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Workers Compensation Audit - Premium Audits

What they are, why they happen and how they go wrong....

A Video About Workers Compensation Audits

Workers Compensation Audits are a necessary part of the workers compensation premium determination process. It's the audit process that determines the final cost of a workers compensation policy.

In this section of our website you will learn:
  • What workers comp audits are;
  • Why they must happen;
  • How audits are tied to the EMR or experience rating;
  • How problems and mistakes occur in the audit process;
  • And what you can do when things go wrong.
Employers are often times intimidated by the workers compensation audit process, the audit and its unknown outcome. For many employers it seems the whole concept of the process is a mystery. In fact it's usually pretty straight forward. Knowledge of the process is important. Armed with a general understanding about how the audit process works, why it happens and how to avoid the common pitfalls will better prepare any employer to breeze through an audit.

We've prepared this section of our website to provide you with helpful information about audits. You'll find general information that may be helpful to you in better understanding how these audits may effect your business.

Workers Compensation Audits:

The audit of a workers compensation policy is a simple concept. The premium for a workers comp policy is calculated by taking the rate for a specific job classification code and multiplying that rate by the exposure base. The exposure base for this type of insurance policy is called remuneration and includes a variety of items with only one being payroll. In simple terms, remuneration equates to payroll, even though other items may also be included. We find many times it's the "other items" that create audit problems. The audit, an examination of the records or books of a company, is a required process that comes after a policy ends. This is when the final cost of the policy is determined.

Workers Compensation Deposit Premium, Auditable Policies and Why Audits Occur:

Did you know that when you purchase a workers comp policy the premium you pay at the beginning is called a deposit premium? You see, a workers compensation policy is known as an auditable policy. This means that any premium paid at the beginning of the policy period will be adjusted once the policy expires. The concept of an auditable policy is one of exactness. Remember, it's the rate times the exposure base that generates the premium and with workers compensation the rate is generally shown per $100.

So with an auditable policy the premium at the beginning of the policy is based on a projected exposure base for that specific policy period. In other words the beginning premium is based on a best guess of the exposure base or payroll. Then once the policy expires, 12 months later, an audit, or examination, of the exposure base is required to determine the actual payroll for the policy period. Once the actual payroll has been determined an adjustment or recalculation of the policy premium is conducted and math takes over. What remains is a comparison of the original estimated payroll to the actual payroll. If the estimated payroll is lower than the actual then a return of premium will occur. See you paid more than you needed when you made the deposit premium. If the actual payroll is higher than your estimate then you will receive an audit bill for an additional premium due. Take a look at the following examples.

  • Here's an example of an audit with additional premium due:
    • At the beginning of the policy: $100,000 (payroll-best guess)/100 x $13.24 (rate) = $13,240 (deposit premium)
    • Audit is conducted and actual payroll is discovered to be: $120,000
    • Recalculation of policy: $120,000 (audited payroll)/100 x $13.24 (rate) = $15,888 (audited premium)
    • Final premium calculation: $15,888 (audited premium) - $13,240 (deposit premium) = $2,648 (audit bill)

  • Here's an example of an audit with a return premium:
    • At the beginning of the policy: $100,000 (payroll-best guess)/100 x $13.24 (rate) = $13,240 (deposit premium)
    • Audit is conducted and actual payroll is discovered to be: $90,000
    • Recalculation of policy: $90,000 (audited payroll)/100 x $13.24 (rate) = $11,916 (audited premium)
    • Final premium calculation: $13,240 (deposit premium) - $11,916 (audited premium) = $1,324 (audit return premium)

We've simplified these examples. In fact many other factors are used in the premium computation formulas but for these examples we want you to see the relationship between payroll, rate and deposit premium. Now it's easy to see what we mean by exactness!

Workers compensation audits occur in order to determine the actual exposure on which the premium for a workers comp policy is based.

