UNDERSTANDING WORKERS COMPENSATION POLICY AUDITS: A COMPREHENSIVE GUIDE FOR BUSINESS OWNERS AND POLICY MANAGERS
Workers’ compensation policy audits play a pivotal role in ensuring that premiums are accurate and reflect the actual risks and operations of a business. Misunderstandings and errors in these audits can lead to either overpayment, underpayment or potential legal complications. It’s essential for business owners and those responsible for managing these policies to understand the intricacies of the audit process, recognize common pitfalls, and appreciate the value of expert guidance.
The following document explains common audit errors and what to look for.
EMPLOYEE MISCLASSIFICATION
Employee misclassification in the context of workers’ compensation is a significant concern for businesses. This misclassification can lead to improper premium calculations, exposing businesses to legal risks, financial penalties, and compromised worker protection. Ensuring accurate classification aligns with legal requirements, upholds workers’ rights, and maintains the integrity of the workers’ compensation system and employer protections.
Variety of Classification Codes: The complexity of job classification codes can easily lead to misclassifications. For example, businesses may inaccurately classify warehouse workers as office clerical workers. This is often done in an attempt to lower premiums, as different job classifications carry varying levels of risk and associated costs. Alternately, employee who are clerical may be classified as warehouse workers leading to premium overcharging.
1099 Independent Contractor: The distinction between an employee and a 1099 independent contract typically hinges on degree of control and independence of work. Key factors include the nature of work performed, degree of control over the work, and financial measures of the Independent Contractors work such as payment and profit. In 2024 new rules are going into effect that will expand work comp coverage and other rights to misclassified 1099 workers and treat them as employees. Independent Contractors who are found to be employees will lead to their payroll being included in the work comp policy.
Impact on Premiums: Misclassifying employees can lead to significant financial repercussions. Since different job codes have different levels of risk, such as clerical work vs manufacturing work, incorrect classifications can result in either overpaying or underpaying premiums. This not only affects the business’s finances but also impacts the insurance carrier, potentially leading to higher premiums for all policyholders.
Verification is Key: Regular verification of employee classifications against their job descriptions and tasks performed is critical. This helps in ensuring that employees are classified correctly, thereby reflecting accurate risk levels and appropriate premium costs.
Industry-Specific Risks: Certain industries have more complex classification systems, which require extra diligence. For instance, industries like construction or manufacturing often have a wider range of job roles and associated risks, making accurate classification more challenging but essential.
Inaccurate reporting and misclassification can lead to assessments of additional premiums after an audit and potentially even errors and omissions (E&O) claims. It’s crucial for businesses to ensure that the information reported on their workers’ compensation applications accurately describes their operations and verify this on the insurance policy. This includes proper classification and an accurate count of all employees.
EXPERIENCE MODIFICATION RATE FACTOR (EMR) ERRORS
The Experience Modification Rate Factor (EMR) is a critical element in calculating workers’ compensation premiums. It’s a numeric representation of a company’s claims history and safety record as compared to other employers in the same industry with similarly classified employees. To summarize, EMR values greater than 1 indicate higher claims and higher risks while values under 1 indicate lower claims and lower risk. Understanding, reviewing, and verifying the EMR is essential for business owners to ensure they’re not overpaying or underpaying for their workers’ compensation insurance.
Incorrect Data Input: The EMR calculation uses employee classifications, payroll and claims for a period of years to calculate the EMR. Errors can occur in the EMR calculation if this information is reported inaccurately whether through clerical mistakes or incorrect claims information. Mistakes happen given the complex nature of the calculation and the amount of people and information to produce the calculation.
Understanding the Calculation: The EMR calculation is complex, relying on years of data and a complicated formula. Misunderstandings of how the EMR is calculated can lead businesses to not question discrepancies, accepting higher premiums without scrutiny.
