Final Premium Audits
- October 17, 2018
- Posted by: thinkjcw
- Category: Safety Articles
After a Workers’ Compensation insurance policy expires the insurance company will
usually visit the commercial business to verify the payroll that was estimated at policy
inception is accurate. Insurance companies have the right to do this as it is a condition of
the insurance contract. When the policy is issued at inception of coverage, payroll for
Workers’ Compensation is estimated. This estimate is usually the best judgment of what
the actual exposure (payroll) will be during the policy year. However, due to the many
factors in the transaction of business, it is almost impossible to estimate exactly what
actual payroll and revenue will be 12 months later at the end of the policy term.
This article is written to inform employers of the elements of a Final Premium Audit
(FPA). The focus is Workers’ Compensation due to the many variables used to calculate
and derive at premium. If employers know at the beginning of the year what auditors will
be looking for after expiration then the audit can go smoothly, contain less errors,
eliminate disputes and reduces re-audits.
Workers Compensation insurance is underwritten based on 3 factors:
Rate, Payroll and Experience Modification Factor
Premium = Rate x Payroll x Experience Modification Factor
The rate is the amount of money charged per $100 of payroll. Rates are actuarially
calculated by compiling the accident cost for each class, plus carrier expenses, plus a load
for profit. Different class codes have different rates because there is different accident cost
for every class code. The rate is a function of the historical accident cost for employees
classified in that code.
Class Codes come from the Scopes Manual, which is published by the National Council
on Compensation Insurance (NCCI). Each operation of a business is defined and given a
4-digit code. The class code describes the particular activities of the operations of
employers. Business owners are classified based on their operations with class codes. A
class code is a 4-digit number (for example 5190, Electrical Wiring within buildings)) that
is assigned to the employees of a company that perform that task. So, if an employer has
employees that wire buildings, all payrolls for those employees goes into class code 5190.
The appropriate classification of employees is critical for an accurate audit as each
code has a different rate. If an employee’s payroll at FPA is put into a class code with a
high rate the employer will have an Additional Premium due (AP).
Conversely, if payroll is moved to a lower rated code a refund may be due. It is imperative
for agents and employers to know and apply appropriate class codes.
For example, let’s assume the rate for 5190 is $7 per hundred of payroll. However, Fred
the Supervisor stays in the office 80% of the time, the other 20% of the time he is in his
truck checking with his foreman at the different job sites as to the completion of that job.
The payroll of Fred the Supervisor can go into another code with a lower rate, 5606
Executive Supervisor. It is easy to understand that the rate for a Supervisor would be lower
as that job has fewer hazards and past accident cost has been lower. However, an employee
that directly supervises a crew is always classified to his crew classification. If Fred the
Supervisor was a direct supervisor, he would have been classified to 5190, Electrical
Except for severance pay and the premium portion of overtime, all gross remuneration is
to be reported by class code. There are quite a few employers who feel since an
employee is not actually working during holiday/vacation/sick days, that applicable
payroll should be excluded. Also cafeteria wages as well as bonuses are included. This
is because these items are included in the benefits a worker receives if they have a lost
time claim. Payroll for audit purposes is sometimes more than payroll as it included items
such as bonuses, vacation time, per diem, mileage reimbursement, and vehicle
allowances. The reason(s) auditors request 941s, W2s, etc. is so they can verify the
validity of the gross W2 wages against these documents. This means that off-periods
(those that do not line up exactly with the quarterly tax documents) will have to be
reconciled by adding in/backing out the applicable time periods. The more you are
organized and prepared with records the more quickly an auditor can complete the audit.
Misclassification of Payroll:
If payroll is mistakenly placed in the wrong code, based on the Scopes Manual
then that payroll will be reassigned at FPA. That is to say the payroll will be moved from
one code to another. If the payroll in question is assigned to a class code with a higher rate
the employer will owe more premiums. The reverse is true, that if payroll is redirected at
FPA to a class code with a lower rate, premium may be refunded to the employer.
Division of Payroll:
If an employer has one employee that works two jobs that are distinctive task with
different exposures, the employer may keep separate payroll records of that employee’s
time and place the appropriate payroll between two different class codes. An employer
would do this to take advantage of a lower rated class code.
