Workers comp premium audit: what it is and how to prepare

What a premium audit is

The premium you pay when a workers' comp policy starts is only a deposit. It is based on payroll you estimated for the year ahead. A premium audit is the insurer's check, after the policy ends, of what you really paid your workers and what work they really did. The insurer then works out the final premium.

If your real payroll was higher than your estimate, or some workers belong in a more expensive class code, you get a bill for more premium. If payroll was lower, you get money back. Audits are part of almost every workers' comp policy, and your policy contract (the Premium section) requires you to keep payroll records and let the insurer see them.

When the audit happens

Most audits start in the weeks after your policy expires or is canceled. The insurer usually contacts you by mail or email with a deadline. Some insurers also run interim audits during the policy year, often for larger accounts.

The insurer can come back later, too. In California, for example, the Department of Insurance says insurers can audit payroll during the policy and for up to three years after it ends. Insurers pick which policies get which kind of audit based on premium size, the type of work, and their own rules.

Types of audits

There are three common formats. The bigger and riskier the policy, the more likely you get the more detailed kind.

• Mail or online self audit: you fill out a payroll form and upload records. Common for small policies.
• Phone or video audit: an auditor walks through your records with you on a call.
• Physical audit: an auditor visits your business, looks at the books, tours the work site, and asks what each worker does.

Records to prepare

The Alaska Division of Insurance lists the records insurers normally ask for. Most insurers in other states ask for the same kinds of records. Gather them for the exact policy dates, not the calendar year:

• Payroll register or payroll ledger, by employee, with gross pay, overtime shown separately, and job title.
• Quarterly federal payroll tax returns (IRS Form 941) and your annual Form 940.
• State quarterly unemployment wage reports.
• W-2 and W-3 forms, and 1099 and 1096 forms for anyone you paid as a contractor.
• A list of every subcontractor and vendor you paid, the amount, and a certificate of insurance that covers the dates they worked.
• Time records or job cost reports that show hours by type of work, if any worker splits time between class codes.
• Owner and officer pay, plus any forms you filed to exclude owners from coverage.
• Your general ledger, check register, or bank statements if the auditor asks to tie payroll to cash paid out.

What counts as payroll

Under the payroll rules used in most states (the NCCI Basic Manual, Rule 2), payroll means money or substitutes for money paid to employees. That includes wages, salaries, commissions, bonuses, holiday, vacation, and sick pay, automatic service charges, and the value of meals or lodging given as pay.

Some pay is left out. Examples include optional tips that customers choose to leave, severance pay, employer contributions to group insurance or retirement plans, and expense reimbursements backed by records. Owners who legally chose not to be covered are left out too.

Overtime is the one most people miss. In most states the extra part of overtime pay (the half in time and a half) is not charged, but only if your payroll records show that extra pay separately for each employee and in total by class code. If your records only show total pay at the overtime rate, one third of that pay is left out. If you cannot show overtime at all, you pay premium on all of it.

Corporate officers are counted between a minimum and a maximum amount that your state sets each year. An officer with no recorded salary is usually counted at the minimum. A few states, such as California, use their own rating bureau rules, so ask your insurer or agent which rules apply to you.

How class code changes move your premium

Each class code has its own rate per $100 of payroll, and the gap between codes can be huge. Office clerical work often costs a small fraction of what roofing or framing costs. The auditor checks what each person really did, and if the work does not fit the code on your policy, the auditor can move the payroll to the right code.

You can only split one worker's pay between two codes if your records show the actual hours spent in each kind of work. Estimates or percentages are not allowed. Without those records, all of that worker's pay goes into the highest rated code that applies to any part of their work. Clerical and outside sales codes generally cannot be split at all: a person who also works in the field is not clerical. Keep daily time records if anyone moves between office and field work.

Uninsured subcontractors

If you paid a subcontractor who had no workers' comp of their own, most states treat their workers as yours for premium purposes. Under NCCI rules the auditor uses the subcontractor's real payroll if you can provide it. If not, the auditor uses the price you paid, or a set share of it that depends on the state and the type of contract. That payroll is charged at the class code the work would carry if your own employees did it.

