subcontractor's name matched the business name on the contract.

Common Mistakes to Avoid: Despite their diligence, the franchisee initially made some common mistakes, such as:

  • Accepting certificates of insurance without verifying the authenticity of the issuing insurer.

  • Failing to follow up on certificates that were about to expire during long-term projects.

  • Not confirming that subcontractors listed their company as an additional insured on their policy.

The franchisee learned that carriers would need proof of subcontractor insurance during audits. Without this documentation, the carrier would include the subcontractor’s expenses in the owner’s payroll, leading to higher premiums.

By adhering to these best practices, the franchisee avoided substantial financial penalties during the audit. They ensured all subcontractors had valid insurance, and they maintained organized records to present to auditors.

Accurate payroll estimations help avoid these costly surprises. Here are some key points to consider:

  • Accurate Payroll Estimations: Ensure your franchisees have a clear understanding of how to estimate payroll accurately. This includes considering factors such as overtime, seasonal variations, and part-time employees. Misestimations can lead to significant financial adjustments during audits.

  • Regular Communication: Maintain open lines of communication with your franchisees regarding their insurance policies and any potential changes. Regular check-ins can help identify and address issues before they escalate. Educate franchisees on the importance of accurate and timely record-keeping.

  • Proactive Planning: Encourage your franchisees to engage in proactive financial planning. This includes setting aside funds for potential audit adjustments and working closely with their insurance consultants to understand potential risks. Having a financial cushion can help absorb unexpected costs without severely impacting the business.

  • Expert Consultation: Recommend that your franchisees seek expert advice from knowledgeable insurance consultants. These professionals can provide tailored guidance and support to navigate the complexities of insurance audits. They can also assist in verifying the insurance coverage of subcontractors and ensuring that all documentation is properly maintained.

Any changes in expense estimates from any of the three categories—Revenue, Payroll, or Subcontractor Cost—should be promptly reported to Rikor to update your exposure. The sooner you make appropriate changes, the more monthly installments will be available to break up any additional premium. This proactive approach helps manage financial impacts more effectively and prevents large, lump-sum payments that can disrupt your franchisees' operations.

In conclusion, the financial burden of surprise audits can be daunting for your franchisees, but with proper preparation and expert guidance, these challenges can be mitigated. By fostering a culture of transparency, proactive planning, and regular communication, you can help your franchisees navigate the complexities of insurance with confidence.

If you or your franchisees are facing advanced insurance challenges, we recommend reaching out to a knowledgeable expert. Contact your franchise insurance consultant at Rikor via email for personalized advice and support.

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