Workers’ Compensation Audit Rules And Guidelines

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by Christopher J. Boggs, CPCU, ARM, ALCM

Workers’ compensation coverage is initially priced on an estimated basis. The insured estimates payrolls (and sometime class codes) at the beginning of the policy period for the upcoming year on which the insurance carrier charges a premium using the prescribed rates. After the close of the policy year, the insurance carrier desires to firm up the numbers to confirm collection of the actual premium earned for the actual exposure insured. This “firming-up” is known as the premium audit.

Premium audits are addressed by Part Five, paragraph G. of NCCI’s Workers’ Compensation and Employers’ Liability Insurance Policy. The form reads as follows:

G. Audit: You will let us examine and audit all your records that relate to this policy. These records include ledgers, journals, registers, vouchers, contracts, tax reports, payroll and disbursement records, and programs for storing and retrieving data. We may conduct the audits during regular business hours during the policy period and within three years after the policy period ends. Information developed by audit will be used to determine final premium. Insurance rate service organizations have the same rights we have under this provision.

Premium Basis

Premium, with rare exception, is based on payroll also known as remuneration. Below are the common remuneration inclusions and exclusions:

Remuneration Included:

• Wages/Salaries;
• Commissions – If on draw, and draw greater than commissions earned – use the entire amount of the draw;
• Bonuses, unless awarded for individual invention or discovery;
• Overtime – One-third of amount is subtracted from the total amount (one-half if it is double-time pay);
• Pay for holidays, vacations, or periods of sickness;
• Pay for time not worked (i.e. paid for an 8 hour day when only 7 hours worked);
• Pay for travel time to or from work or specific job site;
• Employer payments of amounts otherwise required by law (i.e. Statutory insurance, Social Security, etc.);
• Contributions to a savings plan or vacation fund required by a union contract;
• IRS Qualified Salary Reduction Plan (i.e. 401K) (refers to the employees contribution and any qualified agreement between the employer and the employee to pay into a retirement plan in lieu of direct wages);
• Employee Savings Plans – only the amount given by the employee, not the employer’s match, if any;
• Contributions to an IRA made by the employee;
• Payment on any basis other than time worked such as piecework, incentive plans or profit sharing plans;
• Payment or allowance for tools;
• Value of housing/lodging;
• Value of meals; and
• Substitutes for money (merchandise certificates, store credit, etc).

Remuneration Excluded:

• Tips and other gratuities (if the employer has to make up difference between hourly pay plus tips and the specified minimum wage, the additional funds are counted);
• Payments by employer to Group Insurance or Pension Plans (employer matching);
• Special rewards for individual invention or discovery; and
• Severance pay.

Special Payroll Considerations – Sole Proprietors, Partners, LLC Members and Executive Officers

Actual payroll for each employee is used in the calculation of the final workers’ compensation premium with just a few common exceptions. Sole proprietors, partners, LLC members and executive officers are treated differently than regular employees.

Sole proprietors and partners in states that allow these persons to choose to be subject to the workers’ compensation law and covered by the policy are generally assigned a payroll regardless of their actual gross income. This amount is adjusted annually to account for inflation and other cost of living factors. Each state which allows these individuals to “opt in” assigns its own payroll limit (it is not the same throughout the country).

Executive officers are generally subject to an upper and lower weekly payroll limit rather than a set annual payroll like sole proprietors and partners. In North Carolina, for instance, the minimum weekly payroll assignable to an executive officer is $331 per week ($17,212 per year) with a maximum weekly payroll of $1,300 per week ($67,600 per year). An executive office paid $300,000 per year will appear on the audit at $67,600 per year. Remember, not all officers are executive officers. Executive officers are generally limited to the president or CEO, the CFO and certain levels of vice presidents. The delineation is a function of the articles of incorporation and can vary from entity to entity.

Members and managers of an LLC are, once again, subject to state laws. Some states treat these individuals as sole proprietors/partners while others view them as executive officers. The subject law should be reviewed to confirm how these individuals are classified and thus how payrolls will be assigned based on the descriptions above.

Three operational and actuarial reasons for such payroll limitations are:
1) Getting paid more does not increase the likelihood that an injury will occur. A plumbing company executive officer actually engaged in plumbing work and earning $150,000 per year is no more likely to get hurt than the $15 per hour “plumber’s helper.” In fact, he is probably less likely to get hurt due to experience and personal interest. The amount of pay does not increase the chance of injury;

2) Medical costs, theoretically, don’t fluctuate based on the individual’s income. A broken leg costs the same to set for the owner and the hourly employee;

3) Indemnity payments are limited to a minimum and maximum in each state. As discussed in an earlier article on workers’ compensation benefits, each state sets the minimum and maximum weekly indemnity benefits. If the maximum that an injured executive or employee can receive in any given year is $75,000 (just for example sake), it is not reasonable to expect the insured to pay a premium based on a gross income of $200,000. This operational rule is combined with the previous two to limit the amount of payroll assignable to these special classes of people.

Governing Classification and the Single Enterprise Rule

Once final payrolls are calculated, a “Governing Classification” is assigned to the employer. The governing classification is generally based on the class code generating the largest payroll; rarely the highest rated code is used as the governing class (usually only used in construction-related operations if used at all). All employee payroll, with certain exclusions and exceptions expounded upon later, are assigned to the governing classification.