For example, let’s assume, in the morning until lunch an employee does electrical work for
the company. That payroll goes into the Electrical class code (5190) which has a
(assumed) rate of $7. After lunch, that same employee works in as a residential carpenter.
(5645) Let’s assume that rate is about $15 per $100. As the worker is performing two
different jobs at distinguishable times (before and after lunch) payroll can be split. By
keeping accurate and auditable records the employer can realize a savings on the workers’
compensation insurance premium. There are two classes that do not allow any division of
payroll; Clerical (8810) and Outside Sales (8742). A few other codes that fall in this
category such as 7380, Drivers and proper classification should be discussed with their
Composite Rated Class Codes:
A composite rated class code is a class code that contemplates several activities and
derivers a general, collective rate to capture the rate for the exposure. For example, the
salvage yard class code uses a rate which is a composite rate. It contemplates the exposure
for the employees that tow cars into the yard, employees that dismantle cars, employees in
the parts room and employees at the parts counter that sell the parts to customers. As may
be clear, employees at the parts counter have a significantly lower exposure to injury and
should enjoy a lower rate that employees in the salvage yard. However, when the rate was
promulgated it included the accident data for all the employees mentioned and for that
reason the division of payroll or the use of another class code is not available.
Changes to Classifications:
If a class code needs to be changed the following rules apply:
Changes in classifications that result in a decrease in premium (from a lower rated
class code) whether determined during the policy term or a FPA shall be applied
retroactive to inception. That means if the agent, carrier or insured discovers that another
class code is more appropriate to describe the activities of employees and that code has a
lower rate, the code will have applied from inception to expiration of the policy. Don’t
look for the carrier to discover this as underwriters want as much premium for a risk as
Changes in classifications that result in an increase in premium are handled
differently. When the needed change is identified determines the affect on the policy
If the change (which increases premium) is determined within the first 120
days of the policy, then the increase (from a higher rated class code) is applied retroactive
If the needed change is identified after 120 days of inception but before 90 days of
expiration then the change is applied retroactively, which means the carrier can only apply
the change for the remainder of the policy life. For example, let’s say a loss control
representative submits a report to the underwriter of an account. From that report the
underwriter determines another higher rated code is more appropriate to classify
operations. The policy has been in effect for 4 months, so the change can only be applied
for the remaining 8 months.
If a needed change in class codes, that increase premiums, is discovered within the last 90
days of the policy term, no change can be made. However, you can bet that the code will
be changed at renewal, if the policy is renewed.
The above rules do not apply to the reallocation of payroll which means the Auditors takes
payroll form one code and applies it to another class code that is already on the policy.
That is called the re-assignment of payroll. Only when class codes that increase premium
(higher rate) are used do the above rules apply.
Overtime payroll is charged at straight time on an FPA. That means the extra amount paid
for overtime is excluded from payroll for FPA purposes. Let’s assume an electrical
contractor pays his men $10 an hour. In order to finish a job and meet a deadline the
contractor requires a man to work over time at time and a half wages, $15 an hour. Also
assume the Electrician works 45 hours in the week. At FPA the extra 5 hours of overtime
would be used in the FPA at $10 as the extra $5 per hour is excluded for payroll
calculation purposes. The rationale is that just because there is more payroll generated
from the increase in overtime wages there is not a corresponding increase in hazard to
warrant more premiums being collected.
If overtime payroll is not separated, then 1/3 of the total gross (time & a half) overtime
will be deducted from total payroll. Always keep your overtime separate for each
classification available for the auditor. This exclusion of overtime does not apply to USLH
(Federal) work which is any class code with an “F” next to it.
Experience Modification factors:
While it does modify premium, Experience Modification Factors are not relevant to this
article. That is because Mod’s are a comparison of an individual employer’s experience
against all other employers in the same class code in the same state.
Rarely do issues of Mod’s come up at FPA’s.
