Why do I have to pay all this money?
Why is my premium doubling?
What went wrong? And;
Where is my agent?
Have you ever had these questions when you see the result of your workers comp Final Audit?
If you are experiencing Final Audit pains right now, this post is for you.
First, let me explain a Final Audit, what it is and what its purpose is. A Final Audit is when an insurer verifies the information you, the business owner, provided at the beginning of the policy period. The main thing they review is payroll that you either estimated at the beginning of the policy or that you reported during the course of the policy. The purpose of the Final Audit is accuracy. Finding the truth. Exposing mistakes and even fraud. Every policy’s rates and pricing is based on the information you told the insurer and reported to the insurer during the course of the policy. Every workers comp policy has rules it must follow – both from the policy contract itself, but on the state of operation’s labor laws. So not only does the auditor look at the volume of payroll, but he or she also looks at the class codes, and makes sure everything lines up according to the rules of the policy itself and the state of jurisdiction.
Now that we know what the Final Audit is and what it’s for, let’s get into the Top 5 Issues that an employer deals with at the time of the Final Audit that can have a negative effect. I’ll go over them and show you how to solve the problem, or at least how to get started.
ONE – Incorrect Payroll
The first issue is improper payroll. The most obvious reason for a payroll discrepancy is because you start your policy on a payroll estimate and then pay a monthly bill based on that estimate. It is very easy to estimate poorly. Lots of things can change during the course of a year.
- Maybe you just got started and had no idea what your payroll would be.
- Maybe you had a phenomenal year and hired a new employee or two rendering your initial estimate low.
- Maybe you underestimated your payroll projection that the beginning of the year because you wanted a low price and you didn’t know that there was such a thing as a Final Audit.
Regardless of the reason, it is difficult to give an accurate payroll estimate and most business owners are off a little. The audit will true it up.
And even in Monthly Self Reporting payroll, that is, the billing plan where you or your payroll company send your workers comp carrier your payroll numbers each month – even with self-reporting, errors occur. Why?
Typically, it’s because you may not be aware of everything that counts as payroll, which can cause you to improperly report. Some dollars that you spent that you might not think count as payroll do count as payroll.
- I’m talking about Paid Time Off (PTO), sick time, paid vacations, and bonuses.
- These payments and more are all considered payroll and if they are not reported to your carrier, they will get added to your bill in the Final Audit.
What can you do?
The solution to this problem is to understand what constitutes payroll and what does not constitute payroll. Some things are intuitive, but others are not – like bonuses, PTO, and overtime payments. There are lots of resources online and your insurance agent should be able to help.
If you are dealing with a fixed bill, do a self-audit halfway through the policy term. Is your initial estimate lining up with your current progress? If you sense a significant discrepancy, call your agent and update the payroll now so you don’t have to pay it all at once later!
And also, don’t lowball. Don’t come up with an overly low estimate because it can and will come back to get you in the Final Audit.
TWO – Incorrect Classification of Workers
Sometimes the issue is that you work with people and make payments to people that you believe do not count as employees, but as it turns out, in the Final Audit, they are employees and you have to pay workers comp for them.
Examples of these types of workers are:
- People that you think are Independent Contractors but are actually employees.
- Temps, seasonal, and casual labors incorrectly thought of as not-employees.
- Family members. Many people sometimes think that if they employ family members, they don’t have to cover them on workers comp. The first thing is that any other entity outside of a sole proprietor doesn’t have family members. No such thing as a family member in an LLC or corporation for example.
What can you do?
The solution to this problem is to know what constitutes an “employee” and what doesn’t.
Regarding independent contractors: AB5 is the California law that defines an employee and specifies it versus an independent contractor. Many people think that providing a 1099 to said worker is what converts a worker from employee to independent contractor. But that is not correct: 1099s do not convert anyone to an independent contractor. Your best bet is to assume everyone is an employee until proven otherwise.
If you have legitimate independent contractors, as a contractor that uses subcontractors would have, it is imperative that you get your subs’ certificates of insurance and keep them on file. Uninsured subcontractors – especially in the construction industry – count as employees and you do not want to get stuck paying workers comp on subs.
Regarding temps, seasonal, and casual laborers: they’re all employees! Even if you pay cash under the table.
Regarding family members: If your operating entity is anything other than a sole proprietorship, there is no such thing as a family member. Corporations, LLCs, and partnerships: they are non-human legal entities and don’t have family members. So there is no possibility of dealing with any family member exemptions.
