Preparing for a workers’ comp audit is an easy way to minimize stress. In this article, we will review the audit process and provide you with a general idea of what you can expect during an audit. The following steps can help you get ready, and the downloadable workers’ comp checklist can help your business and guide you on how to prepare for a workers’ comp audit when the time arrives.
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Step 1: Schedule Your Workers’ Comp Audit
The first step is to schedule your audit. Please note that this process is usually initiated by your insurer. Generally, six to eight weeks prior to the policy’s expiration, your carrier will notify you that it is time for an audit.
The type of audit you have to schedule varies by insurer and state, but there are generally two main types:
- Physical: As the name suggests, a physical audit is when your insurer sends an auditor to your business to review records, observe operations, and interview employees. The auditor typically has about 30 days to schedule, complete, and submit your paperwork. A physical audit will usually involve more work and is also typically not for a smaller business.
If you’re required to have a physical audit, schedule it so that you’re available to answer any questions the auditor might have. That way, you can ensure the auditor understands your operations so that they can classify your business accurately.
- Voluntary: No one comes to your office for a voluntary audit. Instead, the review is conducted by phone and mail, email, or an online portal. The insurer sends a form for you to fill out and return within a certain time, often 60 days.
Other Types of Workers’ Comp Audits
Not all workers’ compensation audits occur when policies are set to expire. Depending on their situation, some business owners may have a:
- Preliminary audit: Your insurer may conduct an on-site preliminary audit when you first apply for workers’ comp insurance to determine your initial premium. This may be trickier to schedule if you need to get covered quickly to be in compliance.
- Interim audits: Insurers may require an audit during the life of your workers’ comp policy, particularly if you’ve changed operations. Additionally, employers might ask for interim audits if they want to pay their workers’ comp quarterly. Interim audits are usually done by mail.
For both types, you should still receive some sort of notification from your insurer so that you can set time aside for the audit.
Step 2: Gather Your Records
When it is time for the audit, the best way to prepare for a workers’ comp audit will be to gather all relevant records for payroll and employee classifications. This is because workers’ compensation costs are based on your payroll, risk, and claims history, so the auditor needs information about each of these aspects.
Typically, audit notifications spell out the documents the auditor can use to verify the information. This list can be specific to the carrier, but many insurers want some, or all, of the documents mentioned below.
General Information
- Description of company operations
- Job descriptions for each employee
- Number of employees at each location
- Owners/officers names and titles
- Description of work performed by contractors and subcontractors
Cash Disbursements Records
- Payments made to subcontractors
- Payments made to independent contractors
- Payments made to casual laborers
- Receipts for materials purchased
Insurance Records
- Subcontractors’ certificates of insurance
- Business’ experience modification worksheet
Payroll Records
- Accounting ledger
- Payroll journal or register
- Business checkbook
- Federal Profit and Loss From Business Schedule C (Form 1040) For individuals and sole proprietors
- Federal Employer’s Quarterly Tax Return (Form 941)
- Federal Employer’s Annual Tax Return (Form 944)
- Federal Employer’s Annual Unemployment (FUTA) Tax Return (Form 940)
- Federal 1099, W-2, and W-3 transmittals
- State unemployment insurance tax reports (forms vary by state)
- Time cards or number of hours, days, and weeks worked annually
- Overtime payroll records
Your payroll, also referred to as remuneration, is the starting point for your workers’ comp premium, so you want to get that number right when preparing for an audit. However, it’s not always clear what counts as payroll, though you can learn more about it through our ultimate guide on what payroll is.
Each state has its own definition but, in general, remuneration includes:
- Gross wages and salaries
- Total commissions
- Bonuses
- Pay for overtime, holidays, vacation, and sick days
- Employee contributions to 401(k)s, savings plans, and individual retirement accounts (IRAs)
- Payments based on something other than time worked
- Payments you make that would otherwise be the responsibility of the employee, such as Social Security
- Payments or allowances for hand tools or power tools employees use for work
- Lodging and meals included as part of an employee’s pay
Conversely, employee paychecks may include payments that aren’t usually counted as payroll in workers’ comp premium calculations. For example, many states exclude:
- Tips and gratuities
- Employer payments to group insurance
- Severance pay
- Reimbursed business expenses
- Special rewards for individual invention or discovery
- Active military duty pay
- Uniform allowances
- Employee discounts on goods and services
Ensure you identify these to the auditor so that they are not inadvertently included in your total payroll.
