Misclassification Matters

Workers’ compensation is usually the largest insurance expense for the average business.  Workers’ compensation costs have increased significantly in recent years due to rising medical costs, increased litigation of claims and increasing benefits paid to claimants.  Employers cannot generally control these costs, but premiums are based on payroll and how it is classified. Classifying payroll correctly is the employer’s primary means of keeping insurance rates at their lowest!

What is Misclassified Payroll?

The term misclassified payroll may be shown several ways:

  • Individuals may be misclassified;
  • A department or division may be misclassified;
  • Independent Contractors may be misclassified (the business relationship, licensing and other factors may determine the individual should be considered as an employee for premium computation purposes;
  • The business as a whole may be misclassified.

The WCIRB (Workers’ Compensation Insurance Rating Bureau of California) is a rating organization licensed by the California Department of Insurance and designated as the Insurance Commissioner’s statistical agent in accordance with California Insurance Code. The WCIRB develops advisory pure premium rates, and the rules and regulations in the California Workers’ Compensation Uniform Statistical Reporting Plan (USRP).  The Plan is approved by the Insurance Commissioner of the State of California according to California Insurance Code.  The classification system classifies the overall business of an employer in the state of California.

The WCIRB audits employers’ records on a selected basis to ensure that payroll, losses and classifications are accurately reported. Even with oversight from the WCIRB, many misclassifications occur. My experience shows that the vast majority of classification errors are related to Standard Exceptions employees, miscellaneous employees of a multiple enterprise, the use of additional classifications for a Single Enterprise and contractors.

In 2012, Valen Analytics produced a report on payroll misclassification. They found, in the four year period of 2008 through 2011, that the largest percentage of error (14%) was related to construction policies. California has its own Test Audit Program and their results show very similar numbers across all Test Audited Policies, a 14% error ratio.

Classification procedures are complex. Special Industry Classification Procedures exist for several industry groups.  For example, Construction and Erection Work has special industry rules relating to division of payroll provided separate records of payroll are maintained.  The rule provides further guidance relating to proper classification procedures, determination of dual wages, and maintenance of time cards or time sheets. Additional rules related to assignment of the governing classification, miscellaneous employees, executive level supervisors and idle time pay are also addressed.  Construction audits often find numerous misclassifications. And these may be especially problematic as the rates are generally high in this industry.  As an industry with many misclassification issues, and an industry known for its use of casual and unlicensed labor, it is not surprising that they are scrutinized during the workers’ compensation audit.

Whether you are a contractor or any other business, you should prepare for the audit.  Provide the items requested by the auditor and ensure that a person knowledgeable of the business operations and employees’ duties is available to answer questions.

If you employ subcontractors, ensure that they have their own insurance.  Get a Certificate of Insurance to show as evidence when being audited.  Unlicensed and/or uninsured subcontractors may have similar rights to file claims as employees under a policy and the inclusion of amounts paid to these individuals can add up to a significant premium.  Maintain accurate records so that audits can go smoothly and all information can be easily tracked.

After the audit, request a copy of the worksheets. Review these to see what changes, if any were made.

  • Compare the original policy to the final audit billing statement and check for changes in the classifications.  (Was a new classification added?)
  • Compare the estimated payrolls with the final audited payrolls. (Are they significantly higher? Do you know why?)
  • Determine whether the premium portion of any overtime of double time has been excluded.
  • Determine whether any pre-tax IRS qualified Cafeteria 125 plan deductions have been excluded.
  • Check to see that the experience modification factor used on the final audit billing is no different than what is shown on your policy.
  • Were you charged for subcontractors, unlicensed contractors or casual labor?

We already know that approximately 14% of audits that fall within the CA Test Audit program parameter have errors significant enough that the carrier is charged with an error and must make a corrected billing. As with any field or trade, auditors have varied levels of training and expertise, and as humans, are capable of making mistakes!

You do have recourse! If you feel there is a problem with your audit, let an experienced auditor help you.  Expert Audit Services will review your audit, advise you of any disputable errors and write dispute letters on your behalf citing pertinent rules from the manuals of authority and speaking in understood industry language.  If needed, we can refer your case to an attorney specializing in this area.