People are familiar with tax audits from the IRS, their state tax agency and from state industrial relations when it comes to running a business with employees. However, the one area that tends to confuse new business owners and managers is the workers’ compensation audit.
Why Do Insurers Require Workers’ Compensation Audits?
The annual premium audit is a realignment of actual risk of employees covered by a policy versus the estimate figure produced when the coverage year or cycle started. This is necessary for the coverage provider to finalize the full cost of coverage based on actual employment. The estimate was calculated on an assumed employee population but things change over time. To make sure the provider charges the correct premium, the audit provides an after-the-fact review.
Adjusting Employers Classification and Premium
A key factor in appropriate premium calculation involves making sure the business covered is placed in the right insurance policy classification. This can make a big difference in the premium charged. Because a company’s operations can change over time, with functional differences occurring and causing changes in the nature of the growing business, the provider wants to be sure it has applied the right risk classification to the business’ profile.
How is the Premium Estimated?
In simple terms, the workers’ compensation premium for an employer is determined by multiplying a company’s payroll times a rate and then dividing by 100. The payroll, however, includes all employee compensation, not just straight salary or hourly pay. That can include commissions, bonuses, vacation, holiday and sick pay, fringe benefits, and overtime earnings. Other areas include tools provided, employee benefit plans like meals or provided uniforms, and facility provisions such as subsidized rent.
Why Do Insurance Companies Segment Businesses into “Classes”?
Because individual businesses can vary so much but are similar to each other in what they do and provide, they are lumped into classes. Classes can have a tremendous influence on the cost of premiums because some classes have a higher risk status than others based on the work employees generally do. For example, a construction company by its very work nature will be riskier than hospice, but nurses still can get hurt in a medical facility for the terminally ill. However, the construction company will never be classified as medical and vice versa.
Workers’ Compensation Audit Process
The insurance provider starts the audit process, typically on a schedule known only to the insurer. The official notice is sent to the customer to set up a time for the opening entrance conference and to establish work protocols for the auditor. The notice may come as a formal letter or as a phone call or both. The meeting will cover what basic starting information the auditor will need from the company as well as which staff contacts are needed for ongoing communications.
Prepare Someone for Meeting the Auditor
Communication and taking care of the auditor’s requirements makes a big difference in how an audit goes. At a minimum, the auditor should work with seasoned staff who know all aspects of the business, its operations, finances, each employee’s tasks, and is someone who is familiar with the current policy in place.
Paperwork You’ll Need to Have Available
Specific documentation is always necessary in an audit because examiners are trained to start with general areas before going into detail. These general documents include:
- The company’s accounting books.
- Tax reporting and income tax filings.
- Records of payments made, including subcontractors and independent contractors.
- Contractor insurance.
- General business plans and operational descriptions.
- Duty statements for employees.
- Any payroll limitations for known employee classes (i.e. executive officers).
- The experience rating worksheet.
Further, it’s not enough to just hand things over in a big box. The documents should be organized for easy retrieval. The faster the auditor can get through the general overlay of the business, the faster the audit can be completed.
Different Types of Workers’ Compensation Audits
Just like businesses are not all the same, their workers’ compensation audits vary as well. Clearly some are far more extensive and detailed than others. It naturally follows that how the audit is conducted varies by complexity as well.
Small Business: Over the Phone Audits
Small businesses are typically quick operations where the company is reviewed by phone. The auditor is faxed or emailed key documents ahead of time and then by phone conference goes through details where gaps exist for final review. These rarely involve a business because the classification process is pretty simple with a few employees involved.
Mid-Sized Business: Self Audit
Mid-size companies get the luxury of performing their own self-audit, as a full review is oftentimes not cost-effective for a provider. However, these can be followed up with an occasional visit every few years so it’s not to the company’s advantage to fudge the numbers and answers. Documentation still has to be sent to the audit firm for record completion.
Large Business: Physical Audit
Large organizations with lots of employees and various worker groups are where the heavy audit work occurs because there can be a tremendous amount of variance between workers and their purpose. The percentage of workers in a function can shift over time as well with a fast-growing company.
Common Audit Disputes
It is not surprising that there can be disagreements over the audit results on a workers’ compensation premium. It amounts to a serious cost, and companies paying the premium want to be sure it’s as low as possible. Disputes often escalate when the results of the audit trigger a premium increase.
Reason Insurance Companies Charge More for Premiums
There are number of categorical reasons for audit disputes that come up again and again. Regardless of the size of the company, these reasons occur repeatedly.
Payroll Projection was Incorrect
Anytime there is a complex amount of math and human interpretation of reports, there can be an error. Payroll projections frequently trigger numerous complaints, especially where the projection incorporated a faulty assumption in the math.
No One Paid Attention to The Projections During the Policy Year
Most surprises that trigger disputes tend to involve the covered company managers not truly understanding the difference between a projection and a final true-up review via an audit. A bit of education can prevent this problem.
Insured Didn’t Understand Impact of Utilizing Contractors Without Coverage
Being too focused on the bottom line with uninsured third party contractors can end up being a costly mistake. Where contractors don’t have their own insurance, the company may have to pay for the cost of coverage by default. While the company thinks it avoided an expense with a cheaper contractor, in reality the cost was just shifted to their post-audit premium.
Insured Didn’t Fully Understand Workers Comp Premium Audit Process
The final big category of dispute involves the insured having no idea how an audit is supposed to work, what procedure it follows, or how the outcome is to be used. This lack of education is negligence on the part of the company’s managers to be proactive and learn ahead of time.
Fraudulent Behavior by an Employer
There will always be one company that thinks it can fool the premium audit by fudging the numbers. Unfortunately, the calculations that go into a payroll audit are a bit like a Rubik’s cube; you change one side of the mix and the other sides change as well. Fraud frequently leaves these tell-tale signs that an auditor is trained to look for and find quickly.
What Happens If I Don’t Cooperate?
In some cases, companies just don’t want to be helpful and give the least amount of information as possible, seeing the audit as no help at all. In these cases the insurer has other options.
Insurance Company Can Guess Audit Figures
First, the insurance provider can likely guess the general category of a given company in most cases and levy a premium based on an educated assumption. The company then has to pay the cost to keep coverage in place, which is required by law.
Department of Industrial Accidents’ Notified and Business Can Be Shut Down
Further, the company could be reported to state regulators for non-compliance in coverage, since the audit is necessary for true, accurate premium-setting. In this case the insurer is really hitting the company in the jugular, while not expecting any further business from them, but putting the errant business in its place.
Final Thoughts: Hints and Tips as Audit Season Draws Near
In closing there are few areas in which businesses can be proactive to prepare for a future audit.
Separate Overtime Paid Employees
Where workers have significant overtime, they should be separated from the normal group to be tracked independently. This can help authenticate an argument that the business doesn’t typically pay such levels on a regular basis and the premium should not assume an ongoing behavior cost.
Organize Current Subcontractors Certificates of Insurance
Make sure any contractors brought on board have proof of insurance. This matters tremendously and can save your business a lot of money in avoided insurance premium costs when they are identified later in an audit.
Don’t Sign Worksheet Until You Have Reviewed the Audit
Never accept an audit on its face or summary report. Always look at the worksheets and findings themselves. Many audits are extrapolations of samples. The sampling should be representative of your business activity and not be so small it really doesn’t make any sense at all. However, without a second careful look at the worksheets or findings, then just about anything can be included in an audit report.