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What is a Premium Audit?
While workers’ compensation requirements can differ between states, many policies include a routine premium audit process. Depending on the results of a premium audit, an organization may either owe additional expenses to their insurer or have funds returned to them. Review this guidance to learn more about premium audits, how to prepare for an audit, and the next steps following an audit.

Home » Business Insurance » What is a Premium Audit?

What is a Premium Audit?

While workers’ compensation requirements can differ between states, many policies include a routine premium audit process. Depending on the results of a premium audit, an organization may either owe additional expenses to their insurer or have funds returned to them. Review this guidance to learn more about premium audits, how to prepare for an audit, and the next steps following an audit.
While workers’ compensation requirements can differ between states, many policies include a routine premium audit process. Unlike most other lines of commercial insurance (e.g., property coverage)—in which potential exposures can be identified upfront and premium expenses are final—workers’ compensation premiums paid at the beginning of policy periods are provisional amounts.

In other words, these premium expenses are estimates based on an organization’s projected payroll and operations for the upcoming policy period. That being said, the purpose of a premium audit is for an insurer to evaluate an organization’s actual payroll and work performed after a policy period to determine whether the initial premium amount was appropriate.

Depending on the results of a premium audit, an organization may either owe additional expenses to their insurer or have funds returned to them.

 

Premium Audits Explained

To better understand premium audits, it’s first important to note how workers’ compensation premiums are calculated. An organization’s premium is based primarily on three key elements:

 

  1. Employee classification rates—First, employees are assigned class codes based on their work and its perceived risk. These codes are tied to specific employee classification rates. The higher the rating, the riskier the employee’s job role is. For example, a roofer would receive a greater rating than a carpenter due to the risk of falling from height. The National Council on Compensation Insurance typically determines such rates, but some states utilize different systems.
  2. Payroll—Next, an organization’s overall payroll must be considered. In the scope of calculating workers’ compensation premiums, for each employee classification rate, an organization pays per every $100 of payroll. Remember that an organization’s classification rates and total payroll are the elements used to generate its manual premium. This means that the equation for an organization’s manual premium is (employee classification rate(s)) x (payroll/100).
  3. Experience modification factor—Lastly, an organization’s experience modification factor—also known as the mod factor—is calculated using loss and payroll data from the last three policy years, excluding the most recently completed year. From there, the organization’s actual losses are compared to its expected losses by industry type. A mod factor greater than 1.0 is a debit mod, which means that an organization’s losses are worse than expected—resulting in an elevated premium. A mod factor less than 1.0 is a credit mod, which means an organization’s losses are better than expected—resulting in a discounted premium.

 

Putting these elements together, the general equation for a workers’ compensation premium is an organization’s manual premium multiplied by its mod factor. However, given that the initial premium payment takes place at the beginning of the policy period, the elements of the manual premium equation are only estimates.

After all, employees’ job roles or tasks could change throughout the policy, altering their classification rates. Further, the final payroll amount could differ for several reasons (e.g., promotions or layoffs). This is why premium audits are necessary.

Premium audits occur at the end of a policy period—usually within 60 days of the policy’s expiration. These audits allow insurers to check whether the manual premium calculation was accurate.

If either element of the manual premium equation differs from initial estimates, the insurer will recalculate the policy premium cost. Based on how these elements change, this new calculation may either entail the insurer billing the organization for additional premium expenses or the insurer refunding the organization for the cost difference between premium totals. A premium refund can take the form of a check or—in some cases—a credit applied to the following policy premium.

Some states require premium audits for all workers’ compensation policies, while some only require audits for organizations with estimated annual premiums above a specific threshold (e.g., $10,000). State-level departments are responsible for performing routine evaluations to confirm that insurers conduct any required premium audits.

Premium audits can take place remotely—via mail or telephone—or in person. Large organizations with higher premium expenses or more complicated manual premium equation elements (e.g., several different employee classification rates) often require in-person audits. In contrast, smaller organizations with lower premiums usually engage in remote audits. However, organizations that belong to specific high-risk industries may require in-person audits, regardless of size or premium cost.

Auditors can either work for the insurance company providing your workers’ compensation coverage or be hired through a third party. In any case, these audits do not happen by surprise—they are planned ahead of time to allow the organization to prepare.

 

Preparing for a Premium Audit

There are several ways that your organization can prepare for a successful premium audit. First, it’s essential to have a detailed, organized record of the following documents for your auditor:

 

  • Tax information—This includes W-2 forms, 1099 forms, Form 941, Form 944, and your organization’s federal tax return.
  • Payment and payroll records—This includes your accounting ledger, payroll journal, overtime payroll records, material and labor payments, state unemployment tax reports, and individual earnings records.
  • Employee information—This includes a detailed outline of each employee’s job duties, classification rates, and work schedules.
  • Insurance certificates—This includes certificates of insurance for any independent contractors or subcontractors hired. Remember that if the contractors your organization hires don’t supply their own workers’ compensation insurance, you may have to provide coverage for them.
  • Additional business information—This includes your general ledger, sales journal, cash receipts, sales tax records, mod factor worksheet, a detailed summary of business operations, and information on each organization’s owners and partners (if applicable).

