Workers Compensation Payroll Separation – Benefits and Problems for Construction Operations

Payroll separation is where payroll of a single employee or worker is separated and applied to more than one workers compensation class code. Not all employers are allowed to separate payroll. Employers in certain construction operations are allowed to assign a workers payroll to more than one class code. When done correctly, it’s a valuable tool in controlling the cost of any workers compensation policy. When done incorrectly can lead to large additional premium audits. Let’s find out more about the benefits and problems associated with payroll separation for those in the construction industry…

There are very specific rules about the use of payroll separation. For contractors operating in states where NCCI operates as the rating bureau two situations must exist before they can qualify for separation. They are:

  • Payroll separation must be allowed for the type of work, operation and associated classification code, and;
  • Proper payroll records must be kept.

NCCI construction or erection classification codes are identified by an indicator found next to the published code in question. Most construction operations will qualify for the use of multiple codes. However you should never just assume it’s allowed. It must be checked out and verified. Once it has been determined that payroll separation or interchange of labor, a division of payroll between codes, is allowed the next requirement is that of proper payroll record keeping.

Proper payroll records must show the payroll for each employee by classification code. It must show actual hours worked by each employee in each class code. Estimates or use of percentages of time worked in any given classification is not allowed! If proper records are not kept separation is not allowed and the entire payroll is assigned to the highest rated code.

The Benefit of Payroll Separation…

When payroll separation is allowed and an employer meets the requirements of payroll record keeping the employer will realize a much more accurate representation of work exposure to cost.

Here’s two examples:

Employer A, a contractor who builds homes, has workers that perform different tasks associated with building a home. Part of his crew of workers performs exterior carpentry ($60,000 payroll) work, pours concrete and finishs sidewalks and driveways ($50,000 payroll) while others install and finish drywall ($50,000 payroll), carpet ($30,000 payroll)and tile floors ($30,000 payroll).  The rates he pays for each code are (these are not real, I made them up for this example):

  • Carpentry – $15.00/100
  • Concrete – $8.00/100
  • Drywall – $7.00/100
  • Carpet – $6.50/100
  • Tile – $5.50/100

His payroll records properly reflect the class codes associated with each work process and each worker keeps a record of their actual hours spent in each process. He has checked it out and is allowed to separate the payroll of his workers between each of the different classification codes. So the premium he pays is:

  • Carpentry – $15.00 x $60,000/100 = $9,000
  • Concrete – $8.00 x $50,000/100 = $4,000
  • Drywall – $7.00 x $50,000/100 = $3,500
  • Carpet – $6.50 x $30,000/100 = $1,950
  • Tile – $5.50 x $30,000/100 = $1,650
  • For a total premium of: $20,100

Employer B, is a home builder with exactly the same work operations and payroll as employer A. The only difference is that he does not keep proper records according to the rules. His entire payroll is rated in the highest rated classification. Here’s how his premium would be calculated:

  • Highest Rated Classification – Carpentry – $15.00 x $220,000/100 = $33,000
  • Total premium he pays: $33,000

That’s a big difference, $12,900, between two home builders that do the exact same thing! The only difference is proper payroll separation is allowed in Example A and not in Example B.

I’ve used these very, very simple examples to prove a point but please keep in mind the rules governing separation of payroll and proper payroll record keeping are more complicated.  

The Problem with Payroll Separation…

We’ve worked many cases where an employer was told at the beginning of his policy that he could assign each of his employees individual payroll into more than one class only to find out that the auditor did not allow the separation and placed the entire payroll into the highest class. This of course comes as a big surprise to most employers and rightfully so, as you can see in the above examples, a great deal of additional premium is usually involved.

The typical mistakes an employer makes that disallows the use of payroll separation are:

  • Not applying the required payroll recording technique. Many employers use an estimate or some form of percentage assignment for each individual employee. This will not be allowed and will cause an auditor to place all payroll into the highest rated class!
  • Not verifying separation is allowed for their type of operation. 
  • Not being aware of the rules governing payroll separation. 

We receive many calls from employers who have been burned by the rules governing proper payroll separation. Usually they have received a large bill from their insurance company after audit and once they check into it find that all payroll was re-classed into the highest classification. Most of the time this is due to improper payroll records. It’s great when an agent tells his client at the beginning of the policy that he can use this premium saving technique but they must go the extra step and inform the client how to record payroll. When left on their own, an employer will more than likely make this very costly mistake.

So, if you are a seasoned employer or one just setting up your business, make sure you ask your insurance agent if you can qualify for separation. If you can, make sure you ask what you must do in order to have it properly applied! And if you are an insurance agent, be sure you school you client in the proper technique of payroll record keeping!

Whether an employer or insurance agent, when faced with a problem associated with payroll separation, be sure to contact a workers comp consultant for help!

Hope this helps you out!