Insurance Audit Series 3: Properly Breaking Down Payroll by Job Type, Materials Splits, and Employee Duties

We’re going to break down these 3 categories by giving some specific examples of our customer base and how it affects the insurance audit process. All the examples have happened in the past 3 months.  There could be some unintended consequences to how things are reported back to the carrier, and your bookworm could be to blame. None of these issues are of any legal matter. It is just a lack of understanding by commercial insurance consumers on how to properly classify and maintain records as it relates to insurance and the associated audits.

Individual Employee Type Breakdown for Insurance Audit

If you’re in the construction business, you know your general liability pricing is based on employee payrolls. Not all employees are created equal as far as insurance pricing goes. We recommend keeping accurate records for each class of employee. Below are the 4 main categories we look at.

• Clerical Staff
  • Any office staff member including estimators, salesman, and relationship managers. The clerical staff general liability class code is significantly less than any type of construction class code. It makes sense if you think about it. Someone who is in the office has a different risk profile than someone operating heavy equipment, and it is rated as such.
• Executives
  • Anyone who is “C Suite” and above should have a different class code. This could be any employee who is tasked with high-level sales, customer relationships, CFO, CIO, COO, CEO, or something similar. There is a specific general liability class code for these employees. Again, this class is significantly less than in-field construction employees.
• On-site Construction Employees
  • This is where the construction class codes are needed. Whether you’re a general contractor, masonry contractor, concrete contractor, or plumbing contractor, all in-field staff need to fall under the correct construction code on your general liability schedule. (See the section Proper Breakdown of Employee Payrolls by Job Type (Class Code) below.)
• Owner Payroll
  • Any actual partner or owner of the company needs split out from the organization’s payroll. Each owner is assigned a nominal “minimum” payroll rating that varies by each individual insurance carrier. Owners could make up a significant amount of payroll. You don’t want to pay premium on this class, as it’s not required (other than the minimum amount required).

Sales-based organizations: This could be any retail sales operation, distributor, or even manufacturer. The general liability cost analysis is much easier to understand than complex payroll-based operations. You just need to assess that your agents are properly classing your organization for what you do.  There are over 700 individual class codes that are used. Each one has a different pricing model associated with it. In sales-based organizations, the correct class code is key to accurate pricing.

Real Life Example:

We had a Self-Performing General Contractor that lumped ALL company payrolls into various construction codes. Codes such as excavation, concrete construction, prefab building erection, carpentry. Total payroll of the company excluding sub-contractors was approximately $2,200,000. Of that total, over $715,000 was made up of office staff payroll.  There was substantial savings by properly classing the office staff instead of using a construction general liability class code. This resulted in a savings of over nearly $8,000 passed onto the customer.

Proper Breakdown of Employee Payrolls by Job Type (Class Code)

This was briefly touched on in the previous real-life example. Each general liability class code has a slightly different cost associated with it. It’s based on the overall risk profile of the class of business. In simple terms, the more hazardous a class of business is, the more it will cost to insure. Insurance carriers price each class code per $1,000 of sales, manufactured goods, or payrolls.

Here are some current examples from one of our carriers:

• Carpentry is $11.81 per $1,000 of payroll.
• Grading of land is $8.06 per $1,000 of payroll.
• Excavation is $16.96 per $1,000 of payroll.
• Plastics Manufacturing has a cost of $.61 per $1,000 of goods manufactured. 

You can clearly see that excavation is higher than the other construction classes, because it has a higher risk associated, and a higher likelihood of a claim to occur.

Improper classing is a very common mistake in all sorts of construction organizations. They want to get the audit off of their plate as soon as possible and just lump all of the payrolls into one class. Unfortunately, this is not great practice and could cost the consumer thousands more in insurance premiums as each class has a different rating. Make sure these classes are completed correctly from the onset of the insurance plan. This ensures no large out-of-cycle audit invoices to throw off your company’s budgets.

Real Life Example

A pool installation contractor also plows a very minimal amount of snow in the off-season. 98% of their revenue is in pool installations. However, when they completed their audit, a significant amount of their payroll got reported on the snow plowing general liability class code. This then created an invoice of over $6,000. We were able to jump in and properly advise the auditor of the mistake and reverse the audit invoice. Had we not caught the mistake, the insured would have legally owed the difference. Therefore, we always recommend consulting your agent first before finalizing your submission to the insurance auditor.

Subcontractor Payroll versus Material Cost

This is a common problem we see. It all relates to the ease of doing business on the front end.  Subcontractor estimates don’t always break out the labor versus the hard cost of materials. More times than not they submit the estimate with one lump sum of the entire job cost. While this is nice and clean for estimating, it’s a nightmare to split off the material costs when the audit comes around. If the material and labor costs from subcontractors are lumped together on your books, you’re likely paying premium on the material you purchased indirectly from the subcontractors as a general liability expense.

Real Life Example

A large concrete construction organization had submitted a subcontractor payroll report of approximately $6,400,000. There were 2 significant issues with their report as it relates to the insurance costs. Every subcontractor on their report had all their invoices lumped together and had NO breakout of construction material costs. This included the hard cost of aggregates, concrete, blacktop, lumber, mechanicals, along with other items. The second main issue with their report was professional services utilized by the concrete company were also included. Costs like attorney fees, CPA costs, architects’ fees, and consultant charges were part of the subcontractor report. After a long analysis by our agency, we were able to get the subcontractor costs down to their true number, which was around $2,900,000. This saved the customer over $16,000 in general liability costs from the prior year’s plan.

We’re glad you found us and hope this information is valuable to your business. We’d love to work together and become your trusted insurance advisor. Start the conversation today by clicking on the image below!

In case you missed them, in Series 1 we review what an audit looks like for you and in Series 2 we review the proper audit process.

Written by – Commercial Insurance Team at Hitchings Insurance Agency Inc.