Surprise Workers' Comp Audit Bill? Why It Happens

A surprise workers' comp audit bill usually means the payroll you actually paid was higher than the estimate on your policy. The premium you pay during the year is a deposit based on estimated payroll by class code; after the policy ends, the insurer audits your real payroll and bills or refunds the difference. After an acquisition, new hires, raises, retention bonuses, a salaried manager and uninsured subcontractors can push actual payroll well past the seller's old estimate, and the bill lands months later. This guide is for new owners who want to see the bill coming, keep estimates current and keep cash available for debt service.

The short answer

Your workers' comp premium starts as an estimate: the rate for each class code times every $100 of estimated payroll in it, times the experience mod. The audit swaps the estimate for actual payroll.
The insurer can audit during the policy period and for up to three years after it ends, and can also reclassify payroll and charge for uninsured subcontractors.
Growth after closing is the usual cause: new hires, raises, bonuses, a new general manager's salary and add-ons folded into the policy.
Ask your insurer to update the estimate when payroll changes materially, track actual against estimated payroll each quarter, and reserve cash for any balance.
Pay-as-you-go billing spreads premium across payroll cycles, but it does not do away with the audit.

How does a payroll estimate become your deposit premium?

When a workers' comp policy is written, the insurer estimates payroll for the coming year in each class code (the code that describes the work and sets the rate). For each code, it divides the estimated payroll by 100, multiplies by the rate, adds up the codes and applies the experience mod. The result is the estimated annual premium, which you pay up front or in installments as a deposit. State funds can work differently: in Washington, for example, rates are charged per worker hour rather than per $100 of payroll.

The standard policy is explicit that this is an estimate. After the policy ends, the insurer calculates the final premium from actual payroll and the correct class codes. If the final premium is higher than what you paid, you owe the difference; if lower, you get a refund, subject to the policy's minimum premium. Many general liability policies work the same way on sales or payroll, so the same discipline applies there.

The estimate on an inherited policy was usually set by the seller and the seller's broker for the business as it was, sometimes years ago. That estimate is your starting point, not a forecast of your plans.

How does the audit true up the estimate?

Under the standard policy, the insurer can examine and audit your records during the policy period and for up to three years after it ends, and rating organizations have the same right. Records include payroll registers, ledgers, tax reports, contracts and disbursement records. Depending on the size of the account, the premium audit may be a mail-in questionnaire, a phone review or a visit from an auditor.

The auditor checks three things:

How much you paid. Payroll for premium purposes is broader than base wages. North Carolina's version of the NCCI rules, for example, counts commissions, bonuses, and holiday, vacation and sick pay, while the extra portion of overtime pay can be left out only if records show it separately by employee. Each state's rules decide the details.
Which code each dollar belongs in. If the work does not match the codes on the policy, the insurer assigns the proper codes, which can change the bill. See workers' comp class code corrections.
Who else did the work. The policy counts pay to anyone engaged in work that could make the insurer liable. A subcontractor without its own workers' comp can be charged as if its crew were your employees, unless you can show its employer lawfully carried coverage. See 1099 contractors and the workers' comp audit bill.

Read the audit worksheet line by line when it arrives. The premium audit guide walks through the format.

Why does growth after an acquisition cause surprise bills?

Most new owners plan to grow, and the policy rarely hears about it until the audit. These are the usual gaps between the estimate and reality.

Where post-closing audit bills come from
Source of the gap	Why it happens after a deal	How to prevent it
New hires	You add technicians, drivers or crews to grow	Update the estimate when headcount changes materially
Raises and retention bonuses	Pay rises to keep key people through the transition; bonuses generally count as payroll	Include them in the estimate when you approve them
A salaried manager	The seller took distributions; you hire a general manager or pay yourself a salary	Check how your state treats officer and owner payroll. In most NCCI states an executive officer's pay counts only between state-set minimum and maximum amounts. Partners and sole proprietors who elect coverage are usually counted at a fixed state amount, and LLC members are treated like officers in some states and like partners in others (North Carolina uses the fixed amount). Estimate on that basis.
Add-on acquisitions	An acquired company's employees are added to your policy	Add their payroll by code when you add the entity
Uninsured subcontractors	You use more subcontractors or 1099 workers to keep up	Collect certificates showing each subcontractor's own workers' comp for the period of the work, before work starts, and keep them
Reclassification	The work mix changes and the auditor moves payroll to higher-rated codes	Review codes when operations change
A stale estimate	The estimate reflects the business before closing and was never rebuilt for your plans	Rebuild it from your payroll forecast at closing

In a stock purchase there is one more source. The company you bought keeps its policy and its audit obligations, so an audit after closing can bill your company for payroll the seller ran before closing. Who bears that cost economically depends on the purchase agreement; ask deal counsel. In an asset purchase the seller's policy is normally audited on the seller's account. There are exceptions. In Washington, a buyer can become liable for the seller's unpaid workers' comp amounts unless it gives the state written notice of the purchase and no assessment follows within 180 days of that notice. In Ohio, the state fund can transfer a seller's obligations to a buyer in listed situations, such as when the buyer assumes them or is a continuation of the seller. Successor liability doctrines in some courts can also reach a buyer. Confirm with deal counsel how your agreement and state handle it. See stock deal vs asset deal.

