What is a premium or payroll audit, and how can a contractor be ready for an audit?
What is a Premium or Payroll Audit?
A premium or payroll audit is a review conducted by an insurance company at the end of a policy period to determine if the actual payroll, revenue, or other business metrics align with the estimates provided when the policy was issued. For contractors, this process ensures the insurance premiums accurately reflect their actual exposure, such as employee payroll or subcontractor payments, during the policy period.
Why Audits Are Conducted:
Premiums for certain policies, such as workers’ compensation and general liability, are based on estimated payroll or revenue. Audits adjust the premium based on the actual numbers.
Ensures fairness for both the insurer and the insured by accounting for fluctuations in business operations.
Types of Audits:
Physical Audit: An auditor visits the business to review records in person.
Mail or Online Audit: The business submits documentation via mail or an online portal.
Phone Audit: An auditor reviews records through a phone interview.
How Can a Contractor Be Ready for an Audit?
Preparation is key to ensure the audit goes smoothly, avoids penalties, and prevents disputes over adjusted premiums. Here’s how contractors can prepare:
1. Understand Your Policy Requirements
Review your insurance policy to understand what exposures are being audited, such as:
Payroll (gross wages for all employees, including overtime adjustments).
Payments to subcontractors.
Gross sales or receipts (for general liability, if applicable).
Know the classifications for employees and subcontractors. For example, workers may be classified differently based on the nature of their tasks (e.g., office workers vs. field workers).
2. Maintain Accurate Records
Payroll Records:
Detailed payroll reports, including regular wages, overtime, bonuses, and benefits.
Break down payroll by employee classification (e.g., clerical, laborers, supervisors).
Subcontractor Documentation:
Certificates of Insurance (COIs) for all subcontractors to prove they have their own workers' compensation and general liability coverage.
Payments made to subcontractors without proper insurance may be treated as your payroll, increasing your premium.
Tax Documents:
Federal tax filings, such as W-2s, W-3s, and 1099s.
State unemployment tax records.
Job Records:
Track job locations, types of work performed, and hours worked.
Helps validate proper classification of workers.
Financial Records:
Profit-and-loss statements, invoices, and receipts that correspond to payroll or revenue.
3. Prepare for Employee Classification
Verify that employees are classified correctly according to their job duties, as misclassification can lead to higher premiums.
Common classifications for contractors include:
Clerical staff (lower-risk category).
Field workers (higher-risk category).
Supervisors (may fall into an intermediate classification).
4. Gather Subcontractor Insurance Proof
Subcontractors without proper insurance can increase your premium.
Collect and organize Certificates of Insurance (COIs) for all subcontractors before the audit:
Confirm coverage includes both general liability and workers’ compensation.
Check that policies were active during the time the subcontractor worked for you.
Without COIs, the subcontractor’s payroll may be added to your audit as uninsured labor, which can result in substantial premium increases.
5. Understand Exclusions and Overtime Rules
Overtime Pay:
For workers’ compensation audits, only the base rate of overtime wages is typically included. Ensure overtime adjustments are documented separately.
Excluded Payroll:
Verify any excluded payroll items, such as tips, severance, or expense reimbursements.
6. Organize Your Records
Organize your documentation by category and policy period to streamline the audit process.
Keep electronic and physical copies accessible to provide to the auditor if requested.
7. Communicate Changes in Operations
Inform the insurer of any changes in operations during the policy term, such as:
Expansion or reduction in workforce.
Significant changes in the type of work performed.
New subcontractors hired or major projects completed.
8. Review the Audit Results
After the audit, review the findings carefully:
Verify that payrolls, classifications, and subcontractor statuses were calculated correctly.
Dispute any inaccuracies with supporting documentation.
Tips to Avoid Common Issues
Track Subcontractor COIs Regularly:
Request and verify certificates of insurance before subcontractors begin work.
Separate Clerical Staff Payroll:
Ensure clerical staff is properly classified to avoid being lumped into higher-risk categories.
Monitor Payroll Estimates:
If payroll or revenue changes significantly during the policy period, notify your insurer to adjust estimates. This minimizes large surprises during the audit.
Potential Consequences of Poor Preparation
Premium Increases:
If actual payroll or subcontractor payments exceed estimates, the business may owe additional premiums after the audit.
Penalties for Misclassification:
Misclassifying employees or failing to provide subcontractor COIs can result in higher premiums or penalties.
Coverage Gaps:
Failure to prepare properly can lead to disputes with the insurer or even cancellation of coverage for non-compliance.
Benefits of Proper Preparation
Avoids surprise premium adjustments.
Builds trust with your insurance provider.
Streamlines future audits through accurate and consistent record-keeping.
In summary, contractors can prepare for premium or payroll audits by maintaining detailed records, ensuring proper classifications, gathering subcontractor COIs, and staying proactive about operational changes. This preparation ensures a smooth audit process, minimizes unexpected costs, and demonstrates professionalism.