 

In addition to supplying organized documents, it’s critical to ensure that all of the information your organization gives the auditor is truthful. Providing false information (e.g., incorrect payroll, inaccurate job descriptions, phony tax returns, fake insurance certificates, or incomplete financial reports) could lead to prosecution by your state’s insurance department for insurance fraud.

Always check to confirm that your organization’s documentation is accurate and honest. In the case of telephone and in-person audits, be sure that a knowledgeable individual is available to answer any questions the auditor might have.

 

After the Audit

Once the audit is completed, the auditor will send your organization a report detailing their findings—such as whether any classification rates need to be changed or whether the payroll estimate was correct. From there, you will know if your organization must pay more premium charges or will receive a premium refund. If you agree with the auditor’s findings, it’s best to take any necessary actions (e.g., paying extra charges or updating classification rates) immediately.

On the other hand, if you disagree with the auditor’s report, you can file a dispute. Make sure you contact your insurance company directly for instructions on properly disputing a premium audit. Most insurers require you to send audit disputes in writing within a specified period, describe the problem in detail (with adequate reasoning), and suggest an alternative solution. The insurance company will then carefully review your dispute and determine whether an audit revision is necessary.

Any obligation to pay extra premium expenses will be put on hold until the dispute is resolved. If your insurer does not address your dispute the way you wanted, you can appeal their consensus to your state’s workers’ compensation board. It’s best to consult legal counsel for further guidance in this scenario.

 

PAYGO Policies

To minimize the risk of paying large audit balances at the end of a policy period, some organizations opt for pay-as-you-go (PAYGO) workers’ compensation policies. PAYGO policies allow organizations to pay their premium costs in real-time rather than at the policy’s inception, with premium calculations based on actual payroll information.

Nevertheless, PAYGO policies do not excuse organizations from the premium audit process. Organizations with PAYGO policies must still have routine audits to ensure their premium calculations are correct. However, the findings from premium audits tied to such policies usually result in fewer added expenses than traditional workers’ compensation policies.

While workers’ compensation requirements can differ between states, many policies include a routine premium audit process. Unlike most other lines of commercial insurance (e.g., property coverage)—in which potential exposures can be identified upfront and premium expenses are final—workers’ compensation premiums paid at the beginning of policy periods are provisional amounts.

In other words, these premium expenses are estimates based on an organization’s projected payroll and operations for the upcoming policy period. That being said, the purpose of a premium audit is for an insurer to evaluate an organization’s actual payroll and work performed after a policy period to determine whether the initial premium amount was appropriate.

Depending on the results of a premium audit, an organization may either owe additional expenses to their insurer or have funds returned to them.

 

Premium Audits Explained

To better understand premium audits, it’s first important to note how workers’ compensation premiums are calculated. An organization’s premium is based primarily on three key elements:

 

  1. Employee classification rates—First, employees are assigned class codes based on their work and its perceived risk. These codes are tied to specific employee classification rates. The higher the rating, the riskier the employee’s job role is. For example, a roofer would receive a greater rating than a carpenter due to the risk of falling from height. The National Council on Compensation Insurance typically determines such rates, but some states utilize different systems.
  2. Payroll—Next, an organization’s overall payroll must be considered. In the scope of calculating workers’ compensation premiums, for each employee classification rate, an organization pays per every $100 of payroll. Remember that an organization’s classification rates and total payroll are the elements used to generate its manual premium. This means that the equation for an organization’s manual premium is (employee classification rate(s)) x (payroll/100).
  3. Experience modification factor—Lastly, an organization’s experience modification factor—also known as the mod factor—is calculated using loss and payroll data from the last three policy years, excluding the most recently completed year. From there, the organization’s actual losses are compared to its expected losses by industry type. A mod factor greater than 1.0 is a debit mod, which means that an organization’s losses are worse than expected—resulting in an elevated premium. A mod factor less than 1.0 is a credit mod, which means an organization’s losses are better than expected—resulting in a discounted premium.

 

Putting these elements together, the general equation for a workers’ compensation premium is an organization’s manual premium multiplied by its mod factor. However, given that the initial premium payment takes place at the beginning of the policy period, the elements of the manual premium equation are only estimates.

After all, employees’ job roles or tasks could change throughout the policy, altering their classification rates. Further, the final payroll amount could differ for several reasons (e.g., promotions or layoffs). This is why premium audits are necessary.

