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When companies hear the word “audit,” this can send chills down their spine.
Audits can be nerve-wracking, bone-flinching, and anxiety-ridden.
Before you start thinking your insurance company is solely out to collect your hard-earned money, this article might be able to shed some light.
Don’t leave just yet!
Workers Compensation Audit: The Truth
It’s a known fact that workers compensation audits can save you from paying too much for your workers compensation premium.
How so?
Workers compensation audits provide a ton of payroll information, data, and labor codes you might miss if you perform the audit yourself.
Sure, there might be small, common errors here and there, but neglecting these and being unaware of these errors only spells trouble for your company.
Insurance companies make sure the estimated payroll matches the actual payroll and scope of work during the policy period.
After all, when your first workers compensation policy is being set up, your policy premium is only based on an estimated calculation.
The results and data collected during the audit and policy period will reveal the right workers compensation premium your company should be charged with.
In other words, accurate data is critical in the audit process, down to every last penny.
Now here comes the truth.
Should there be errors within your estimation and calculations, without a workers comp audit, you might be paying more than needed.
Meaning, you could be paying for a higher workers comp premium when in truth, you should be paying a lower amount.
Workers compensation audit errors are common in businesses, and it’s only normal to feel resistance towards a work comp audit.
However, workers compensation and your insurance company are simply two peas in a pod working together to bring the right workers comp premium for your company.
When to Expect a Workers Compensation Audit
Insurance companies send a notice ahead of time informing your company that your workers compensation premium audit is due within X days.
Some companies provide a 35-day timeframe, while others might offer a longer or shorter timeframe.
It’s also important to remember that work comp audits are not performed randomly. These are mandatory annual reviews once a company has a workers compensation policy.
In case your workers compensation policy is canceled, a workers compensation audit will still take place but only for the policy period you had workers compensation coverage.
How Is a Workers Compensation Audit Scheduled?
This depends on your insurance company.
Your insurance company may notify you through email, phone, or directly. Nevertheless, rest assured, your insurance company will notify you ahead of time.
Before we dive into how to prepare for a workers comp audit, let’s discuss the documents you need and the types of workers compensation audits.
Types of Workers Compensation Audits
The type of workers comp audit depends on the size of your premium and nature of your business operations.
A more complicated business and larger premium will most likely require a physical audit.
Physical Workers Compensation Audit
A physical audit is a workers comp audit performed at the location of your business or office.
Once your workers compensation policy expires, a premium audit is requested within 60 days after your policy expiration date.
During this period, a premium auditor will notify you by phone or email and schedule an appointment.
Take note, though. It’s crucial to complete your audit and submit it to your auditor within the given timeframe.
If you submit all the requirements beyond the requested timeframe, your insurance company may charge a higher audit bill and possibly, add 25% more to the original payroll.
Voluntary Workers Compensation Audit
Unlike a physical audit, a voluntary workers comp audit is done by mail. The audit form is mailed within 60 days your workers compensation policy expires.
It’s also imperative to complete the audit form within the given timeframe.
The form sent by your insurance company will contain information related to classification codes [R] shown in your policy and will ask you to verify the actual payroll exposure for each job class.
It’s also possible that your insurance carrier will request additional documents and tax returns or reports.
Furthermore, a voluntary type of audit can be more complicated than a physical audit. For someone who has never completed an audit, filling up this form may be confusing.
In cases like these, it helps to ask your auditor or insurance company for help. Ensuring the accuracy of the information provided will determine the final audit premium and policy of your company.
So, Which Audit Type Is Better?
Neither one is truly better than the other. As mentioned earlier, this depends on the nature of your business operations, size of your premium, and the workers compensation insurance policies in place.
Some companies may offer to do a phone audit where your insurance company will perform the audit remotely.
Phone audits may be a better option for some; however, your insurance company may not provide this type of audit either.
Field audits, or physical audits, are a preferred method for businesses starting out.
Between the two types of audits, field audits have the advantage of transparency and improved communication since the audit process is performed with both parties present at the same place.
