Guides
Premium audits: how they work and how to prepare
How workers' comp and general liability audits turn estimated premium into final premium, what auditors count, and how to avoid and dispute a surprise bill.
A premium audit is the insurer's check, after the policy ends, of the payroll, sales or other exposure it charged you on. You pay a deposit up front based on your estimate. The audit replaces the estimate with actual numbers, and you either owe more or get money back. Workers' compensation and general liability policies are the ones most often audited, and the surprises are usually in payroll definitions, subcontractors and class codes, not in arithmetic.
What the policy says
Audit rights are written into the standard forms. Under the NCCI Workers' Compensation and Employers Liability Policy (WC 00 00 00), Part Five, Section G, the insurer may examine and audit your records that relate to the policy, including ledgers, journals, vouchers, contracts, tax reports and payroll and disbursement records, and may conduct audits during regular business hours during the policy period and within three years after it ends. The same policy requires you to keep the records needed to compute premium. Final premium is determined after the policy ends from actual payroll and the proper classifications and rates, and the policy sets a floor at its minimum premium (Insurance Journal, Audit Rules and Guidelines; Texas Mutual, Premium Audit Basics). The ISO CG 00 01 general liability form has a Premium Audit condition in Section IV: the advance premium is a deposit, the insurer computes the earned premium at the close of each audit period, and an excess is returned to the first named insured. Carrier forms and state rules vary, so check yours.
Other lines can be audited too, such as liquor liability on sales, umbrella and excess on the underlying exposures, and commercial auto for some fleets. If a policy was written on an estimate of an exposure base, expect a true-up.
How audits are done
Carriers use several formats, and the one you get depends on the carrier and the size of the premium:
- Mail-in or online. You receive a packet or log in to a secure system, describe operations, enter payroll and upload documents.
- Telephone. The auditor talks to your designated contact and may request documents.
- Physical (field) audit. The auditor visits your premises or your accountant's office and may look at operations.
- Interim audits. Some carriers audit quarterly or semiannually during the term for larger or changing accounts.
Texas Mutual's published guide, for example, says physical and telephone audits end with an exit interview that gives an indication, not a final figure, of the premium impact, and that the carrier's corporate review follows before the final statement is mailed.
What the auditor asks for
| Document | What it proves |
|---|---|
| Payroll register by employee, with job description | Gross pay, classification, officer pay |
| Federal Form 941 and state unemployment reports | Reconciles payroll to filings |
| Subcontractor list with amounts paid | Cost of subcontracted work |
| Certificates of insurance for each subcontractor | Whether subs were insured |
| Profit and loss statement and general ledger | Operations, labor costs, sales |
| Check register, 1099s, invoices and contracts | Nature of work paid to others |
| Sales tax returns (for sales-based GL audits) | Gross receipts |
What counts as payroll
In workers' compensation, premium is based on remuneration, a broader concept than the wages on a W-2. The NCCI Basic Manual sets inclusions and exclusions, and state rules can differ. As summarized in trade press on those rules, common inclusions are wages and salaries, commissions, most bonuses, pay for holidays, vacations and sick time, travel time, piecework and incentive pay, and the value of housing and meals. Common exclusions include tips, expense reimbursements, severance pay, employer contributions to group insurance and pension plans, employee discounts and the premium portion of overtime.
Two points cause most disputes:
- Overtime. Only the premium portion is excluded: one-third of pay at time and a half, or one-half of pay at double time. You generally need payroll records that show overtime pay separately to get the credit.
- Executive officers. Officer payroll is often subject to a state-set minimum and maximum rather than actual pay, and the amounts change periodically. Who counts as an officer, and whether LLC members and owners are included or excluded, depends on state law. See can owners and officers exclude themselves from workers' comp?.
Subcontractors and class codes
Uninsured subcontractors. If you hire a subcontractor who does not carry workers' compensation, many states and the rating rules treat the subcontractor's labor cost as your payroll. A certificate of insurance on file before the work starts is what keeps that cost off your audit. General liability audits also charge for subcontracted work when subcontractors lack their own liability coverage. See managing subcontractor insurance and certificates and certificates of insurance: what they prove and what they do not. Whether a worker is an employee or a true independent contractor is a state-law question; see independent contractors and workers' comp: the misclassification risk.