Premium audits occur at the end of a policy period—usually within 60 days of the policy’s expiration. These audits allow insurers to check whether the manual premium calculation was accurate.

If either element of the manual premium equation differs from initial estimates, the insurer will recalculate the policy premium cost. Based on how these elements change, this new calculation may either entail the insurer billing the organization for additional premium expenses or the insurer refunding the organization for the cost difference between premium totals. A premium refund can take the form of a check or—in some cases—a credit applied to the following policy premium.

Some states require premium audits for all workers’ compensation policies, while some only require audits for organizations with estimated annual premiums above a specific threshold (e.g., $10,000). State-level departments are responsible for performing routine evaluations to confirm that insurers conduct any required premium audits.

Premium audits can take place remotely—via mail or telephone—or in person. Large organizations with higher premium expenses or more complicated manual premium equation elements (e.g., several different employee classification rates) often require in-person audits. In contrast, smaller organizations with lower premiums usually engage in remote audits. However, organizations that belong to specific high-risk industries may require in-person audits, regardless of size or premium cost.

Auditors can either work for the insurance company providing your workers’ compensation coverage or be hired through a third party. In any case, these audits do not happen by surprise—they are planned ahead of time to allow the organization to prepare.

 

Preparing for a Premium Audit

There are several ways that your organization can prepare for a successful premium audit. First, it’s essential to have a detailed, organized record of the following documents for your auditor:

 

  • Tax information—This includes W-2 forms, 1099 forms, Form 941, Form 944, and your organization’s federal tax return.
  • Payment and payroll records—This includes your accounting ledger, payroll journal, overtime payroll records, material and labor payments, state unemployment tax reports, and individual earnings records.
  • Employee information—This includes a detailed outline of each employee’s job duties, classification rates, and work schedules.
  • Insurance certificates—This includes certificates of insurance for any independent contractors or subcontractors hired. Remember that if the contractors your organization hires don’t supply their own workers’ compensation insurance, you may have to provide coverage for them.
  • Additional business information—This includes your general ledger, sales journal, cash receipts, sales tax records, mod factor worksheet, a detailed summary of business operations, and information on each organization’s owners and partners (if applicable).

 

In addition to supplying organized documents, it’s critical to ensure that all of the information your organization gives the auditor is truthful. Providing false information (e.g., incorrect payroll, inaccurate job descriptions, phony tax returns, fake insurance certificates, or incomplete financial reports) could lead to prosecution by your state’s insurance department for insurance fraud.

Always check to confirm that your organization’s documentation is accurate and honest. In the case of telephone and in-person audits, be sure that a knowledgeable individual is available to answer any questions the auditor might have.

 

After the Audit

Once the audit is completed, the auditor will send your organization a report detailing their findings—such as whether any classification rates need to be changed or whether the payroll estimate was correct. From there, you will know if your organization must pay more premium charges or will receive a premium refund. If you agree with the auditor’s findings, it’s best to take any necessary actions (e.g., paying extra charges or updating classification rates) immediately.

On the other hand, if you disagree with the auditor’s report, you can file a dispute. Make sure you contact your insurance company directly for instructions on properly disputing a premium audit. Most insurers require you to send audit disputes in writing within a specified period, describe the problem in detail (with adequate reasoning), and suggest an alternative solution. The insurance company will then carefully review your dispute and determine whether an audit revision is necessary.

Any obligation to pay extra premium expenses will be put on hold until the dispute is resolved. If your insurer does not address your dispute the way you wanted, you can appeal their consensus to your state’s workers’ compensation board. It’s best to consult legal counsel for further guidance in this scenario.

 

PAYGO Policies

To minimize the risk of paying large audit balances at the end of a policy period, some organizations opt for pay-as-you-go (PAYGO) workers’ compensation policies. PAYGO policies allow organizations to pay their premium costs in real-time rather than at the policy’s inception, with premium calculations based on actual payroll information.

Nevertheless, PAYGO policies do not excuse organizations from the premium audit process. Organizations with PAYGO policies must still have routine audits to ensure their premium calculations are correct. However, the findings from premium audits tied to such policies usually result in fewer added expenses than traditional workers’ compensation policies.

The Last Word

Overall, it’s crucial for your organization to have a clear understanding of the premium audit process and how it can impact your workers’ compensation costs. More than anything, make sure your organization is fully prepared for an audit—never ignore an insurer’s audit request.

Most workers’ compensation policies include a contractual obligation to allow an audit to occur for as long as three years after the policy’s expiration. Failure to comply could result in the termination or nonrenewal of your policy.

Contact an InsureGood Advisor today for additional workers’ compensation guidance and resources.

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