Step-by-Step Guide to Prepare for a Workers Compensation Audit
In this section, we’ll guide you through some steps to prepare you for the days leading to the audit along with the documents needed to comply with your insurer.
Step 1: Schedule Your Audit
Earlier, we discussed the two types of audits an auditor may perform on your business (physical and voluntary audits).
You’re already aware the audit type depends on your insurer, premium, and operations. However, there are 2 additional types that may happen:
- Preliminary audit – It’s possible your insurer will conduct a preliminary audit on-site when you first apply for workers compensation insurance. This audit will help determine your initial premium.
- Interim audit – In the event your business changes operations, your insurer may ask for an interim audit. This is also one approach or method your insurer will use if employers want to pay for their workers compensation insurance every quarter.
Step 2: Collect and Prepare Any Records & Documents Needed
Workers comp audits require a lot of documents on your part to ensure the verification leads to accurate results.
Also, workers comp costs are based on your risk, payroll, and claims history, so your insurance carrier and the auditor will need certain documents to verify the information.
Below, you’ll find a list of requirements needed for the workers compensation audit. Your insurance company may request for all, if not some, of the requirements listed below:
General Information
- Job descriptions of each employee
- Descriptions of company or business operations
- Number of employees in each location
- Scope of work performed by subcontractors and contractors
- Business owners names and titles
Payroll Records
- Your checkbook (Only submit this if this is your only form of keeping records)
- Accounting ledger
- Individual Earnings Records
- State Unemployment Tax Reports
- Payroll Journal and Summary
- Form 1040 – Federal Profit and Loss from Business Schedule C
- Form 944 – Federal Employer Annual Tax Return
- Form 940 – Federal Employer Annual Unemployment Tax Return
- Federal Tax Report 941’s – reports that cover the audit period
- All overtime payroll information
Employee Records
- Number of Employees
- Hours, Days, and Weeks your employees worked annually
- Detailed explanations of job duties for every employee
Cash Disbursement Records
- Payments made for materials
- Payments made for labor
- Payments made to subcontractors
Certificates of Insurance
- For all independent contractors
- For all subcontractors
Experience Modification Worksheets
- Useful for verifying your auditor applies the correct E-MOD to your policy (if applicable)
Detailed Description of Your Business
- Useful for justifying workers compensation classification code
The list we provided is a general list of requirements your auditor will ask for. Make sure to provide your auditor and insurance company only what is asked for.
The faster the audit process goes, the better it will be for you and your insurance company. Additionally, it helps to identify or know what you should include or what counts as payroll.
What Is Part of Payroll Records?
Payroll is the starting point of your workers comp premium, so it’s crucial to know what counts as payroll and what doesn’t. [R]
The following items below outline what payroll includes:
- Total commissions
- Gross wages and salaries
- Bonuses
- Overtime, Holiday, Vacation, and Sick Leave Pay
- IRA’s, savings plans, and 401k contributions
- Allowances allocated for tools that employees use for work
- Meals and lodging included in an employee’s salary
- Payments made to Social Security
- Payments made based on factors apart from the time worked
What Is Excluded From Payroll Records?
Many states exclude certain payments that aren’t counted as payroll. These include:
- Group insurance payments
- Reimbursements for business expenses
- Severance pay
- Tips and gratuities
- Uniform allowances
- Active military duty pay
- Discounts for employees on goods and services
- Special rewards for new inventions
Before finalizing your list, make sure to verify this with your auditor so that it’s not included in your total payroll.
Finally, business owners’ salaries are typically not included in a workers compensation audit since the owners themselves do not have workers compensation insurance.
However, some states may offer workers compensation coverage for the owners and will be treated differently from an employee’s salary.
Step 3: Update Job Descriptions
While most information regarding your payroll is indeed vital to a premium audit, the job description of each employee is just as important too.
Why?
Because job descriptions determine the appropriate class code for your business.
