How to Prepare for Workers’ Comp Audits in 4 Steps [+Checklist]
This article is part of a larger series on Workers' Compensation Insurance.
Insurers that issue workers’ compensation insurance audit policies when they expire. They do this because initial premiums are usually based on an estimate of the policyholder’s payroll, and they need the actual payroll to charge the right amount. As a result, workers’ comp audits can be stressful for business owners because they may end up owing money.
Preparing for a workers’ comp audit is one way to minimize your stress and, while we can’t list the specific rules for every carrier, we can give you a general idea of what to expect. The following steps can help you get ready, plus you can download a checklist to use when your audit rolls around.
1. Schedule Your Workers’ Comp Audit
The first step is to schedule your audit. Typically, your insurer notifies you that it’s time for an audit about six to eight weeks prior to your policy’s expiration date. The type of audit you have to schedule varies by insurer and state, but there are generally two main types:
- Physical audit: 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.
- Voluntary audit: No one comes to your office for a voluntary audit. Instead, the review is conducted by mail and phone. The insurer sends a form for you to fill out and return within a certain time, often 60 days.
If you’re required to have a physical audit, schedule it so you’re available to answer any questions that the auditor might have. That way, you can make sure the auditor understands your operations so that they can classify your business accurately.
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’ compensation 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 every quarter. Interim audits are usually done by mail.
For both types of audits, you should still receive some sort of notification from your insurer so that you can set time aside for the audit.
2. Gather Your Records
Workers’ compensation insurance 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.
- 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
- Accounting ledger
- Payroll journal or register
- Business checkbook
- Federal Profit and Loss From Business Schedule C (Form 1040)*
- 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
*For individuals and sole proprietors
Cash Disbursements Records
- Payments made to subcontractors
- Payments made to independent contractors
- Payments made to casual laborers
- Receipts for materials purchased
- Subcontractors’ certificates of insurance
- Business’ experience modification worksheet
What Is Included in Payroll
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. Each state has its own definition but, in general, remuneration includes:
- Gross wages and salaries
- Total commissions
- Pay for overtime, holiday, 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 like 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
What Is Excluded From Payroll
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
Make sure to identify these to the auditor, so they are not inadvertently included in your total payroll.
Are All Salaries Included in a Workers’ Comp Audit?
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.
3. Update Your Job Descriptions
The risk your employees face in their jobs is another part of calculating your workers’ comp costs so that 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.
Why Job Descriptions Matter in a Workers’ Comp Audit
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. Using the wrong class code could mean you’re paying the wrong premium.
The basic formula for calculating workers’ compensation insurance costs factors in three numbers: the rate assigned to your class code, your experience modification rate, and your payroll divided by $100.
Let’s say, for example, 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 also 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 costs $3,110 per year:
Breweries - Craft Beer ($3.11 x $100,000 / $100)
However, your auditor may miscalculate your premium if you forget to mention that you also have a clerical employee (class code 8810) who earns $40,000 per year. Clerical employees are an example of standard exception classes. These classes aren’t included in the governing class code and get rated separately. The base rate for your clerical worker is 20 cents, so the employee only costs $80 to insure each year:
Clerical - Office Employee ($0.20 x $40,000 / $100)
Ultimately, your workers’ comp bill should look like this:
Clerical - Office Employee ($0.20 x $40,000 / $100)
Breweries - Craft Beers ($3.11 x $60,000 / $100 )
Base workers’ comp premium
When you rate the office employee differently than 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.
4. Review the Auditor’s Work
Once your audit is complete, review the auditor’s work to make sure his information matches your understanding of your business’s payroll and operations. Essential 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 experience modification rate 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 not be available 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.
How to Dispute a Workers’ Comp Audit
If you don’t have to pay any additional premium―or maybe even received 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.
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. Workers’ compensation premiums are complicated things, so mistakes are pretty common. Below are a few of the most common errors:
- Including items in payroll that shouldn’t be there
- Using the wrong class codes for employees
- Changing your experience modifier
- Charging for an insured subcontractor
- Including exempt workers in 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 a payment plan where your insurer charges you each time you run payroll. This usually requires you to upload or enter your payroll information to the insurer’s platform manually. However, some payroll companies can integrate with your insurer to upload your data and pay your premium automatically.
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.
Workers’ Comp Audit Frequently Asked Questions (FAQs)
The stress of a workers’ comp premium audit can create additional questions for small business owners, especially if they hope to avoid one or are concerned that they’ll be asked to pay a huge premium one theirs is over. We answer a few of those questions below.
Am I required to undergo a workers’ comp audit?
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.
What happens if I don’t comply with a workers’ compensation audit?
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.
What if I can’t afford the retroactive premium audit bill?
Premium audit bills result from unanticipated payroll during the course of a year and generally are due upon receipt or within 30 days. If the bill is substantial, contact your insurance carrier’s billing department. Most carriers will set up a payment plan, often splitting the bill over three payments. Ask the billing department for your options.
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.