Workers' Comp After Buying a Business: 7 Checks

Most mistakes on an inherited workers' compensation policy show up later, as an audit bill or a revised experience mod, so check seven things in your first weeks. Confirm that the class codes match what employees actually do, the payroll estimate matches your plan, your own status as an owner is settled, every state with workers is listed, the experience mod is right and the ownership change has been reported, the employer's liability limits meet your umbrella, and past audits hold no surprises. This guide is for buyers who want to know whether the seller's workers' comp setup fits the company they now own.

The short answer

In an asset purchase your new company usually needs its own workers' comp policy from the closing date; the seller's policy cannot be transferred without the insurer's written consent.
Class codes classify the business, not job titles. Codes that describe the seller's business of five years ago can mean overpaying now or a bill at audit.
Set the payroll estimate to your plan, not the seller's last year, and ask for the last three audit reports along with the loss runs.
The experience mod usually follows the business to the buyer, even into a new limited liability company, and in most states the policy requires you to report the ownership change to the insurer within 90 days.
Check that employer's liability limits meet what your umbrella requires and that every state with employees or jobs is listed.

How is workers' comp priced, and why does that matter to a buyer?

Workers' compensation pays the benefits your state requires when an employee is hurt or made sick by the work. For each class code (a number that describes the type of business), a state-approved rate per $100 of payroll is multiplied by the payroll in that class, and the total is multiplied by the experience modification factor, usually called the mod. That premium is only an estimate: after the policy ends, the insurer audits actual payroll and codes, and you pay the difference or get a refund.

So wrong codes, stale payroll or an unreported ownership change rarely hurt on day one. They show up at audit, after you have set the year's budget and your lender's covenant model.

Deal structure matters too. In an asset purchase your new company is a different employer, and the standard policy cannot be transferred without the insurer's written consent, so you usually need your own policy effective at closing. If the seller's staff were covered through a professional employer organization (PEO) or a pay-as-you-go plan tied to the seller's payroll account, that arrangement usually does not carry over to your new company either; see changing payroll providers without a workers' comp gap. In a stock purchase the same legal entity keeps its policy and its audit obligations.

The rules also vary by state:

The National Council on Compensation Insurance (NCCI) handles rating data in most states.
11 states have their own rating bureaus.
In North Dakota, Ohio, Washington and Wyoming, workers' comp can only come from the state fund.
Texas lets most private employers choose not to carry workers' comp.

Do the class codes match what your employees actually do?

Workers' comp classifies the business, not each person's job title. Under NCCI rules, the business in each state gets a governing class code for its main operation, and that code usually includes most employees. A few standard exception codes, mainly clerical office employees (8810) and outside salespeople (8742), can sit alongside it, but only for people whose duties fit. A dispatcher who also loads trucks is not clerical.

Owner-run businesses drift. The policy may still describe residential service when half the revenue now comes from commercial installation. The mismatch can run either way: you may be overpaying, or heading for an audit bill when the auditor assigns the right codes.

Two rules trip up new owners. One employee's pay can be split between codes only when payroll records show actual hours and pay in each; estimates are not accepted, and without records the pay usually goes to the highest rated code. And California, Pennsylvania and Delaware use their own classification systems, so a code from NCCI material may not exist there. See workers' comp class code corrections and the class code glossary entry.

Are the payroll estimates and audit history realistic?

The estimated payroll on the policy sets the deposit premium. If the estimate reflects the seller's smaller business, or leaves out the managers you plan to hire, the audit will catch up with you. The insurer can audit during the policy and for up to three years after it ends, so a low estimate is a liability you can see now.

Ask for the last three audit reports along with the loss runs. They show how the insurer has been classifying payroll, whether past audits produced large additional premium, and whether the auditor charged for subcontractors. The standard policy counts pay to "all other persons engaged in work that could make us liable" toward premium. So a subcontractor without its own workers' comp can be billed as if its crew were your employees, unless you can show the subcontractor lawfully carried coverage. Collect certificates from subcontractors before they start, and keep them.

What counts as payroll, such as bonuses and overtime, varies by state, so check your state's rules before you set the estimate. See payroll estimates and surprise audit bills and 1099 contractors and the workers' comp audit bill.

Are you, your partners and your officers included or excluded?

Many states let certain owners, such as sole proprietors, partners, limited liability company members or corporate officers, choose whether the business's policy covers them. Who can opt out, and which state form must be filed, depend on the state and the type of entity.

This is a real decision for an owner who works in the business. An excluded owner gets no workers' comp benefits for a work injury, and personal health or disability coverage may not fill the gap, since some plans exclude work injuries. An included owner adds payroll and premium. The seller's choice does not decide yours: check whether the seller filed an exclusion that names people who are no longer owners, and whether you, your co-investors or a hired president need to be added or excluded. If you choose to be excluded, ask a benefits advisor about disability coverage for yourself. See do sole proprietors need workers' comp.

Are all the states where people work listed?

A state that is missing from the policy can mean no coverage for the workers there. The information page (the policy's first page of key details, like a declarations page) lists states in two places. Item 3.A lists the states where the policy provides workers' comp coverage directly. Item 3.C lists other states where the policy can apply if work begins there after the policy starts, and you must tell the insurer as soon as it does. If you already have work on the start date in an Item 3.C state that is not in Item 3.A, the standard policy does not cover that state unless you tell the insurer within 30 days. A state on neither list is not covered at all.

Item 3.C coverage generally pays benefits you owe in that state, but it may not meet that state's own requirement to carry workers' comp. Once you have regular employees or ongoing work in a state, ask the insurer to add it to Item 3.A.