How big can the bill get, and when does it arrive?

A hypothetical example. A buyer closes on a commercial services company in an asset deal and binds a new workers' comp policy using the seller's estimate of $2 million of payroll. Over the year, the buyer adds eight technicians, hires a general manager and pays retention bonuses, and actual payroll reaches $2.8 million. Using an illustrative blended rate of $5.00 per $100 and a mod of 1.00, the deposit premium was $100,000 and the audited premium is $140,000. The $40,000 balance arrives a few months after the policy ends, in the same quarter as a loan payment and a slow season. Had the estimate been raised to $2.8 million when the new hires started, the extra premium would have been spread across the remaining installments instead of arriving as one bill. The rate is made up for the example; real rates depend on the codes, the state and the carrier.

The total cost of the year is about the same either way. What changes is timing, and timing is what strains a business carrying acquisition debt. A large unplanned bill can also hit the cash your lender's debt service coverage test (cash flow compared with loan payments) looks at, right when the covenant is measured.

How do you keep your estimate current?

At closing, rebuild the estimate from your own payroll forecast by class code, including planned hires, raises, bonuses and management salaries, not the seller's figure.
Compare actual to estimate every quarter. Pull payroll by class code from your payroll system and compare it with the estimate on the policy's information page.
Ask for a mid-term change when the gap is material, through your broker. The insurer can endorse a revised estimate and adjust the remaining installments.
Reserve cash for any expected balance, so the audit is a known item in your cash forecast.
Keep the records the auditor wants: payroll by employee and code, overtime shown separately, time records for anyone whose pay is split between codes, and subcontractor certificates.
Reconcile before the audit. Auditors often compare your payroll records with your quarterly payroll tax filings, so check that the two agree and that any differences are explained.
Consider pay-as-you-go. Billing each payroll cycle from actual payroll keeps premium closer to reality, but the insurer keeps its audit rights, so it reduces surprises without removing them. See pay-as-you-go workers' comp and payment plans.

If you are moving payroll providers after closing, line up the workers' comp billing at the same time; see changing payroll providers without a workers' comp gap.

What if you think the audit is wrong?

Audits are done by people working from records, and errors happen. Common ones include:

The full overtime pay counted when the extra portion should have been excluded.
Pay items your state excludes, such as certain expense reimbursements or severance, counted as payroll.
Subcontractors charged even though you had valid certificates showing their employers lawfully carried workers' comp for the period they worked.
Payroll assigned to the wrong state or the wrong code.
Payroll of a different legal entity included.

Ask your broker to request a revised audit, in writing, with the documents that support each correction, and ask the insurer how long you have to dispute. If the insurer will not change it, rating organizations and state regulators have dispute processes, which differ by state. Pay any undisputed amount on time; unpaid audit balances can lead the insurer to cancel your current policy for nonpayment, send the balance to collections and make the next policy harder to place.

Morrow can review an audit worksheet against your payroll records, flag likely errors and help prepare a request for revision. The insurer decides the outcome.

Keep reading

Frequently asked questions

Why did I get a workers' comp bill months after the policy ended?

Because the premium you paid during the year was a deposit based on estimated payroll. After the policy ends, the insurer audits actual payroll and class codes and bills the difference if actual payroll was higher, or refunds it if lower.

Can I lower my workers' comp payroll estimate to reduce the deposit?

You can ask for the estimate to match your real expected payroll. Setting it lower than you expect only moves the cost to the audit, often as one larger bill.

How long can the insurer audit my workers' comp policy?

Under the standard policy, during the policy period and for up to three years after it ends. Keep payroll and subcontractor records for at least that long.

When should I ask my insurer to change my payroll estimate?

Whenever actual payroll is running materially above or below the estimate, for example after new hires, raises, bonuses, a new manager's salary or an add-on joining the policy. Your broker can ask the insurer to endorse a revised estimate and adjust the remaining installments, which spreads the cost instead of leaving it all for the audit.

Do bonuses and overtime count toward workers' comp payroll?

Generally bonuses do, and overtime does too, though under the NCCI rules in many states the extra portion of overtime pay can be excluded if records show it separately by employee. Each state's rules decide the details.

I bought the company's stock. Do I owe the audit bill for the seller's months?

Usually the company owes it, because in a stock deal the same legal entity keeps its policy and audit obligations. Whether the seller reimburses the company depends on the purchase agreement, so ask deal counsel.

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.

Payroll Estimates and Surprise Workers' Comp Audit Bills