Here's a few questions, answers and points to consider:
  • Why is the insurance company allowed to conduct an audit? - A workers compensation policy is a contract. It's a contract between you and the insurance company and within the contract you will find duties and conditions. When you purchase or buy a workers compensation policy you agree to abide by the terms of the policy. One of the policy agreements is called "AUDIT." You will generally find this under the policy section titled "PREMIUM." It's here where you give the insurance company the right to examine your records.

  • What kind of information will they want to review? - Within the "PREMIUM" section of a policy you'll find the insurance company has the right to examine your records. They go on to identify the type of records include tax reports, vouchers, contracts, payroll and other disbursement records, various journals, registers and ledgers. Records may also include computer programs and other electronic storage and retrieval systems.

  • When can the insurance company conduct an audit? - The standard workers comp policy allows the insurance company access to your records for audit during regular business hours during the policy period and within three years after the policy period ends. Within this section of the policy you also allow insurance rate or advisory organizations the same rights as the insurance company.

  • What happens if you do not complete the audit? - Typically an insurance company needs to complete the audit within 60 days after the expiration of the policy. Audits are time sensitive because there are certain reports that must be filed by the insurance company with the rating authority within certain reporting periods so it's important that you work with the auditor to complete the audit in a timely fashion. If the audit is not completed, the insurance company may label your account "Non-Cooperative" causing your current policy to be cancelled. They will produce an estimated audit adjustment to your policy and send you a bill. In some states an estimated audit may be as much as a 25% increase over your original policy premium. They may also report you to the rating authority as "Non-Compliant" and in some situations a non-compliant policy may keep you from being able to buy workers compensation insurance.

Importance of Accurate Audit Data - Employer, Agent, Insurance Company and System Perspective:

Most employers, agents and even insurance company personnel are not aware of the importance accurate audit data plays in the overall picture of the workers compensation system. The workers compensation system, regardless of the state, rating bureau or rating authority, whether monopolistic or not, data drives the entire world of workers compensation! It fits together like pieces of a puzzle and for most it's never that apparent.

Employers may look at the audit process as just another opportunity for an insurance company to get their hands on the employers hard earned money. Sometimes, we might agree. However, audit is the process of gathering an employers accurate rating data, plugging that data into the rating formula and generating the final premium for the employers workers compensation policy. So for an employer the net effect of the audit process is one of economic interest. If the audited data shows less payroll than the original policy was established on there will be a return of premium to the employer. It the audited data shows an increase in payroll over the original policy then there will be additional premium due. A pure single economic interest.

The insurance agents perspective is a little different. Keep in mind that an agents primary duty is to place the employers policy with a financially sound insurance company or in a sound workers compensation program of some kind that meets the employers determined needs. Those needs will typically address the availability of coverage, cost (how much does it cost?,) and additional services provided by the agent to the employer such as involvement in safety programs, certificate management and even policy and audit review services. The agent perspective is one of service with the ultimate goal of retaining the employers trust and continued business relationship. For an agent, accurate collection and application of the employers audit data is crucial in maintaining the work relationship. Again, an economic interest.

The insurance company depends on accurate audit data to provide them with the correct premium for an employers work exposure. But it's bigger than just one employer. It's at this point where we move more from a pure single economic interest into a broader, overall program effect. The insurance company has many employer clients exposed to problems associated with inaccurate audit reported data. The insurance company relies on accurate application of this data to assist it with future rate development and in the analysis of work process acceptability. Audit data, as gathered from all their employer/clients and analyzed as a whole, plays a big role in determining the future direction of an insurance company workers compensation program. Profitability, program sustainability and future growth are all related. So, while the insurance company still looks at audit data from an economic interest, it does so from a much broader perspective.

Rating Bureaus and the Workers Compensation System, as a whole, are driven by data. Accurate audit data is but one of the key items of collection. Audit data plays a role in determining costs associated with each individual classification code. Rating payroll and claim data all come together when the rating authority or rating bureau crunches data to develop loss costs, rates, expected loss rates and other vital factors used to support the entire workers compensation system. When experience rating formulas are applied to an individual employer it's their historical audited payroll that is used to determine their individual expected losses as used in the EMR formula. The role of the rating bureaus is one of the broadest perspective. While an insurance company is concerned with their policyholders and their individual book of workers compensation business, it's the role of the rating bureaus that encompass all insurance carriers and all their clients. The rating bureaus interest in accurate audit data spans the greatest perspective. Work they do preserves the entire workers compensation system.