After an acquisition the list often lags reality: a remote employee, a crew sent across a state line, or an add-on with staff somewhere new. A private policy cannot cover the four monopolistic fund states, so employees there need a state fund account. Those state fund policies do not include employer's liability, so employers usually add stop gap coverage on another policy.

Will the seller's claims history follow you (the experience mod), and is the sale reported?

The experience mod compares the business's past claims with what is expected for a business of its size and type. Above 1.00 raises premium and below 1.00 lowers it. See experience modification rate.

Many buyers assume a new company starts fresh at 1.00. Under NCCI rules the general rule is the opposite: when a business changes hands, including an asset purchase into a brand new limited liability company, its payroll and claims history usually follows the operations to the buyer. Leaving the old experience behind is rare.

In NCCI states and several bureau states, the policy requires you to report an ownership change to the insurer within 90 days, whether or not a mod currently applies. States with a monopolistic fund and some bureau states run their own processes. Under current NCCI rules, a mod recalculated because of an ownership change applies back to the date of the change, up or down, so reporting late does not avoid an increase. The rating organization, not the insurer or the broker, decides the result. To read the worksheet and spot errors, see how to check your experience mod for errors.

Is your coverage for employee injury lawsuits high enough (employer's liability)?

Part Two of the standard policy is employer's liability. It covers lawsuits over employee injuries that fall outside the workers' comp benefit system, where the law allows them, such as a claim from a third party who was sued by your injured employee. Its limits appear in Item 3.B as three numbers: each accident, disease policy limit and disease each employee.

Many commercial umbrellas list employer's liability as underlying insurance and require a minimum limit for it; if the workers' comp policy carries less, the business may have to pay the difference before the umbrella responds. Some customer contracts and leases also name employer's liability limits. Compare all three numbers with the umbrella's schedule and your contracts. See workers' comp vs employer's liability and the umbrella and excess review.

What belongs on your workers' comp checklist?

New owner workers' comp checklist
Item	Where to find it	Red flag
Named insured	Information page	Seller's entity after an asset purchase
Class codes	Information page, Item 4	Codes that do not describe current work
Payroll estimate	Information page, Item 4	Well below current or planned payroll
Owners and officers	Endorsements and state filings	An exclusion naming the seller; your own status unclear
States	Items 3.A and 3.C	Employees or jobs in unlisted states
Experience mod	Rating worksheet	Ownership change not reported within 90 days
Employer's liability	Item 3.B	Below the umbrella's required underlying limit
Audits and loss runs	Audit reports; loss runs for three to five years	Large audit bills, open claims, charges for subcontractors

A hypothetical example. A buyer acquires a commercial cleaning company with 40 employees through an asset purchase into a new limited liability company. The seller's policy shows $1,000,000 of cleaning payroll, $150,000 of clerical payroll, a 1.15 mod and one state. The review finds three problems: the buyer's plan adds a second shift that will lift cleaning payroll to about $1,400,000, two "clerical" employees spend half their day cleaning, and a crew now works in a second state. The buyer's broker asks the carrier to write the new policy around the plan with the seller's 1.15 mod carried over, move the two employees to the cleaning code and list the second state, and helps the buyer report the ownership change on time. The deposit is higher than the seller paid. But the buyer is far less likely to face a large audit bill, and any mod change from the ownership report arrives early enough to budget for instead of as a surprise a year later.

Morrow can review the workers' comp policy, audits and mod worksheet you inherited and request quotes where it makes sense; carriers and the rating organization decide any new terms and the mod.

Keep reading

Frequently asked questions

Does the seller's workers' comp policy cover my employees after closing?

In an asset purchase, usually not. Your new company is a different employer, and the policy cannot be transferred without the insurer's written consent, so you need your own policy effective at closing. In a stock purchase the same company keeps its policy, but in most states the policy requires you to report the ownership change to the insurer within 90 days. Confirm with the carrier before closing.

Will my new company start with a clean experience mod?

Usually not. Under NCCI rules a business's claims history generally follows its operations to the buyer, even when the buyer is a brand new limited liability company. Dropping the old experience is rare and needs all three of these: a near-complete change of owners, a change in operations big enough to change the governing class code, and a change in the work process and hazards. Independent bureau states have their own rules.

Who pays the audit bill for payroll from before I bought the business?

Usually the named insured on the policy that covered that period. In a stock deal that is the company you now own; in an asset deal it is normally the seller. The purchase agreement decides who bears the cost, and some states, such as Ohio and Washington, have successor rules. Ask your deal counsel.

Do I have to cover myself under the business's workers' comp policy?

It depends on your state and your entity type. Many states let certain owners, partners, members or officers choose to be included or excluded, using a state form. If you exclude yourself, you get no workers' comp benefits for a work injury, so ask a benefits advisor about your own disability coverage.

What should I do if we hire someone or start a job in another state?

Tell your insurer before the work starts. Your policy lists the states it covers directly and, separately, other states it can extend to only if you give prompt notice. Once you have regular staff or ongoing work in a new state, ask to add it to the states covered directly. Workers' comp for employees in North Dakota, Ohio, Washington or Wyoming can only come from that state's fund; check with the fund whether your work there requires coverage.

References

Just bought a business? Get your insurance reviewed.

Send Morrow the declarations pages, loss runs and key contracts you inherited. Morrow can review them against the business you bought, flag gaps and request quotes where it makes sense. Any new terms depend on carrier underwriting.

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This article is general information, not legal, tax or financial advice, and not a coverage determination. Coverage depends on the actual policy wording, carrier underwriting, your purchase agreement and your contracts. Ask your attorney and accountant about deal and legal questions.

New Owner Review: Workers' Compensation