In general, business owners do not have to carry workers’ compensation insurance for themselves, so their salaries aren’t considered during a workers’ comp audit.
However, some states give sole proprietors, corporate officers, partners, and limited liability company (LLC) members the option of getting coverage. When they do, their salaries are treated differently because their pay is often significantly more than regular employees.
Most states set an annual wage for sole proprietors and partners that is different from their regular salaries. Somewhat similarly, corporate officers who opt-in on workers’ comp receive a weekly salary that falls somewhere between a maximum and minimum salary determined by the state. LLC members get one or the other, depending on the state’s workers’ compensation rules.
Step 3: Update Your Job Descriptions
The risk your employees face in their jobs is another part of calculating your workers’ comp costs, so the auditor will investigate everyone’s duties and your business’s general operations. This may involve reviewing job descriptions you already have, or it could mean completing a form that lists what each employee does. Either way, you should have a strong understanding of what the people who work for you do. A good way to accomplish that is to update your job descriptions—or create them if you haven’t already.
You might be tempted to skip this step, but detailed job descriptions can be a big help in a workers’ comp audit. Accurate job descriptions help your auditor determine the appropriate governing class code for your business. That class code has a corresponding base rate that is used in a formula to determine your costs, and using the wrong class code could mean you’re paying the wrong premium.
If you’d like a customizable template, check out our guide on how to write a job description. It also includes a video that walks you through the process.
The basic formula for calculating workers’ compensation insurance costs is:
Total cost of workers’ compensation insurance = | Employee’s estimated annual payroll __________________ $100 | × | Premium rate for the class code | × | Experience modification rating (EMR) |
Let’s say you run a craft beer brewery in Wisconsin with a payroll of $100,000. The auditor assigns your business the class code 2121, which means your base rate is $3.11. To keep things simple, let’s assume your experience modifier is one, so it doesn’t impact your rate and that there are no other fees or discounts.
If all of that is true, then your workers’ comp cost is $3,110 per year. It is calculated like so:
- Divide the payroll by 100 ($100,000 ÷ $100 = $100)
- Multiply the quotient by the premium rate of the class code ($100 × $3.11 = $3,110)
- Multiply the product with the experience modifier ($3,110 × 1 = $3,110)
However, your auditor may calculate your premium incorrectly if you forget to mention that you have a clerical employee (class code 8810).
Clerical employees are an example of standard exception classes. These classes are excluded from the governing class code and get rated separately.
The clerical employee earns $40,000 per year, and the base rate is 20 cents. It’s a given that the employee only costs $80 to insure each year:
- Divide payroll by 100 ($40,000 ÷ $100 = $400)
- Multiply the quotient by the premium rate of the class code ($400 × 20 cents = $80)
- Multiply the product with the experience modifier ($80 × 1 = $80)
Ultimately, your workers’ comp bill should look like this:
Breweries - Craft Beers ($3.11 x $60,000 / $100 ) | $1,866.00 |
Clerical - Office Employee (20 cents x $40,000 / $100) | $80.00 |
Base workers’ comp premium | $1,946.00 |
When you rate the office employee differently from the rest of the staff, your overall insurance costs go down. Having this information on hand during your audit helps the auditor assess your premium accurately.
Step 4: Review the Auditor’s Work
Once your audit is complete, review the auditor’s work to ensure their information matches your understanding of your business’s payroll and operations. Key information to review includes:
- Payroll data: Check that your audited payroll matches the payroll from your accountant or accounting department.
- Governing classification: Unless your operations have gone through a massive overhaul, your governing classification should match the one on your original workers’ comp policy.
