Seven ways to make sure your premium audit is incorrect
By Kevin Ring
Every year, like clockwork, the notice arrives: the workers' compensation premium auditor is scheduled to visit. For many business owners, this process feels like a necessary evil, a bit like a trip to the dentist. You gather your records, answer some questions, and hope for the best. Months later, a final bill (or, less commonly, a refund) arrives and you pay it, assuming the number is correct.
Here's a bold statement: more than 75 percent of premium audits are incorrect. When I've said this in a room full of auditors I get nods of agreement. Why? Because most of those mistakes happen long before the auditor arrives. They are not the auditor's fault. They happen because employers are often unprepared for the audit and don't keep their records in a way that ensures they only pay what they owe and not a penny more.
An auditor can only work with the information they are given. If the records are unclear or incomplete, they make a judgment call, and that judgment call will almost always be in favor of the insurance company. Here are seven of the most common ways your audit can be wrong, even when the auditor does their job perfectly.
- The ghost of operations past
One of the most frequent and costly errors begins with a simple mistake: copying the classifications from the prior year's policy without a second thought. I recall a story about an advisor who visited a plywood manufacturer. Looking at their policy, he saw classifications for an active sawmill operation. But as he toured the facility, he noticed something was missing: a sawmill. When he asked the owner about it, the owner said, "Oh, we offshored our manufacturing years ago. Now we just bring the finished plywood into our warehouse and distribute it."
For years, this business had been paying a high-risk manufacturing rate for what was now a much lower-risk wholesale distribution business. The error cost them over $400,000. Your business evolves, and so must your classifications.
- Mingling overtime pay
Except for Pennsylvania and Delaware, the premium portion (the "half" in "time-and-a-half") of overtime pay can be excluded from the audit. So, if you pay an employee $20/hour for regular time and $30/hour for overtime, that extra $10/hour doesn't count toward your workers' comp premium. But here's the catch: your payroll records must clearly separate regular pay from overtime pay. If your records just show a lump sum of total wages, the auditor has no choice but to include all of it.
- Including tips and gratuities
For restaurants, hotels, and any other business where employees receive tips, this is a big one. Money received directly from customers isn't considered payroll for workers' comp purposes. However, if your payroll system doesn't clearly distinguish between the wages you pay and the tips employees receive, that money can easily end up in the pot, artificially inflating your payroll and your premium.
- Forgetting about employee benefits
If you contribute to your employees' health insurance, 401(k) plans, or other group benefits, that employer-paid portion is not included as payroll for the audit. These are significant expenses that can add up quickly. Once again, the key is clean record-keeping. If these contributions aren't clearly separated in your financial statements, an auditor may have no way of knowing they should be excluded.
- Paying on severance
Severance pay is another area where businesses often overpay. The rule is simple: workers' compensation premium is paid for employees who are working. Money paid to a terminated employee who is no longer working is not subject to workers' comp premium. If your records don't make a clear distinction, you could be paying a premium on someone who hasn't been on your job site in months.
- Not separating work into different classifications
This is a subtle but powerful way to overpay. Imagine a construction company that has a crew of carpenters. Most of the time they are out on job sites framing houses, which is a high-rate classification. But what if one of those carpenters spends a significant amount of his time working in the shop, building cabinets or repairing tools? That work falls under a much lower-rated (and therefore cheaper) classification.
If the employer's records just show that this employee is a "carpenter," the auditor must put his payroll into the highest-rated classification that applies to his work. However, if the employer keeps records that show a division of that employee's time-so many hours on the job site, so many hours in the shop-the auditor can split his payroll between the two classifications. This requires diligent time-tracking, but for businesses with employees who perform a mix of high- and low-risk tasks, the savings can be substantial.
- The uninsured subcontractor trap
For businesses that hire subcontractors, this is a minefield. If you hire a subcontractor who doesn't have their own workers' compensation insurance, their payroll will be included in your audit. The problem is how do you determine their payroll? If all you can provide the auditor is a check for the total job-say, $20,000 to Bob's Painting-the auditor must include the full $20,000 as payroll. That means you're paying a premium on paint, ladders, and brushes. If Bob's invoice breaks out labor from materials, the auditor can use the labor figure, but even then, rules often require them to use at least 50Percent of the total contract price. Clear documentation and ensuring your subcontractors are insured is the only way to avoid this trap.
Ultimately, the premium audit is the final exam for your workers' compensation policy, and you can't cram for it the night before. For too many business owners, it's a passive process of handing over a stack of papers and simply hoping for the best. But as these seven examples show, hope is not a strategy. An accurate audit is the direct result of proactive financial stewardship throughout the year.
The power to control this outcome rests entirely with you, the employer. It's built through diligent record-keeping and a commitment to documenting every detail. These are far from the only items that could be included on your audit without proper records, so it's critical you discuss the rules with your agent to make sure you are keeping your records in the best way. Instead of treating the audit as a dreaded annual ritual, view it as the moment you prove you are in control of your costs. Do the work in advance, and the final bill will never be a surprise; it will simply be a confirmation that every dollar you've earned stays exactly where it belongs.
Kevin Ring is the Lead Workers' Compensation Analyst for the Institute of WorkComp Professionals, which trains, certifies and mentors insurance agents to help employers reduce workers compensation costs. A licensed property and casualty insurance agent, he is the co-developer of a workers comp software suite that will help insurance professionals in working with employers.