If the business is a sole proprietor, most – if not all – policies come with a resident relative exclusion for family members residing in the household. In order to cover them, you must disclose to the carrier or your agent that resident relatives work for you and you need to list them on the policy by name.
THREE – Misclassed Employees / Wrong Class Codes
Sometimes the issue is that your employees are classed differently than you expect. This can cause a big audit bill. Often times a misclassed employee is a simple mistake. There are almost too many reasons to list why a business could improperly classify an employee. A simple misunderstanding of what the worker truly does, or just picking the wrong class code is easy to do. Restaurants alone have six class codes to pick from!
There are also some rules around class codes that prevent workers from being put into a class code you think they should be in.
For example, class code 8810 for clerical office workers requires a physical separation in that company’s place of business. If you have a shoe store and your bookkeeper that never interacts with customers sits at a desk in the showroom with all the shoes where people shop; that worker will be classified as shoe store, not clerical. So, a physical separation is important.
Another common mistake occurs in split rate class codes. This applies to contractors that have different class codes based on the hourly rate you pay your employees. An experienced foreman that gets paid a high wage will fit into a class code with a lower workers comp rate than an inexperienced field worker that gets paid a low wage. The low-wage worker fits into a class code that has a higher workers comp rate. Putting your low-wage worker in the high-wage class will come back to haunt you in the Final Audit.
What can you do?
You need to find the right class code up front. Take the time to make sure they’re classified correctly before starting your policy. And you must know the rules and particularities of your specific workers comp class codes.
There are many resources to determine the correct class code. Usually, your agent is your main source of help, but if you don’t have an agent, you can go to WCIRB and do a class search right here: https://www.wcirb.com/products-and-services/classification-search
FOUR – Employees with Split Duties Not Documented
Sometimes the issue is that your employees do work that could fit into two separate class codes. Business owners tend to classify their workers based on what that employee does the majority of the time. But the rules of workers comp state that if an employee does any work that could fall into multiple class codes, they belong in the class code with the highest rate, 100% of the time. This can cause a big audit bill. Let’s say you’re a plumbing company and you have a worker that does sales 90% of the time but also does plumbing work in the field 10% of the time; the auditor will put that employee in the plumbing class code, which is 5, 6, 10 times higher than the sales class. Ouch!
What can you do?
The solution to this problem is to document employees with split duties. You must document when the employee does the low-risk work in class code A and when they do the high-risk work in class code B. Fortunately, most payroll companies have the ability to create class code options for your employees when they log into their application. Whichever way you do it – manually on paper, or on a spreadsheet – documentation is key. For your auditor, if it’s not documented, it doesn’t exist and they are obligated to abide by the rules.
FIVE – Who Can Be Excluded?
Most business owners know that they as owners can be excluded. This is the one time where the word exclusion in insurance is good. The reason is if you don’t have to cover yourself on workers comp, you don’t have to pay for yourself on workers comp and most business owners don’t want to pay for workers comp on themselves (although, it’s not a bad idea in many cases). But there are rules around who can be excluded and who cannot be excluded. In addition, there are specific processes that must be followed in order to exclude eligible owners.
In California, and most likely all other states, it works like this:
- In a sole proprietorship, the sole proprietor is automatically excluded. There is no process to follow to make sure the exclusion happens.
- All other entities, the owners and officers are automatically included unless you proactively follow the process to exclude them. In order to qualify to be excluded, you must own at least 10% of the corporation and be an officer. There are a few exceptions and variances for family members that are owners whereby you can own less than 10% and still be excluded, but 10% is the general rule.
What can you do?
Know the rules of exclusion/inclusion and disclose any family member that works for you if you’re a sole proprietor. If you’re any entity other than a sole proprietor, every owner/officer, manager/member or partners must sign the officer exclusion form if they want to be excluded. It must be done up front. Many insurers will not allow retroactive officer exclusion forms.
So there you go – the top five workers comp issues that show up at the Final Audit with some basic steps on how to avoid them. May your next Final Audit be quick, easy, and affordable. And may you even get some money back. Yes, it happens!
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- Set an appointment. Just click on the link HERE.
- Have a conversation. We’ll learn about you and your business, gathering all the information needed to offer you a quote.
- We’ll present you with a solution. Once we’ve received your custom quote, we’ll reach out to you and schedule a time to discuss and review it. There is no-pressure – we only want win-wins!