The fix is simple: get a current certificate of insurance before the job starts, make sure the dates cover the whole job, and keep it with the contract and invoices.

Example: how an audit changes the final premium

Here is a simple example with made up rates. A small framing contractor estimated $300,000 of field payroll at a rate of $5.00 per $100, plus one office worker at $40,000 in the clerical code at $0.25 per $100. The deposit premium was $15,100.

At audit, three things change. Field payroll was really $360,000, which is $18,000 of premium. The office worker spent part of most days on job sites and there were no time records, so all $40,000 moves to the framing rate, which is $2,000 instead of $100. And the contractor paid an uninsured subcontractor $20,000, which adds another $1,000 at the framing rate.

The final premium is $21,000, so the contractor owes $5,900 more. Experience mod, discounts, taxes, and fees would change the exact numbers, but the lesson holds: growth, class code changes, and uninsured subcontractors are the three big drivers of a large audit bill.

Audits also feed your experience mod

Your insurer reports audited payroll and losses to your state's rating bureau, and that data is used to work out your experience modification rate in later years. An error in the audit can follow you for three years through your mod.

The California Department of Insurance notes that if an audit is never completed, the rating bureau may leave out the unaudited payroll when it figures your mod, which typically means a higher mod. Checking the audit closely protects both this year's bill and future rates.

What happens if you ignore the audit

Skipping or stalling an audit costs far more than the audit itself. Your insurer can cancel or refuse to renew your policy and send the unpaid premium to collections. Many states also allow an audit noncompliance charge.

The size of that charge depends on the state. In California, the Department of Insurance says an employer who does not allow an audit may owe up to three times the estimated premium. North Carolina allows up to three times the estimated annual premium, but the insurer must first make two attempts, tell you which records it needs, and tell you the amount of the charge. If you later complete the audit, the charge is refunded or credited and your premium is based on the real audit. Texas rejected this kind of charge in 2015, which shows how much the rules vary.

If you cannot meet the deadline, call the auditor and ask for more time in writing. A missed letter is much easier to fix early than after the charge is billed.

How to dispute an audit result

Audit mistakes are common, so read the bill line by line. Check the policy dates, payroll by class code, overtime, officer payroll, and any subcontractor payroll that was added. If something looks wrong, follow these steps:

• Ask the insurer for the audit summary showing payroll by class code and how the premium was figured. Delaware, for example, expects insurers to send this detail with the audit bill.
• Write to the insurer's audit department, explain each item you disagree with, and send proof such as certificates of insurance, overtime reports, or time records. Keep copies of everything.
• Pay the part of the bill you do not dispute so the policy is not canceled while the dispute is open.
• If the insurer will not fix it, use your state's formal process. In most states that use NCCI rules, NCCI's Dispute Resolution Services handles disagreements about class codes, payroll split between codes, and experience mods, and an appeals board can hear the case.
• Watch the deadlines. In Oregon, an employer insured by SAIF has 60 days from the final audit bill to appeal to the Department of Consumer and Business Services. In Delaware, you can appeal to the rating bureau during the policy or within 12 months after it ends. Tennessee sends unresolved premium disputes to the Department of Commerce and Insurance.
• If you think the insurer is not following the rules, you can also file a complaint with your state insurance department.

Ways to avoid a big audit bill

Most large audit bills come from payroll that grew without anyone telling the insurer. A few habits keep the final number close to the deposit:

• Give a realistic payroll estimate at renewal, not a low one to cut the deposit.
• Tell your agent or insurer during the year if payroll grows a lot, you hire for a new type of work, or you start using subcontractors.
• Ask about pay as you go billing, where premium is based on each payroll run, so there is less to settle at audit.
• Show overtime separately in your payroll system, and keep time records for anyone who works in more than one class code.
• Collect certificates of insurance from every subcontractor before they start work.
• Set money aside during strong growth years in case the audit bill is larger than the deposit.