If you pay for workers' compensation insurance, you know an insurance audit can keep you up at night—especially if you're anticipating a soul-crushing bill. Unfortunately, you can't make an audit magically vanish into thin air. But you can make it more manageable and less daunting.
Let's take a deep dive into how you can keep tabs on your workers' compensation to achieve a successful insurance audit.
What Is a Workers’ Compensation Audit?
Before we can help you take on your insurance audit, it’s important to understand what it is. When you buy a workers’ compensation insurance policy, the premium payments are estimated.
Your premiums are determined by:
- Employee wages including bonuses and tips
- Employee class codes which are three- or four-digit numbers insurers use to determine the risk of each job. Class codes are determined by third-party bureaus and can differ depending on the state you're in or an employee's wage in some cases.
- Cost of uninsured independent contractors
To check that the estimates are right, your insurance company can request a workers’ compensation audit. This audit verifies the premium estimate matches your needs for insurance coverage.
If there is a difference between the estimates and what you actually need, it means you’re either overpaying or underpaying for your coverage. In that case, your insurance carrier will require a premium adjustment. An adjustment means you will either have to pay more or less for insurance.
If you overpaid for workers’ comp insurance (i.e. your premiums turned out to be too high), you’ll get money back...and while that’s a great thing in theory (and definitely better than the alternative), you could have spent that money investing in your company or paying off debts earlier in the year. And if the premiums were too low, you’ll owe money back and, well, we all know that isn’t ideal.
A Final Audit Statement is sent to you after the audit is complete. The Final Audit Statement shows any premiums you must pay your insurance company (additional premiums owed) or any refunds they owe you (returned premiums paid). Usually adjustments result from errors in payroll calculations or incorrectly classifying the type of employee work or class codes.
Types of Workers’ Compensation Insurance Audits
Although all audits have the same objective—making sure you’re paying the right amount for coverage—not all workers’ compensation audits are the same. The kind of workers’ comp audit your business receives depends on the size and industry of your business operations and your insurance premium amount.
Generally, there are four categories of workers’ comp audits—physical audits and voluntary audits.
- Phone audits: An insurance carrier goes through your payroll records and other relevant documents with you via phone.
- Mail audits: You’re mailed audit forms to verify your payroll and other pertinent information–which you fill out and send back.
- Physical Audits—Larger companies with higher insurance premiums likely need a physical audit. This means that the premium audit will take place at your headquarters.
- Voluntary Audits—If you run a small business, your insurance company may only require a voluntary audit. With a voluntary audit, your insurer sends an audit form via mail. You’ll have to complete the audit form and provide supporting documentation.
What an Insurance Company Looks for in a Workers’ Compensation Audit
So, what are insurance auditors looking for?
You guessed it—to make sure your payroll and classification codes are correct.
Here are some of the documents the insurance company’s auditor will review and verify during an audit:
- Payroll records such as payroll journals and summaries, overtime payments, federal tax returns from the IRS, state tax returns, and state unemployment tax reports
- Certificates of insurance for subcontractors and contractors
- Employee records including Form 941, job roles of each employee, time worked, and your total number of employees
- Cash disbursements for subcontractor payments, materials, and labor
- Description of business operations
Remember, the insurance company wants to ensure their estimates match your actual payroll, which is why they’re requesting all these documents. You’ll also notice subcontractors on this list. Insurers will want to make sure they’re actively insured. If not, you will likely be charged an extra insurance premium for the subcontractors that don’t have coverage.
When Should You Expect a Workers’ Compensation Premium Audit?
The majority of states and the National Council on Compensation Insurance (NCCI) require insurance providers to audit most workers’ compensation policies. Once your workers’ compensation policy term expires, your insurance provider will notify you of an audit within 60 days. In most cases, your insurer will notify you via email or phone.
These audits are mandatory as part of your workers comp coverage. So, like filing your taxes or renewing your license, an insurance audit is something you’ll need to be ready for as soon as your policy period ends.
Why Is it Important to Comply with the Workers’ Compensation Audit?
Since a workers’ compensation audit is usually required by law, it’s in your best interest to be on your best behavior. Even if you want to kick and scream the whole way through—which is understandable—not complying comes with some hefty consequences.
For example, your insurer has a set amount of time for completing the audit. If the audit is not complete within that time frame, your policy can be canceled, and you must pay an uncooperative surcharge. Sometimes the surcharge can reach upwards of 25 to 50 percent of your original estimate.
Non-compliance is also a red flag for future insurance companies. They'll see you as a bigger risk, which can result in higher premiums.
Common Workers’ Comp Audit Pitfalls to Avoid
Clearly, complying with a workers’ compensation premium audit is essential—both for your pocketbook and to protect your company. To make the process run smoothly, keep in mind the top six common mistakes to avoid during your workers’ comp audit.
1. Incorrect Payroll Estimates
You’ll want to make sure your payroll estimates are as precise as possible. Accurate estimates make for a smooth auditing process. They also help you avoid a hefty bill after an audit.
Work with a licensed insurance advisor who understands the operations of your business and is aware of the changes that can happen during the policy term. Transparency may simplify the audit process.