The governing classification is intended to represent the exposure created by the overall operation business, not the exposure of each individual employee. Applying the single enterprise rule, the governing classification is designed to anticipate all the normal activities conducted by a particular operation or business. For example, a steel fabrication plant may have employees that rivet, others that bend and shape the steel, others that paint the finished product and still others that add braces and brackets. Even though there are different exposures presented by each of these operations, all payroll is assigned to the same class code.

Further, there are some activities a business conducts that appear to be so unrelated to the primary operations as to require or allow separate classification be assigned. However, NCCI considers some of these activities to be an integral part of the business’ operations thus the payroll of the individuals engaged in these activities is included in the governing classification. Known as “General Inclusions” these included activities are:
• Employees that work in a restaurant, cafeteria or commissary run by the business for use by the employees (this does not apply to such establishments at construction sites);
• Employees manufacturing containers such as boxes, bags, can or cartons for the employer’s use in shipping its own products;
• Staff working in hospitals or medical facilities operated by the employer for use by the employees;
• Maintenance or repair shop employees; and
• Printing or lithography employees engaged in printing for the employer’s own products.

Payroll for any employee engaged in the above activities is assigned to the governing classification.

Exceptions to the Governing Classification Rules

There are exceptions to the governing classification and single enterprise rules. These are:
• The “Standard Exception” classifications;
• The “Interchange of Labor” rules;
• The “General Exclusion” classes; and
• Employers eligible for classification under the “Multiple Enterprise” rule.

Each of these will be detailed in the next article. Additionally, the “ABC’s” of premiums audits will be presented.



All terms in this glossary and the glossary itself is taken from the book “The Insurance Professional’s Practical Guide to Workers’ Compensation: From History through Audit.” The book is available now to add to your insurance library.


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Comments

  • September 17, 2008 at 4:21 pm
    JERRY FULMER says:

    Since when did emplyrs contributions to retirement plans / IRA’s become wc wages?

  • September 18, 2008 at 8:40 am
    Chris Boggs says:

    Jerry,

    How have you been? It’s been a while.

    I mis-typed, I meant “employee.” I will correct the article.

  • September 18, 2008 at 11:46 am
    Sarah says:

    If I have a sole executive officer of a corporation excluded on a Work Comp policy, and there is no employee payroll, what should the starting payroll basis be, since I can’t have a policy based on $0 payroll? Thank you.

  • September 18, 2008 at 11:49 am
    InsIsMyPassion says:

    You could back into a payroll if the state will not allow an “If Any” basis.
    Use the payroll that will develop the minimum premium for the class code.

    Since the insured has to pay a minimum premium anyway, might just as well use the payroll that generated the premium (remembering to subtract the expense constant and terrorism charges).

  • September 18, 2008 at 1:13 pm
    al mathis says:

    An excellent article – clear – concise and very helpful addition to the WC series!

  • September 18, 2008 at 3:40 pm
    JERRY FULMER says:

    Carriers can write policies with “if any” exposure as I understand. At audit, in NCCI states – the policy can be closed at zero exposure – for code 8810 / clerical–and the min. prem. be adjusted, at audit to the 8810 minimum–per WC Manual rules. You may have to pay a higher min. going in as the “if any” exposure may be based on a higher rated code. But at audit-zero policy exposure begets closing policy on codee 8810 rates.

  • August 31, 2010 at 8:32 am
    Wayne McDonald says:

    Is profit sharing considered remuneration and as such to be included in payroll for premium computation purposes? Would berevement pay be considered payroll? New hires who work one day are entitled to it. Workers who don’t have a close relative die are not? How does the death of a loved one make that occasion related to job function?

  • April 13, 2011 at 12:55 pm
    Terry says:

    I am filed as a LLC in Michigan. I have excluded myself for Workers’ Comp Benefits, but two other members were not excluded, thus didn’t sign exclusions. Is their contract pay included as payroll in an audit?

  • April 25, 2011 at 11:36 am
    Susan Rood says:

    very high mode rate can I exclude ceo of WC . He is a sales employee

  • September 16, 2011 at 12:36 pm
    MeaganT. says:

    This is the first time I have been asked to assit an auditor for our workers comp policy and was hoping for some advice. We are a small biz with only one employee and no claims. Primarily, are all of the items that the auditor is asking for, below, is she legally allowed to ask for? I just want to make sure since it was not on your list above. Thank you!

    3. General Ledger, Cash Disbursements or report showing the payments made to any independent contractors, casual/contract laborers or subcontractor.

    4. Certificates of Insurance if you paid/used any subcontractors, or independent contractors.

    5. In addition to the information and records above, I will need to review your overall business operations and the duties of individual employees.

  • March 1, 2012 at 3:09 pm
    Sherry Hollingsworth says:

    If an individual is an officer in more than one corporation, and active in both corporations and he/she excludes coverage under workers comp of one corporation but is covered under workers comp of the other corporation…..would there be any coverage if the individual was injured working in the business where he/she is excluded under the policy he is covered under even though the injury is not related to the company he is covered under.? Thanks

  • January 6, 2014 at 6:44 pm
    Joe Blumberg, CPCU says:

    I am trying to find out if a member of an LLC takes a “draw” instead of a salary, does the auditor pick up the “draw” as it it were salary?

  • January 30, 2014 at 1:48 am
    Jerry Freeman says:

    I am in Tennessee a my question I am a sole proprietor of a very small operation if you have a deficit at year end and can show you did not take salary are you still subject to the payroll limit?

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