Review and Verification: Businesses should conduct regular audits of their EMR statements to ensure that all claims and safety records are accurately reflected. Given the complexity, it is best to seek a professional review. Expert who are familiar with calculation can uncover errors and provide opportunities for correction. Professionals can you’re your businesses to understand how the EMR is applied to their policy and the potential financial impact of errors in its calculation.
Addressing EMR Errors: If discrepancies are found, businesses should dispute inaccuracies with their insurance provider or the ratemaking authority who has calculated the Experience Mod Rating Worksheet.
Strategic Decisions Based on EMR: A company’s EMR is often considered when bidding for contracts, especially in the construction industry. General Contractors who are bid letting commonly require a mod score of 1.0 or lower. These contractors are looking for businesses who can work safety at a job site and know how to priority proper risk management which leads to lower claims and a EMR below 1.0. In this case a lower EMR can provide a competitive edge to getting contracts.
Insurance Negotiations: Understanding one’s EMR can be a powerful tool during insurance renewal negotiations. Businesses with EMR’s below 1 can typically negotiate from a stronger position given their history of safety. Business with high mod values which are consider greater than 1.5 may find that given their past history, insurance companies may not offer a quote and competition will be limited leading to higher costs in addition to the high mod score.
SUBCONTRACTORS COUNTED AS EMPLOYEES
From a workers’ compensation coverage and claim perspective, the mis-classification of subcontractors can have numerous unintended repercussions such as inflated premiums, increased EMR, unexpected audit liabilities and potential legal issues. Common issues are when 1099 subcontractors are actually employees or when systems are not followed and there is no choice but to count subcontractors as employees. It’s important to consult legal counsel to ensure correct classification when concerns exist.
Work Comp Premium Calculation: When subcontractors are incorrectly classified as employees, your workers’ compensation premium may be inaccurately calculated. This is because premiums are partly based on the classification of workers, which determines the perceived risk associated with their job duties. Businesses commonly find this out at audit leading to increased premiums. Lack of subcontractors purchasing their own in insurance such as liability and workers compensation common lead to unintended coverage by the contractors’ policy thus leading to additional premium.
Claims Responsibility: In the case of a workplace injury, if a subcontractor is wrongly classified as an employee, the employer may be wrongfully held responsible for the claim. This could result in the employer’s workers’ compensation insurance covering the claim, which can increase the employer’s claim history and potentially lead to higher premiums in the future.
Experience Mod Factor (EMR) Impact: The frequency and severity of claims affect an employer’s EMR, which in turn affects the cost of workers’ compensation premiums. Misclassified subcontractors filing claims under the employer’s policy can lead to an inflated EMR, resulting in higher premiums.
Audit Complications: During a workers’ compensation insurance audit, if it’s discovered that subcontractors were incorrectly classified, the employer may face additional premiums for the misclassified individuals. This can be retroactive, leading to significant unexpected costs.
Legal Consequences of Misclassification: Should a misclassified subcontractor suffer an injury, they may pursue legal action if they are not covered by their own workers’ compensation insurance. This could lead to lawsuits and further liabilities for the employer.
Subcontractor Insurance Verification: It’s essential to verify that subcontractors have their own workers’ compensation insurance. In addition to a normal workers compensation policy another option may be a ghost policy which provides limited coverage but does provide insurance certificate documentation. Without this verification, employers’ risk assuming unintended liability for injuries to subcontractors. These certificates are required for clear records during the insurance audit documentation process. Failure to procure these prior to work starting can lead to the problems mentioned in this document.
Preventive Measures: Employers should establish clear contracts with subcontractors, defining the nature of the work relationship and responsibilities regarding workers’ compensation insurance. They should also maintain proper records and verify subcontractors’ insurance to present during audits. This is commonly done with insurance certificates. When in doubt, have your insurance broker review certificates for coverage compliance
MISSING PREMIUM CREDITS AND POLICY MODIFIERS
Actively managing your workers compensation policy and outcome can result in a lower EMR, lower claims, and better outcomes. Another key part of managing the workers compensation policy is the premium component of the policy. This is done through premium credits, rating methodology, and policy modifiers.