As a business owner, you must also make sure that your internal payroll matches the audited payroll. To do this, ensure the information you provide your auditor is correct and that you verify the auditor’s work.
Bonus Tip:
Using a workers’ comp platform like Hourly eliminates the guessing game. Hourly connects your payroll data directly to workers’ comp, so your premiums are always based on actual wages (not estimates).
2. Not Classifying Employees Correctly
Class codes are used to calculate your workers’ compensation insurance premiums. Employees with a higher risk of injury on the job are assigned class codes and insurance rates that reflect that risk.
Most states use the class codes established by the National Council on Compensation Insurance (NCCI), and you can use this Alphabetical NCCI Code List to find the right class codes for your employees. Some states have their own classification system for workers’ comp codes (or use a modified version of NCCI workers’ comp classification codes). Click here to see if your state is one of them. These agencies have the final say on correct classifications. Make sure to get in touch with a licensed insurance advisor who can walk you through the process and help you figure out the right class codes for your team members.
Incorrect job classification can result in you having to pay a lump sum on your audit bill at the end of the process.
Some employers in the construction industry are allowed to use payroll separation for premium calculations.
Payroll separation means you can divide employees’ wages across different class codes based on their various job duties. For example, let’s say you’re a homebuilder and your workers are currently splitting their time between carpentry, pouring concrete and installing drywall. In this case, their wages can be spread across the different tasks (for example, you might have $10,000 worth of wages going into carpentry, $8,000 for pouring concrete and $5,000 for installing drywall). Your workers’ comp premiums will be based on these wages and their corresponding class codes. This can save you money, since some tasks will result in lower workers’ comp rates compared to others.
If you keep accurate time tracking and payroll records and operate in an NCCI state, payroll separation is a wise choice.
When in doubt, you can always contact a licensed insurance advisor if you have specific state-related questions.
Bonus Tip:
Hourly lets your team switch class codes on the fly to keep up with the type of work they’re doing. This way, you can avoid receiving a big bill due to incorrect class codes during your audit.
3. Failing to Include Deductions
Not everything on your payroll is considered when calculating workers’ comp premiums. For example, you can deduct severance pay and portions of overtime pay (if you pay more for overtime than regular hours).
Bonus Tip:
For a complete list of deductions that apply to your business, check your state’s workers’ comp regulations. Common deductions include bonus pay, tips, employee perks, and officer exclusion.
4. Paperwork Errors
Staying organized is key to a successful workers’ comp audit. Organizing and filing all payroll records and other documentation throughout your policy term can streamline the process.
Remember, the items you’ll need to have available for your audit include:
- Payroll records such as payroll journals and summaries, overtime payments, federal tax returns from the IRS, state tax returns, and state unemployment tax reports
- Certificates of insurance for subcontractors and contractors
- Employee records including Form 941, job roles of each employee, time worked, and your total number of employees
- Cash disbursements for subcontractor payments, materials, and labor
- Description of business operations
If you use your checkbook as your method of recordkeeping, you may need to hand it over to your insurance company. But, if you have another method of tracking your payroll, you can keep it where it belongs—in your hands.
Also, list overtime earnings separately. Since some insurers discount overtime premiums, you’ll want to make sure you qualify for any discounts available.
Try to verify all information you have is factual. Even if an error was an honest mistake, it could still result in a policy cancelation or fine. And, who needs another headache like that?
Bonus Tip:
As a best practice, we recommend creating a workers’ comp document checklist to prepare for an audit. Having the right document ready for your auditor helps ensure a speedy auditing process.
5. Not Confirming All Subcontractors and Contractor Have Certificates of Insurance
One requirement of a premium audit is to prove that your subcontractors and contractors have insurance. This is because your insurance carrier wants to make sure you’re only covering your own workers, not contractors.
If you don't have certificates of insurance and support documentation, your insurer may charge an additional premium for their coverage—and you won’t want that.
Bonus Tip:
Always check to see if your contractors' certificates of insurance and coverage dates match the dates they worked for you.
6. Not Checking State Requirements and Deductions
Unfortunately, workers’ compensation insurance requirements and exclusions vary by state. Small businesses operating in one state don’t have to worry about changes in other states as much, but multi-state corporations do. You can’t assume that the rules of one state will apply in another.
Bonus Tip:
When in doubt, consult your state’s workers’ compensation rules or find a licensed insurance advisor who can answer your questions.
Be Proactive with Your Workers’ Comp Audit
To make sure you have smoothest audit you possibly can, take the bull by the horns and be a proactive participant in the auditing process.
Being communicative with the auditor ensures they have everything they need for the audit. And, remember, when the audit is over, review the auditors' worksheet for accuracy. If there is a need for a premium adjustment, make sure you understand the impact this change will have on your company. After you sign the worksheet, make a copy for your records.
However, if the workers' comp policy worksheet is not complete, don't sign it until it is. You want to understand what you're signing before you do.
Knowing the common audit pitfalls and using these tips will streamline the audit process. Pairing your knowledge of your business operations with a licensed insurance advisor's expertise will increase your chances of success.
Oh—and using an easy-to-use platform like Hourly will help too.
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