Some commercial policies cannot be priced accurately at the start of the year, because the things they are priced on have not happened yet.
So the carrier starts with an estimate and checks afterward. That check is the audit.
The Short Version
If your policy is rated on payroll, sales, square footage, or subcontracted cost, the premium you paid up front was provisional. The audit reconciles it against what actually happened.
Keep the estimate close to reality during the year and the audit is uneventful.
Why A Policy Starts On An Estimate
Workers compensation premium in most states depends on how much payroll you have and what kind of work those employees do. General liability is rated on a basis that varies by classification. A business owners policy, usually called a BOP, can carry auditable exposures too, though many smaller ones are written flat.
None of those figures exist in January for the year ahead. The carrier has to use a number, so it uses yours.
That is why the estimate deserves more thought than it usually gets. It is the number the whole year is priced on and then measured against.
What Gets Measured
Payroll, and not the payroll you think. For workers compensation this is usually the controlling figure, generally calculated per hundred dollars of payroll at a rate tied to the classification, then adjusted by an experience modification factor where one applies. Two details matter more than anything else in this article. In most states the overtime premium portion is excluded and overtime is reported at straight time, which only helps you if your records break it out. And auditable payroll generally includes bonuses, commissions and certain fringe benefits, so it is often a larger number than the base wages figure.
Worth knowing: not every state works this way. Some use a monopolistic state fund, and Washington rates workers compensation on hours worked rather than payroll. If you have employees in another state, that is a coverage question before it is an audit question.
Classifications. Payroll is split by the kind of work performed, and the rates attached to those classifications can differ substantially. An employee whose duties changed in March may belong in a different classification than the one assigned in January.
Sales, square footage, or units. General liability uses several rating bases depending on classification. Sales or revenue is common. So is area, measured in square feet, which is the usual basis for offices, retail space and buildings leased to tenants. Some classifications rate on units or admissions. If your basis is sales, note that the figure usually permits specified deductions such as returns and allowances, so the number is not simply your top line.
Subcontracted cost. This gets its own section, because it causes the most trouble.
Subcontractors, And Why The Certificate Is Not The Whole Answer
There is a common belief that collecting certificates makes subcontractor cost go away at audit. That is close to true on workers compensation and not true on general liability, and the difference is worth understanding.
On workers compensation, a subcontractor you cannot show carried their own coverage can commonly be picked up as though they were your employee, under statutory employment rules that vary by state. Here the certificate genuinely is the thing that prevents the charge. It needs to evidence workers compensation specifically, and it needs to have been in force for the dates the work was actually performed. A general liability certificate alone, or one that expired mid-project, generally will not do it.
On general liability, total cost of subcontracted work is a rating basis in its own right. Subcontracted cost is generally rated whether or not the sub was insured. What the certificate usually changes is the rate or the classification applied, not whether the cost appears at all. If you collect every certificate and still see subcontracted cost on your general liability audit, nothing has gone wrong.
Two more things catch people.
Sole proprietors with no employees are often exempt from carrying workers compensation on themselves. They are still commonly picked up on the hiring business’s audit. Exempt from having to carry it is not the same as invisible at your audit.
And where you cannot document how much of a contract was labor versus materials, carriers commonly charge on the full contract amount. Documenting that split as you go is one of the highest-value habits in this whole article.
It Can Go Either Way
An audit is a reconciliation, not a collection.
If exposures came in above the estimate there is likely additional premium. If they came in below, the result may be a return premium or a credit, and that happens automatically because the audit measures actual exposure either way.
What telling us during the year buys is different and still worth having. It lets us reduce the deposit or the installments so you are not overpaying across the whole term and waiting to get it back. On workers compensation specifically, pay-as-you-go arrangements that report payroll each period are the structural fix, because they largely remove the gap that creates surprises.
What You Will Need
The list varies by carrier and policy. It commonly includes:
- Payroll records, with overtime shown separately
- Federal and state quarterly payroll tax filings
- Payroll broken out by type of work performed
- Owner and officer compensation detail
- Employee job duty descriptions, which are the evidence behind any classification argument
- Sales or revenue figures, and often the sales tax or business tax return that supports them
- General ledger, profit and loss, or cash disbursements journal
- Subcontractor payment records, with the labor and material split documented
- Certificates of insurance for every subcontractor, showing workers compensation, in force for the work dates
- 1099s
Gathering these as the year goes is a different experience from reconstructing twelve months under a deadline.
Why Mid-Year Matters More Than Audit Season
By the time an audit happens, the exposure is fixed. Nobody can change what the payroll was.
Everything that determines whether the result is comfortable happened during the year. Hiring, a strong quarter, a new service line, three jobs that needed subcontractors, an employee who moved from the office to the field.
This is a shared job rather than yours alone. We ask for updated business information ahead of renewal, and we process endorsements when something changes. What we cannot do is see a change nobody told us about. A renewal question catches something that started eleven months ago, eleven months late, which is the only reason mid-year contact matters at all.
If The Audit Looks Wrong
Tell us, and act on three things.
Dispute in writing, before the due date shown on the bill. Verbal disagreement does not usually start a clock.
Keep paying the portion you do not dispute. This is the mistake that turns a billing disagreement into a coverage problem. Withholding the full payment while a dispute is open can trigger cancellation of your current policy for non-payment.
Ask for the audit worksheet. It shows the figures, the classifications, and how the result was reached. Disputes commonly come down to payroll assigned to the wrong classification, a subcontractor counted as uninsured when a certificate exists, overtime charged at full rate, or figures that swept in something they should not have. All of those are correctable, and in some states a classification dispute can be taken to the rating bureau or the state insurance division.
One practical note. Audits are conducted by mail, by phone, or in person depending on the carrier and the size of the exposure. A physical audit is a records review, not a safety inspection.
The Bottom Line
An audit is not a loss control inspection and it is not a penalty. It is the carrier checking an estimate that everyone knew was an estimate.
The uncomfortable results usually trace to the same cause. The business changed, the estimate did not, and nobody found out until the year was over.
If payroll, sales, subcontractor use, or the kind of work your people are doing has shifted meaningfully, let us know and we can review it with you. That conversation is much easier in month four than in the reconciliation.