In effect, each class code corresponds to a base rate used to determine costs. Job classification codes are more essential than you would think.
If your auditor receives the wrong job classification code, you might be charged for the wrong premium.
To calculate workers compensation insurance costs, use the formula:
Rate assigned to your class code x experience modification rate x payroll/100 = premium
For example,
Your company’s payroll amount is $150,000 and your auditor assigns your business to class code 2121. A class code of 2121 corresponds to a base rate of $3.11.
With an experience modifier of 1, the formula is as follows:
3.11 x 1 x $150,000/100 = $4,665.00
This means $4,665.00 is your workers comp costs per year.
It’s important to note that class codes vary. Not all class codes have the same base rate. If you have a clerical employee, for example, the class code would be 8810.
Furthermore, clerical employees are not part of the governing class codes and are given a separate rate. In this case, the base rate of a clerical employee is $0.20.
Since the payroll amount of clerical employees per year is $40,000, we apply this to the formula and get:
$0.20 x 1 x $40,000/$100 = $80.00
If we add this to the example we presented earlier, your base workers’ comp premium would be $4,745.00
Providing your auditor with the right job descriptions ensures an accurate assessment.
Don’t overlook the job descriptions of your employees. Take the time to review each one and if you don’t have one yet, make sure to create one to ensure accurate work comp rates. [R]
Step 4: Review All the Information
Once you’ve submitted all the information, make sure to review the auditor’s work.
This ensures that it matches the information you have on your end.
Things to review include:
- Governing classification – Your governing classification should accurately match your original workers comp policy. If your business went through a major overhaul, you’ll have to take note of all changes made and check your workers comp policy diligently.
- Additional classifications – Check whether you have standard exception classes or job descriptions to note in your policy. For a construction business, you can use multiple class codes for individual employees.
- Payroll audit data – Ensure the payroll data matches the payroll from your accounting department.
- Experience modifier – Generally, most states prohibit insurers from changing the modifier during the policy term. If your auditor changes it, ask them why.
After you’ve performed the review, all that’s left is to sign the paperwork. The paperwork is to ensure you’ve taken part in the audit, understood the terms, and will also reveal the audit billing statement.
If the audit was performed through the phone or remotely, your insurer will send you a summary of the auditor’s findings by mail.
Finally, if you find the results do not match the accuracy of the information you have on your end, contact your insurer immediately.
Common Mistakes to Look Out For
The reason why accuracy in audits is important is because errors and mistakes may lead to you being charged with an additional premium. [R]
However, an additional premium does not necessarily mean the auditor made a mistake. Identifying the mistakes made in premium audits will help reduce the cost of worker compensation premiums.
Here are some mistakes worth noting:
- Including payroll items that shouldn’t be included
- Including exempted workers in the payroll
- Charging an insured subcontractor
- Using the wrong class code
Whether it’s a voluntary or field audit, it’s crucial to identify these mistakes ahead of time.
Are You Required to Undergo a Workers Compensation Audit?
As long as you have workers compensation insurance policy or apply for one, it’s necessary to undergo a premium audit.
The National Council of Compensation Insurers (NCCI) states that the policyholder should allow an audit anytime within a 3-year time period of the policy expiration date.
Who Qualifies As An Independent Contractor?
Independent contractors provide a service to a business for a predetermined price. However, independent contractors work under their own terms and usually have more than one customer.
Be sure to save copies of contracts or any invoice of each contractor. You may be required to show a breakdown of labor and materials so this will come in handy.
Tips for a Workers Compensation Audit
- Gather all current certificates of insurance for all subcontractors paid during the policy period. Without it, you’ll be charged extra.
- Separate records of employees with overtime pay from employees paid by class codes.
- During the audit, bring someone who is knowledgeable about the business.
- Don’t give out too much information. Be direct and straightforward with your answers.
Conclusion
- Before you go, it helps to choose an insurance company you know you can trust. Choosing the right insurance company will also influence how the auditing process will be conducted.
For any more questions, let us know in the comment section below.
