Last Updated: Apr 21, 2021
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While workers’ compensation requirements can differ between states, many policies include a routine premium audit process. Different from 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 purely 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 at the conclusion of 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. Review this guidance to learn more about premium audits. Part 2 of this series will cover how to prepare for an audit and next steps following an audit.
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:
- Employee classification rates—First, employees are assigned class codes based on the work they perform and the perceived level of risk associated with that work. 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. Such rates are typically determined by the National Council on Compensation Insurance, but some states utilize different systems.
- 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. Keep in mind that an organization’s classification rates and total payroll are the two 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).
- 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, throughout the course of the policy, employees’ job roles or work tasks could change—altering their classification rates. Further, the final payroll amount could end up being different for a number of 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 is different 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 place in the form of a check or—in some cases—a credit applied to the next 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—such as 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, whereas smaller organizations with lower premiums usually engage in remote audits. However, organizations that belong to certain high-risk industries may be required to have 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.
Access our online Payroll Audit Tools today at: www.ameritrustconnect.com/resources/payroll-audit-tools
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This Work Comp Insights is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice.
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