Recap. So from the individual employers economic impact to the larger gathered data pool for all employers, accurate workers compensation audit data plays an important role. From rate making to experience rating, from program selection to profitability, it all goes hand in hand. Knowing the interests of all the players can help put the importance of the audit process in perspective.

Three Different Types of Audits:

There are three different audit procedures that an insurance company can use to gather your policy data. If you are a reader of our blog you'll recognize these commonly used data gathering techniques. If you haven't visited our blog, you should! That's where you'll find a great deal of additional information related to audits and the entire audit process, including case studies.

Three common audit types are:
  • The Physical Audit -
    • A physical is just what you think. That's where the insurance company auditor makes an appointment with you and schedules a physical visit to your place or work or job site. The information they will need to complete the audit remains the same and consists of payroll records, operation and job descriptions, overtime along with verification information. Physical audits may be performed by insurance company employees or more than likely by independent subcontract auditors.

  • The Self Audit -
    • A self audit describes the process of mailing you, the employer, a form used for gathering the raw audit information, having you complete and return the information directly to the insurance company audit department for processing.

  • The Telephone Audit -
    • A telephone audit is often used in conjunction with some type of self audit form. This is where the insurance company has you, the employer, provide them with payroll and other audit data, sometimes on a self completed form that you mail back and then are contacted by an insurance company audit employee who goes over the form and verifies the data you've provided. Sometimes the telephone audit skips the part where you complete a form and send it to the insurance company rather they just conduct the audit entirely over the phone.
The method an insurance company uses to gather audit data will depend on the type of employer, the industry of the employer, the size of the employer in terms of total number of employees and size of payroll. Physical audits are the most common for medium to large employers. Another trigger for a physical audit being completed is if the employer is in the construction industry. There are many considerations as to the type of audit that an insurance company will consider. How an audit is conducted can have a real impact on the accuracy of the information gathered. Be sure to read our section on how to prepare for an audit.

Typical Audit Problems and Mistakes:

Use this link to see the Top Ten Workers Compensation Audit Errors and Mistakes. Workers Compensation Audits, while simple in concept, can be complicated. The audit process in itself is a combination of written rules and regulations with a splash of interruption and experience on the auditors part. We've worked with clients where they had the same workers compensation carrier, agent and auditor for years and never had a workers comp audit problem. Then they changed agent, carrier or a different auditor was assigned and their audit came back completely different than before. It happens. Audit problems and mistakes can come from a variety of different areas, here's just a few:
  • An incorrect class code is used;
  • The business operation changes;
  • A more descriptive classification is now available;
  • The audit is not completed at the policyholders place of business;
  • The business owner does not accurately describe the operations to the auditor;
  • The auditor misinterprets and misapplies the operations of the business;
  • Incorrect charges applied for owners;
  • Incorrect charges applied for contractors;
  • And many more!
For such a simple concept workers comp audits can sure cause a lot of trouble! Simple mistakes can turn into large premium issues and unknown or misapplied rules can ruin a business.

Why Workers Compensation Audit Problems and Mistakes Happen:

