Audit Basics

Workers Compensation insurers are required by statute to perform annual premium audits at specified intervals and thresholds. Furthermore, insurers are required to report statistical data to the Workers’ Compensation Insurance Rating Bureau. Such data includes audited exposures by classification, rates and claims data.

To fulfill their reporting obligation, and as a generally prudent business practice, premium audits are conducted. The workers’ compensation audit is a policy provision in the workers’ comp insurance policy. It is a contractual obligation, not an option.

When purchasing a Worker Compensation policy, a deposit premium is paid which is based on estimated exposures. (Premium is calculated based on the applicable exposure by classification code and the rate applicable to code’s rate.)

At the end of the policy period, the insurance company will conduct an audit. The audit is based on an auditor’s examination of the policyholder’s original payroll records and books of accounts. The auditor is charged with developing the actual exposure and ensuring the proper classification of the business and its employees. The audited exposure is then compared to the originally estimated exposure. A final billing is then adjusted accordingly and the policyholder receives a statement of additional billing or a refund for the difference.

Premium is calculated as a rate per $100 of payroll/remuneration, subject to the application of scheduled discounts, credits and/or surcharges that may be applied under the terms of the policy contract.

The business is assigned to the classification(s) that best match the business of the employer, not the separate employments, occupations or operations within the business. A business may be a single enterprise consisting of a single operation or a number of separate operations that normally prevail in the business described by a single classification, or it may be considered a multiple enterprise. A multiple enterprise describes a business consisting of two or more distinct operations that don’t normally prevail in the business described by a single classification.

Rules relating to classification assignment procedures are very specific and many are misinterpreted or overlooked by business owners, agents and even auditors.

The audit will look at the contemplated classifications and payroll/remuneration. The auditor should conduct a reasonable and adequate interview to ensure that the business and employees are classified correctly. Premium charges depend on the accuracy of the information provided as well as the projected payroll for the policy period.

The auditor will be able to give you all the credits that you are entitled to if your records provide all the necessary details. There are many rules requiring you, as the employer, to provide segregated and summarized records in order to receive these credits. In this day, with so many computerized payroll systems, this is rarely a problem as these can usually be created from the payroll software being used.

What you can expect from an audit:

  • The audit should be performed within 60 days of the expiration of your policy
  • The auditor should tell you in advance what records they will need to review to complete the audit
  • The auditor will likely review a number of the business’ financial documents, not solely payroll documents.
  • The auditor will likely do a walk-through of your premises to get an understanding of your business operations so as to validate the business and employees’ class assignments
  • If an audit is not completed due to problems stemming from the Insured, it may be returned to the carrier as non-productive. (Non-productive audits may result in cancellation of a current policy and/or billings based on an increased estimated exposure.)

What records you will need to supply for the audit:

The auditor should provide you with a listing of financial records needed to complete the audit. Commonly requested documents include:

Payroll records for the policy period to include:

  • Payroll Journals/Registers/Summaries
  • State Unemployment Income Reports (CA DE9s)
  • Federal Tax Returns (941s)
  • W2s
  • Individual Earnings Records
  • Time Cards

Additional Financial Records requested may include:

  • General Ledger
  • Check Register or Disbursements
  • 1099s issued
  • Amounts paid to subcontractors
  • Cash payments for casual labor

Other additional records may be requested:

  • Sales/Revenues from different sources
  • Contractor State Licenses of subcontractors
  • Certificates of insurance showing evidence of workers’ compensation coverage for subcontractors and independent contractors
  • Business Licenses of Independent Contractors
  • Invoices

In addition to providing records, an owner or knowledgeable employee should be available to answer any questions the auditor may have. The auditor should ask sufficient questions to ensure they have a good understanding of your business operations, as well as duties associated with specific job positions, in order to properly classify both.

The auditor will ask about the owners and officers of the company as there are special rules governing their inclusion/exclusion and minimum and maximum amounts to be included in the audit.

Payroll records should show sufficient detail of earnings and deductions to enable the auditor to give you any appropriate credits. Such credits may include the exclusion of the premium portion of Overtime or Double-time earnings, severance pay, discovery or invention awards, expense reimbursements, per diem, tips reported by employees, and Cafeteria Plans.

Often, policyholders want other earnings types to be excluded. In most states, ‘payroll’ and ‘remuneration’ are synonymous and mean the monetary value of compensation. Remuneration includes gross wages, salaries, commissions, piecework, profit sharing or incentive plans, bonuses, vacation, holiday and sick pay, overtime payments, the market value of gifts, and all substitutes for money earned during the policy period. Also included may be a number of other payments or allowances, the market rental value of lodging provided to an employee, the value of store certificates, or any other substitute for money received by employees as part of their pay

Further, when the employer’s business is classified on a divided payroll basis, remuneration of employees may be divided, subject to specific rules and limitations. Such division is only allowed when complete and accurate records have been maintained and are supported by original time cards.