Workers’ Comp Audits Explained

A Workers’ Compensation policy can create an unpleasant surprise at the end of the year: an additional premium bill after the audit.

We see this fairly regularly. Recently, a local mechanic we work with ended up owing roughly $2,000 more in Workers’ Comp premium after their audit. Nothing went wrong with the business. Actually, the opposite happened.

They grew more than they expected.

Their payroll ended up higher than the estimate used when the policy was originally written, so the premium had to catch up with the actual exposure. That is an important point about Workers’ Compensation insurance:

The premium you pay during the year is often based on an estimate. The audit determines what actually happened.

Why Does a Workers’ Comp Audit Happen?

When a policy begins, the carrier generally uses estimated payroll and employee classifications to calculate the Workers’ Comp premium. At the end of the policy period, an audit compares those estimates against the business’s actual results.

The Hartford explains that an audit verifies payroll and also reviews employee classifications and subcontractor use. Travelers similarly notes that the original premium is estimated from expected operations and may be adjusted after actual payroll, classifications, subcontractors and other information are reviewed. The Hartford

That adjustment can go either direction. If payroll was lower than expected, the business may receive a credit or lower final premium. If payroll was higher, or other exposures were greater than estimated, the business may owe additional premium.

For a growing contractor, that second situation is especially common.

1. Your Payroll Grew

This is probably the simplest and most common reason we see. Suppose you estimated $500,000 of payroll when the policy started. Business goes well. You hire another crew, employees work more hours and actual payroll ends up at $650,000. That’s great from a business-growth standpoint.

But the insurance company was collecting premium based on the lower estimate throughout the year. At audit, the carrier now has the actual payroll. The result can be an additional premium bill. This doesn’t necessarily mean anything was wrong with the policy.

You simply had more exposure than originally projected.

The problem is when a successful year ends with an insurance bill the owner never budgeted for.

2. Your Payroll Records Don’t Clearly Separate Classifications

Payroll alone isn’t the only thing affecting Workers’ Comp premium.

What your employees actually do matters too.

Different job duties can have different Workers’ Compensation classification codes and rates because the injury exposure may be very different. A contractor could have employees performing two different types of work with different rates. The trouble starts when the company’s records don’t clearly show which payroll belongs to which operation.

We have seen situations where a policy was set up using multiple classifications, but the company’s internal payroll documents did not adequately differentiate the employees or work between those classes. That can create an audit dispute, and potentially move payroll into a more expensive classification when the records don’t support the intended separation.

Travelers specifically asks payroll records to identify each employee and the description of work performed, noting that this may differ from the employee’s job title. Travelers So if your policy uses multiple Workers’ Comp classifications, your accounting and payroll records should be able to support why the payroll was separated that way.

3. Uninsured Subcontractors Can Show Up at Audit

This is a major issue for contractors. A common misconception is: “I paid them on a 1099, so they’re automatically not part of my Workers’ Comp exposure.”

It isn’t necessarily that simple.

Whether someone qualifies as an independent contractor is determined by applicable rules and the facts of the working relationship, not simply whether they receive a W-2 or 1099. And subcontracted labor creates another problem when the subcontractor cannot provide proof of its own Workers’ Compensation coverage.

Travelers says a business may be charged premium for work performed by an uninsured independent contractor or subcontractor when a valid Workers’ Compensation Certificate of Insurance is unavailable. State requirements can vary. Travelers That is why contractors should collect and retain Certificates of Insurance showing Workers’ Comp coverage for subcontractors throughout the period when they are actually working.

Travelers’ audit documentation specifically asks for COIs when applicable, along with information about subcontractor payments, dates worked, work performed and material costs. Travelers Simply paying someone as a subcontractor doesn’t make the exposure disappear.

4. Your Business Changed During the Year

Contractors rarely stay exactly the same for twelve months. You may:

• Add employees
• Create another crew
• Move employees into different jobs
• Add a new type of work
• Use more subcontractors
• Expand geographically
• Change ownership or entity structure

Any of those can affect what the carrier finds during an audit. The Hartford specifically notes that changes in job duties or classifications can result in a different final premium. The Hartford One of the easiest ways to avoid surprises is simply to tell your agent when the business changes rather than waiting until renewal or audit.

The Easiest Solution: Use Actual Payroll When Possible

One option we like when it is available is pay-as-you-go Workers’ Compensation, sometimes called payroll reporting. Instead of paying Workers’ Comp based primarily on one annual payroll estimate, the premium is calculated using actual payroll reported throughout the year.

The Hartford explains that pay-as-you-go billing can reduce the likelihood of a large year-end adjustment because premium payments more closely follow actual payroll. It does not eliminate the audit, but it can make the payments during the year more accurate. The Hartford

For a contractor whose payroll changes with workload, crews and growth, that can make budgeting considerably easier. Instead of guessing in January how much payroll you’ll have for the entire year, the Workers’ Comp premium follows payroll more closely as it happens.

What If Payroll Billing Isn’t Available?

You can still manage the exposure proactively. One thing we do with clients is check in during the policy year. If we estimated $400,000 in payroll six months ago but the business is now obviously trending toward $550,000, we don’t necessarily need to wait for the audit to learn that.

We can:

• Update the payroll estimate when appropriate
• Help estimate the additional premium
• Spread some of that additional cost through the remaining policy term when possible
• Or at minimum help the owner understand approximately how much money should be set aside

The $2,000 additional premium our mechanic client owed wasn’t necessarily a bad thing. The business grew. The goal is simply for growth not to create an unexpected cash-flow problem.

Contractors Should Keep Better Records Before the Auditor Asks

A few habits can make the audit substantially easier:

• Keep payroll separated by employee and actual job duties.
• Maintain accurate descriptions of what each employee does.
• Keep contracts and invoices for subcontracted work.
• Obtain Workers’ Compensation COIs from subcontractors before they begin work.
• Make sure those COIs cover the entire period the subcontractor works for you.
• Tell your agent when payroll or operations change materially during the year.

Carriers may request payroll summaries, tax filings, check registers, disbursement records and subcontractor documentation as part of the audit process. Travelers Good recordkeeping isn’t just an accounting exercise. It can directly affect the premium calculation.

The Bottom Line

A Workers’ Compensation audit shouldn’t be viewed as the insurance company randomly deciding what you owe at the end of the year. It is essentially a reconciliation. The policy started with estimates. The audit looks at what actually happened.

For contractors, the biggest surprises often come from:

Payroll growth.
Classification issues.
Uninsured subcontractors.
And changes nobody reported during the year.

Growing faster than expected is a good problem to have. Getting an unexpected insurance bill because nobody adjusted the estimate isn’t.

If your payroll has changed significantly since your Workers’ Comp policy started, or you use subcontractors and aren’t sure how they will be handled at audit, we can help review where your policy is tracking and estimate what the year-end adjustment could look like before the bill arrives.

Workers’ Compensation rules, classifications and treatment of subcontractors vary by state, carrier and individual circumstances. Coverage and premium calculations depend on the applicable policy and audit rules.