Your Workers’ Compensation Final Audit

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By Jeff Cavignac, CPCU, ARM, RPLU

The ultimate cost of your workers’ compensation program is determined by a number of factors, not the least of which is your final audit.

The workers’ compensation audit process can be confusing, complex and, if done incorrectly, expensive. It doesn’t help that the audit process is set up so that most errors benefit the insurance company.

The company may simply ask you to send the information needed to perform the audit, or may choose to conduct a physical audit in your office. In either case the auditor will probably want to see your State quarterly wage and withholding reports (DE-6s), payroll journals, and any previously filed payroll reports for the period being audited. Occasionally, other records that relate to your workers’ compensation policy may be requested as well.

Regardless of which records are requested, it is imperative that the payroll is placed in the appropriate classifications and that any rules that could work to your advantage are employed.

Understanding the Audit Process

The following information will help you better prepare and understand the audit process.

Premium Basis – Your premium is based on gross payroll, not net payroll.  Gross payroll includes salaries, commissions, bonuses, vacation and holiday pay, sick pay, overtime payments (which can subsequently be deducted), the value of gifts, all substitutes for money earned or paid during the policy period, including meals and lodging in lieu of wages, automobile allowances, and any amount by which an employee’s salary is reduced to fund a pension or deferred compensation plan.

Appropriate Classifications – Don’t overlook clerical and sales classifications.  In addition, if you have several classifications on your policy with various rates, make sure you understand the differences so you can classify your employees in the most favorable category.

Split Payroll Classifications – Some payroll classifications allow you to split an employee’s payroll among various class codes (recognize that many codes, including clerical, do not allow this split).  In order to take advantage of such a split, proper payroll records must be kept that specifically identify time worked in each classification.

Dual Wage Classifications – Some construction and erection operations divide employees into two separate classifications based on an employee’s hourly wage rate.  Premium rates are higher for the lower hourly wage rate.  In order to take advantage of the higher wage rate classification, the law requires that time cards or time logs must be kept that show actual hours worked and start and stop times for each employee for each day.  The time keeping requirements apply even if you pay prevailing wage or have union employees.

Executive Officers and Partners – Executive Officers and Partners are capped for payroll purposes.  For 2014, the minimum amount that an executive officer or partner can be charged is $39,000, and the maximum amount is $101,400.  If you have elected to exclude executive officers or partners, make certain that their payroll is not included in the audit.

Overtime – You are not required to pay workers compensation premium on the overtime portion of a wage.  In other words, if somebody who normally makes $10 an hour works an hour of overtime and is paid $15, you would pay premium for the overtime hour based on a rate of $10 per hour, not on a rate of $15 per hour.  It is important that your payroll records be maintained to show the regular rate of pay, the overtime earnings by employee, and a summary by type of operation performed so the auditor can give you credit for overtime excess.

Severance – If you have paid severance to anyone in the past year, you can deduct this from your audit.  You are not required to pay workers compensation premium on severance pay.

Payments to Inactive Employees – Payments to inactive employees are not counted when calculating your workers compensation premium.

Third Party Sick Pay – Were there any employees hurt on the job that received disability payments (short or long term) from a disability carrier or provider?  If this third party sick pay was included in the employee’s W-2 and/or payroll register, you can deduct it.

Travel Expense Offset – Did any employees receive additional funds to offset travel expenses?  This is not chargeable as payroll.

Form 1099 – If anyone was paid by Form 1099 through your payroll, was this amount deducted for workers compensation purposes?

Uniform Allowance – Was anything added to individuals’ payrolls to compensate for required work clothes or safety equipment?  If so, this can be deducted.

Any Other Additions or Exclusions – Other than base pay, bonuses and commissions, were there any other additions or exclusions to payroll?

Subcontracted Work – If you subcontract work you will be asked to supply basic information about your subcontractors and verification that they have appropriate insurance.  Recognize that if they do not carry the appropriate insurance, you will be charged a premium based on their exposures (see attached explanation of how that premium will be charged).

Owner-Controlled Insurance Programs (‘Wrap-Up’ Policies) – Were you involved in any owner-controlled insurance programs (‘wrap ups’) that extended to workers compensation?  If so, you can deduct the payrolls included under the ‘wrap’ from your payrolls submitted for the audit.

Preparing Your Audit Package

Once you have all of your records in order you should prepare an Audit Package to give to the auditor when they arrive.

  1. Classification – Use a spreadsheet to place each employee into the correct classification (Exhibit 1). Any questions as to where to classify specific employees should be discussed with your broker.
  2. Remuneration – Adjust for excluded remuneration.
  3. Adjust for Exempted or excess corporate officers’ payroll.
  4. Delete the overtime portion of any payroll.
  5.  Summary Statement – Total payrolls for all classifications and prepare a Summary Statement (Exhibit 1).
  6.  Owner Controlled Insurance Programs (OCIP) Payroll – Keep separate records of OCIP payroll and exclude it from your audit payroll.
  7.  Time Cards or Time Logs – If you are using dual wage classifications, have time cards or time logs showing actual hours worked and start and stop times for each employee available for the auditor to review (Exhibits 3 & 4).
  8.  Subcontractors – If you employed any subcontractors, compile the appropriate Certificates of Insurance and have them available to show to the auditor.
  9.  Uninsured Contractors – Confirm that any uninsured contractors are placed in the appropriate classification.

The Auditor Arrives

  1.  Treat the Auditor as a Welcome Guest – Assign a knowledgeable and friendly person to work with the auditor. Treat the auditor as a welcome guest.
  2. Audit Package – Present the auditor with your Audit Package.
  3. Volunteer Nothing – Answer the auditor’s questions, but do not offer gratuitous information.
  4. Premises Tour – Provide the auditor with a tour if he/she wants one, but don’t allow him/her to roam freely and unaccompanied around the work place.

Exhibit 1

Exhibit 2

Exhibit 3

Exhibit 4

Final Comments

In general, the insurance companies’ auditors do an excellent job. If, however, you have questions or think the audit may be inaccurate, you should contact your broker.

If done correctly, the audit process will result in an appropriate premium charge. If done incorrectly, it can result in dramatic overcharges. The key to making certain your audit is done properly is to understand the process and prepare accordingly.