Many individual parts of the audit process must come together in one place to develop an accurate representation of the exposure base for a specific workers compensation policy period. These items are varied and include:
  • Correct application of the named insured entity;
  • Proper application of ownership inclusion or exclusion;
  • Correct descriptions of the business operations, work processes and materials used;
  • Accuracy of the original policy and how it was established;
  • Correct understanding by the agent and/or underwriter of the nature of the business insured;
  • Correct application of classification codes;
  • Agent and underwriter understanding of remuneration, what actually makes up the exposure base and how unknown facts at the beginning of a policy period can have a negative effect on the audit;
  • Accurate communication of changes in operations during the policy period;
  • Improper application of reclassification of the risk;
  • Hidden application of rules of remuneration, agent and/or underwriter did not understand certain aspects which the auditor rightfully discovered and applied at audit;
  • Proper subcontract and statutory employee application;
  • Improper interpretation of rules that apply;
The first opportunity for an audit error or mistake to occur is when the original policy is established. The insurance agent and company underwriter must be knowledgeable in workers compensation. The client must be educated in the workers compensation audit process. There are many pieces of a workers compensation audit puzzle and with each piece comes the opportunity for an error or mistake.

Frankly, it boils down to communication and knowledge.
  • The insured or client must accurately present a representation of their business to the agent and underwriter when the policy is first being established, this is crucial;
  • The agent and/or underwriter must then correctly apply the proper classification code to this clients business;
  • The agent and/or underwriter must properly educate the client as to the makeup of remuneration and those items that must be included in the exposure base;
  • The client must provide accurate projections of payroll and include other remuneration items that may affect the ultimate exposure base;
  • The client must communicate throughout the policy period any changes in operations or work processes to the agent or underwriter;
  • Proper adjustments to the policy must be made during the year to account for any changes;
  • The auditor must be provided with timely accurate detailed information from the insured or client and insurance company in order to do their job.
Too many times it seems like it's the auditors job to clean up a mess that's caused by everyone else in the process. Maybe it's the agent who wants to sell the cheapest premium to a client. Maybe it's the client who demands to have the lowest cost for his insurance. Maybe it's just an incomplete understanding by those involved in the process. But you can bet when it comes to workers compensation audits, it's accuracy that counts! It really is in the details!

What You Can Do When An Audit Goes Wrong:

Unfortunately, when it comes to workers compensation audits, one size does not fit all! Each client, each customer, each insured brings a different problem which demands a different solution. Can you fix your problem by yourself? Sometimes the answer is yes! But you really have two basic choices when you need help with a workers compensation audit problem:
  • Fix it yourself; or
  • Find professional help.
How can you determine if it's a problem you can fix?
  • Is the problem obvious?
  • Does the problem stem from information provided to the auditor?
  • Have accurate payroll and other remuneration items been accounted for?
  • Can you accurately pin point the problem and respond with the required support documentation?
If you answered NO to any of these questions, you may want to consider finding outside help. Here's another page on our website that may provide you with valuable help in making this decision.

We've said it before and we'll say it again, do not wait to find help with a workers compensation audit problem. Time is not on your side in adverse audit situations. It is critical you do not wait until the last minute to seek help!

Topic Menu: Workers Compensation Audits

Video Transcript:

Workers Compensation Audits, while simple in concept, continue to cause many employers a great deal of trouble!

Hi! I'm Randy Sieberg with Workers Compensation Consultants.

A workers compensation audit is a necessary step in determining the final cost of any workers compensation insurance policy. Conducted after a policy has expired, the audit process is designed to discover the actual exposure base generated by an employer over the policy period in question. When you buy a workers compensation policy you give the insurance company the right to perform an audit.

While there are many pieces that make up the audit puzzle, it only takes one error in the process to cause a costly problem. Faced with a error or mistake in a workers comp audit an employer has two choices, they can try to fix the problem themselves or they can seek out professional help.

On the "workers compensation audit" page of our website you'll learn:
  • What a workers compensation audit is;
  • About auditable policies;
  • About workers compensation deposit premiums;
  • Why workers comp audits occur;
  • About typical audit problems and mistakes and why they occur;
  • And what you can do when an audit goes wrong.
Information on this page may help guide you through the audit process.

You'll find we try to provide a great deal of free information for employers concerning the workers comp audit process along with other workers compensation issues on our website.

We really believe the better informed an employer is of the audit process, the better outcome they will have at audit time!

I hope you find this information useful. And don't forget to visit our website at work comp consultant.com!

Thanks for watching!

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