Certificates of Insurance:
Certificates of Insurance are evidence of insurance coverage. If an employer hires a
contractor to perform work that can be construed to be in the normal operations of the
employer, the hired firm is a sub-contractor. For example, if a home builder hires a painter,
the painter is a sub-contractor. However, if a restaurant hires a painter the painter would be
an Independent Contractor as painting is not in the normal course of operations of a
Sub-contractors will enjoy the workers’ compensation insurance coverage of the prime
contractor if the sub-contractor does not have his own coverage. The laws of most states
will not allow an injured sub-contractor or employee of the sub to go without medical care
and benefits, if needed. The law allows the uninsured sub-contractor to become a statutory
employee of the prime contractor. That is to say, the state statutes make the uninsured sub
an employee of the primary contractor. Because the insurance company had the risk of loss
from an uninsured sub-contractor, the insurance company has the right to collect premium
on that risk. Therefore, employers should obtain valid Certificates of Workers’
Compensation insurance on all sub-contractor or be faced with an Additional Premium at
FPA. The Certificate is legal insulation for the prime contractor in that if the sub or his
workers get hurt, while working for the prime contractor, the sub has to call on his own
Work Comp cover to respond to the injury, not the general contractor’s.
Waivers of Subrogation:
Often, in order to obtain contracts, prime contractors will require the sub-contractor to give
up their right to sue the prime contractor in the event the prime is negligent and such
negligence causes injury to the employees of the sub-contractor.
When an injury occurs in the workplace the insurance company will pay medical benefits
and lost time wages if work is missed over a prescribed period of time. Because the
insurance company has paid benefits, ordinarily the insurance company retains a right of
subrogation. Subrogation means a legal right to pursue the negligent party with the intent
of recovering the benefits paid on the premise that the money would not have been paid
had not the other party been negligent and therefore that money should be reimbursed by
the responsible party.
However, as mentioned, often a sub-contractor has to give a Wavier of Subrogation to
obtain contracts. That means the insurance company attaches an endorsement to the policy
that states the insurance company will not subrogate (go after) the prime contractor if the
prime contractor is negligent. Because the insurance company is giving up a legal right to
collect money from a potentially negligent party, the insurance company usually requires
an additional premium charge. This charge is sometimes picked-up at FPA.
In many states the officers of a company may elect to be excluded from Workers’
Compensation insurance coverage and avoid premium payment. Usually, an officer must
own a certain percentage to enjoy the exclusion say 10% or more, for example.
If the employer has a USLH class code on the policy, officer payroll for that code
cannot be excluded, even if the officer is excluded.
Officer Minimum and Maximums:
Typically, to be consider a corporate officer a person must hold 10% or more of
ownership, except for sole proprietors as they own 100% of the company by definition.
Officers of companies are subject to Minimum payrolls and Maximum payrolls in most
states. For example, as of May 1, 2016 in Louisiana the Minimums and Maximums for
audited payroll are:
Type of Company Minimum Payroll Maximum Payroll
Corporations or Limited Liability
Company’s or Sub Chapter S
Partnerships or Limited Liability
Sole Proprietors $45,000 $45,000
In conclusion, the assigning of appropriate class codes to an account is critical for the
accurate collection of appropriate premium. Employers may be able to lower insurance
cost by having knowledge of the NCCI Audit rules discussed above. In addition, the
treatment of overtime pay is often a point of contention at FPA. The maintaining of clear
and separate overtime records will assist the Auditor in excluding payroll that should not
be used in the FPA. Certificates of Insurance are important to obtain because, by statute,
an employer is responsible for the injuries to Sub’s and their employees. The carrier will
want premium for this exposure and the injury may increase the employers Experience
Modification Factor. If an employer has USLH coverage special rules apply. Employers
that know and apply these basic rules will have less work to do at FPA.
This article was written by Chris Conti, owner of RiskWise, a safety consulting and injury
management Company and InsureWise, an insurance agency. Chris can be reached at
(225) 414-7542 or [email protected] or www.insurewise.bz
This is not and should not be construed as legal advice and RiskWise Management, LLC
and/or InsureWise, LLC make no representations or warranties that this information is
accurate and/or that it will be honored by insurance companies at Final Premium Audits.
Competent advise should be sought on all insurance matters.