Maximizing Savings: Premium credits and modifiers affect the overall policy premium that your business pays. Insurance companies can reduce or increase premium based upon several factors. Commonly these are rate deviation, credits and debits, program credits, safety program credits, drug free workplace credits, and early payment discounts. It’s not easy to identify these on a quote or policy declaration page, so it best to discuss these with your trusted insurance broker.
Audit Vigilance: During audits, it’s common for businesses to not claim all credits or modifiers they’re eligible for, often due to a lack of awareness or misunderstanding of the qualifications for these credits.
Strategic Reviews: To ensure all potential savings are captured, it’s advisable to conduct a strategic review of the policy with the help of a knowledgeable broker or auditor who can identify all applicable credits and modifiers. As them to identify which savings opportunities are available, which were included in the policy, and how to maximize savings going forward.
PAYROLL CLASSIFICATION ERRORS
Some industries allow for payroll to be distributed across various job classifications to reflect the actual work performed. This is especially common in industries like construction. Classifying payroll correctly can reduce premiums by allocating payroll to less risky and therefore less expensive classifications.
Customized Payroll Allocation: In those industries with variable job duties, it is allowed to divide an employee’s payroll amongst the different workers compensation class codes to reflect the actual work they perform. This is permissible as long and complete and accurate payroll records are maintained. Records must be specific to the hour or dollar and not tied to percentages. This can provide significant premium savings by using correct codes and correct classifications rather than placing all payroll in the highest rated class code which is the rule when proper records are not maintained.
Audit Challenges: It’s common for businesses to not claim all credits or modifiers they’re eligible for, often due to a lack of awareness or misunderstanding of the qualifications for these credits or payroll splits. If these are not communicated to the auditor, they may not be aware either. During audits, missteps can occur if auditors do not recognize allowable payroll splits or if the documentation does not clearly support the distribution of payroll, leading to potential inaccuracies in premium calculations.
Documentation: Paperwork is important and without it, errors can happen. Maintain detailed records and job descriptions to justify payroll splits. This helps in demonstrating to auditors the rationale behind the distribution of payroll among different job classifications.
PAYROLL REPORTING ERRORS
When it comes to workers compensation audits, there are several common payroll reporting errors that can lead to additional costs for businesses. Being watchful for these errors can help businesses ensure they are only paying for what they actually owe.
Incorrect Payroll Reported: Certain payroll elements like the extra pay portion of overtime or double-time, severance pay, and some types of bonuses may not be subject to workers’ compensation premiums and can be deducted from the total payroll calculation.
Owner or Officer Payroll: Most states have regulations that dictate whether owners and officers are automatically included or excluded from coverage, and this can vary significantly based on the state, the type of business entity, and the individual’s role within the organization. Failure to accurately complete and submit the required forms may result in the owner or officer being automatically included or excluded according to state law, potentially leading to unexpected premium costs at the time of audit. It’s best to clarify coverage intent prior to the start of the policy to avoid any errors at audit.
Incomplete Records: Failing to properly produce the documents requested during an audit can lead to additional charges. Records such as payroll reports, timecards, work schedules should be retained for submission during the audit reporting time. Failure to properly report payroll and information can lead to higher classifications and ultimately higher costs. When data is missing, the rules state that highest rated classes must be used.
Audit Preparedness: Prior to an audit, review the company’s payroll records to ensure all permissible deductions are accounted for. This may require a detailed breakdown of payroll and hours worked, particularly for overtime.
To summarize, understanding and actively managing these aspects of workers’ compensation insurance can result in significant financial benefits for a business. Regular policy reviews, clear documentation, and a proactive approach to managing audits are essential to capitalize on potential savings and accurate premium calculations. It is often beneficial to seek the expertise of an insurance broker or auditor who can provide guidance tailored to the specific needs of the business and ensure that all financial advantages are realized.
We encourage business owners and policy managers to proactively engage in the audit process and consider the expertise of trusted brokers to manage their workers’ compensation policies effectively.