- Any additional classifications: If your state allows them, check whether standard exception classes have been noted. The same goes for construction businesses that get to use multiple class codes for individual workers.
- Experience modifier: Most states prohibit insurers from changing your EMR during the policy term. If the auditor changes yours, you should ask why.
Once you review the auditor’s work, sign any paperwork the auditor requires to indicate you’ve taken part and understand the results. This step may be unavailable to you if you completed the audit remotely, but your insurer should send you a summary of the auditor’s findings. If those results seem out of whack, you can request more information from your insurer.
If you don’t have to pay any additional premium (or maybe even receive a refund), you can relax until next year’s audit. However, your insurer might decide you paid too little and send you a bill. In that case, you either need to write a check or dispute the audit.
What Is a Workers’ Comp Audit & How Does It Work?
A workers’ comp audit is a review of your business’s payroll and job classifications with the goal of confirming your business has the proper coverage and is paying the correct premium.
When you apply for workers’ compensation insurance, the carrier will ask you how many employees you have and what the total payroll is. Toward the end of the policy period, the carrier will initiate a workers’ comp audit to ensure the estimated information is correct. The result of the audit can mean your business owes the insurance company additional funds or that the insurance company has overcharged your business and owes your business a refund.
For example, you open a burger joint and inform the insurance carrier you will have four employees and the total payroll will be $300,000. Unfortunately, business was slow and you ended up with three employees and a total payroll of $200,000. The result of the audit will be, you overpaid for workers’ comp and the insurance carrier will issue your business a refund for the overpaid premium.
How To Dispute a Workers’ Comp Audit
Each carrier has its own rules for disputing a workers’ compensation audit. However, most insurers expect employers to file a dispute in writing within a set time, so you should contact your carrier immediately.
Most likely, your carrier will want details on why you think your bill is incorrect and an estimate of what you think it should be. You won’t have to pay the additional premium while your insurer evaluates your complaint, but you may be required to pay any undisputed portion by the due date on the audit bill.
Common Mistakes in Workers’ Compensation Audits
Being charged an additional premium doesn’t automatically mean the auditor made a mistake. That said, workers’ compensation premiums are complicated things, so mistakes can occur. Below are a few of the most common errors:
- Including items in payroll that shouldn’t be there
- Changing your experience modifier
- Using the wrong class codes for employees
- Charging for an insured subcontractor
- Including exempt workers in the payroll
How To Make a Workers’ Comp Audit Easier
Every company that issues workers’ compensation insurance reviews policies at the end of their terms, so you can’t avoid an audit. However, you can make the audit process easier if you opt for pay-as-you-go workers’ compensation.
Pay-as-you-go workers’ comp is simply a payment plan where your insurer charges you each time you run payroll. This usually requires you to upload or manually enter your payroll information to the insurer’s platform. However, some payroll companies can integrate with your insurer to automatically upload your data and pay your premium.
The big selling point here is that a pay-as-you-go plan means your workers’ compensation premium is more accurate. Your insurer still needs to audit your policy because there could be errors in classifications or remuneration but pay-as-you-go plans generally result in smaller premium adjustments.
Frequently Asked Questions (FAQs)
Almost all workers’ compensation insurance policies have language that makes the audit a requirement for the policyholder. The policy created by the National Council of Compensation Insurers (NCCI), used in most states, says the policyholder must allow an audit anytime within three years of the policy’s expiration date.
If you choose not to comply with your insurer’s request for an audit, it could cancel your premium, which can make it difficult to get a policy later on. Moreover, state law may allow your insurer to fine you—sometimes up to 300% of the original premium—and send your account to collections. Ultimately, your insurer can sue to collect both the original bill and the additional fines.
Bottom Line
Understanding the workers’ compensation audit rules when preparing for your annual review makes the process easier and produces more accurate results. By having well-organized company files and payroll data, a small business owner helps the auditor get a clear picture of the company’s operations while also minimizing her own stress.
The Hartford is a great carrier for workers’ compensation. Its audits are usually conducted by mail and over the phone, and it has a pay-as-you-go option. You can get a quote online in minutes.