Class codes. The auditor must classify your business and allocate payroll under the Basic Manual or your state's rules. The business is generally assigned one governing classification, with standard exceptions such as clerical office staff and outside sales that can be separated if they meet the rule's requirements. Reclassification at audit is a common source of additional premium, and it is also where an employer can win a reduction by documenting that operations were correctly classified. See workers' comp class codes and why they matter.
A worked example (hypothetical)
Say a small manufacturer's policy was written on estimated payroll of $400,000 in a single class at a rate of $5.00 per $100 of payroll. For simplicity, ignore the experience mod, discounts and taxes. The deposit premium is $20,000.
At audit, the carrier finds gross pay of $440,000, including $60,000 of overtime paid at time and a half. It also finds $30,000 of bonuses and $25,000 paid to a subcontractor with no certificate on file.
| Step | Amount |
|---|---|
| Gross pay | $440,000 |
| Add bonuses | $30,000 |
| Less overtime premium (one-third of $60,000) | -$20,000 |
| Add uninsured subcontractor cost | $25,000 |
| Audited payroll | $475,000 |
Final premium is $475,000 / $100 x $5.00 = $23,750, so the audit bills $3,750 more. If the payroll records had not separated the overtime, the credit could be lost and audited payroll would be $495,000, for a final premium of $24,750. If the subcontractor had provided a certificate, the $25,000 would have stayed off the audit. These figures are invented; use the workers' comp premium calculator with your own, and see how workers' comp premiums are calculated for the full rating steps.
If you do not cooperate
Refusing or ignoring an audit can cost far more than the audit. Rating bureaus authorize audit noncompliance charges in some states. Under Rule XV of Pennsylvania's rating bureau, for example, a carrier that has endorsed the policy for it may charge two times the estimated annual premium, but only after two documented attempts to get the audit information, and the charge must be refunded or credited if the employer later allows the audit (PCRB Rule XV). Other states set their own methods and limits. An unfinished audit can also delay the data used for your next experience mod, and a policy cancellation or nonrenewal for noncompliance follows on some accounts. The cooperative path is cheaper.
How to prepare all year
- Keep payroll records by pay type. Separate overtime premium, tips, reimbursements and bonuses so the exclusions are provable.
- Collect certificates of insurance before any subcontractor starts, and track expiry dates.
- Reconcile payroll to Form 941 and the state unemployment filings each quarter. The auditor will.
- Review classifications mid-year if operations changed, and ask your broker to confirm that the code and payroll split on the policy match what people do.
- Update estimates during the term. If payroll is running well above or below the estimate, ask for an endorsement or an interim adjustment so the deposit is closer to reality. Where payroll swings, consider pay-as-you-go workers' comp: how it works and who it suits, which bills on reported payroll each period.
- Choose a single audit contact who knows payroll, subcontractors and operations, and respond to document requests by the stated deadline.
- Ask for the working papers. The audit statement should show how each class and payroll amount was reached.
Disputing the result
Start with the auditor and the carrier's audit department: send a written explanation and supporting documents, and pay the undisputed premium. If the dispute concerns the rating rules, most NCCI states have a filed Dispute Resolution Process. The policyholder tries first to resolve it with the carrier, pays undisputed premium, and then can ask NCCI for help. An NCCI consultant reviews the dispute, a classification inspection may be arranged for a fee, and if it is still unresolved a state appeals board or committee can hear it (NCCI, Dispute Resolution Process). States with their own bureaus have their own procedures, and a state insurance department complaint is another route. Misstating payroll to cut premium is a different matter; see insurance applications: why accuracy matters and what misrepresentation costs.
Key takeaways
- The deposit premium is an estimate. The audit, which can happen up to three years after a workers' comp policy ends, sets the final premium.
- Payroll for premium is not the same as taxable wages: overtime premium, tips and reimbursements are excluded, while bonuses, vacation pay and uninsured subcontractor costs are typically included.
- Certificates of insurance from every subcontractor, collected before work starts, are the best defense against audit charges.
- Keep records organized by pay type, reconcile to tax filings, and update estimates during the term to avoid large true-ups.
- Cooperate with the audit, and use the carrier-then-bureau dispute process if you disagree with a classification or payroll treatment.