Understanding a Product Liability Audit

Why No Refund?

One of the least understood aspects of a product liability audit is the perceived unfairness of why there is no refund of premium at the end of the policy period from the insurance carrier when actual sales fall short of projections.

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 $1 million in sales and the other distributor had $10 million in sales, the distributor with $10 million should receive a lower rate per $1000 of sales than the lower selling distributor.

Clearing up the confusion

Product liability insurance carriers do not offer full refunds if actual sales fall short of projected sales because of the risk of abuse by the policy holder. Overestimating projected doesn’t allow 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: The current system provides no refund when actual sales are less than projected sales.

• Projected sales are $15 million
• Based on this projection, the insurance company provide an $8.00 rate 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 $35 million.
• Based on this projection, insurance carrier provides a $6.00 rate per $1,000 of sales.
• Annual premium is $210,000
• At the end of policy period, actual audited sales are $15 million.
• Because a $120,000 refund is received from the insurance carrier, the actual paid premium is $90,000.

Making sense of it all

There is not a business person in the world who would not invest $90,000 if they could guarantee a return of $30,000 at the end of 12 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.