How Payroll Impacts Your Workers Compensation Coverage 

Most business owners understand that payroll affects workers compensation premium. Higher payroll = higher premiums.

But payroll accuracy also determines something even more critical: who’s actually covered if an injury happens. Get it wrong, and you could face coverage gaps or surprise bills.

On this episode of the WorkSafe Podcast, we discussed these scenarios and more with Tammy Canton, Underwriting Specialist at MEM. With decades of experience helping businesses navigate work comp premiums, Tammy knows exactly where things go wrong and how to get them right from the start.

Why payroll is the foundation of your work comp policy 

Understanding how payroll impacts your coverage goes beyond simple premium calculations. 

“Payroll is the basis used to calculate premium,” Canton said, “so this is why it is so important to have correct payroll information at the start of the policy period.” 

In addition to premium, your payroll determines the structure of your policy. If you file a claim, your insurance carrier verifies that the injured worker’s paycheck matches the entity named on the policy. If there’s a mismatch, you could discover you don’t have coverage for that person. This can happen despite paying premiums for years. 

The critical payroll mistake that creates coverage gaps 

The most serious payroll mistake happens before you even calculate premiums: insuring the wrong business entity. 

Who pays employees? The multiple entity challenge 

Complex business structures create the biggest opportunities for coverage gaps. 

According to Canton, listing the correct named insured is critical because it’s the foundation of the insurance contract. If the named insured is incorrect, complications can arise during claims and audits. 

Here’s how this plays out in real situations: A claim gets reported, but the entity paying the employee isn’t the same one listed on the work comp policy. Or during an audit, payroll records and tax forms belong to a completely different business entity. 

The entity that compensates the employee is considered the employer. This can be challenging to navigate for: 

• Businesses with complex structures 
• Parent companies with subsidiaries 
• Multiple LLCs under one umbrella 

➡️ Here’s an example: Your parent company, ABC Holdings, owns two subsidiaries. ABC Holdings handles corporate officer compensation, while Subsidiary A pays all other employees. If your policy only lists ABC Holdings as the named insured, workers employed by Subsidiary A might not have work comp coverage. 

“In some cases, payroll may be distributed across multiple entities,” Canton noted. “We would need both entities as named insureds to make sure everyone is covered.” 

Checklist: Are your policy and payroll aligned? 

Before your next renewal, verify: 

✅	The entity listed on your policy is the one that pays your employees
✅	Pay stubs show the same business name as your insurance policy
✅	All entities that pay wages are included as named insureds
✅	Your business structure hasn’t changed since your last policy update
✅	Corporate officers are paid by the entity listed on the policy

Why payroll companies don’t equal coverage 

Using a third-party payroll service doesn’t change who needs insurance coverage. 

The payroll company processes payments but has no “insurable interest” in your employees. They don’t actually employ anyone. Your business is the employer and needs to be the named insured, regardless of who cuts the checks. 

📍 Read next: Work Comp for Multiple Business Entities 

Managing seasonal and fluctuating payroll 

Workforce changes throughout the year can complicate premium and coverage. 

How payroll changes affect your premium 

Work comp covers more than just full-time employees. Part-time employees, seasonal help, and even some contractors count toward your payroll and your premium. 

This can create cash flow challenges for a business with a fluctuating workforce. You might pay premiums based on projected high-season payroll, then operate with skeleton crews for months. 

Pay as You Go: a solution for variable businesses 

Instead of paying estimated premiums upfront, Pay as You Go lets you report actual payroll monthly and pay premiums accordingly. 

It’s an excellent payment option for seasonal businesses with fluctuating payroll, like a masonry contractor. When business is slow and payroll is lower, your premium payments aren’t as high as during the busy season. 

Here’s a quick comparison of Pay as You Go vs. a traditional annual premium payment: 

Pay as You Go	Annual premium payment
Monthly payment based on payroll	Upfront estimate, adjusted at audit
Payments align with cash flow	Large upfront payment
Minimal year-end adjustments	Potential for surprises at audit time
Best for seasonal or fluctuating businesses	Best for stable payroll
Requires monthly payroll reporting	Set it and forget it

“It’s a really good way to streamline the work comp experience and manage cash flow throughout the year,” explained Revee White, MEM Director of Marketing and Customer Experience. 

Learn more about MEM’s Pay as You Go option to better align your premium payments with your actual payroll. 

The subcontractor coverage misconception 

A common payroll-related misconception involves hiring subcontractors without their own work comp coverage. 

The first step toward clearing up these misunderstandings is knowing whether your subcontractors have their own coverage. “If they don’t,” explained Canton, “we need to get them included on your policy, because there would be coverage under the policy.” 

Here’s what happens: You hire a landscaping crew to maintain your property. They don’t carry work comp insurance. During your annual audit, this subcontractor’s payroll gets added to yours, impacting your premium. 

Even worse, if one of the crew’s employees is injured on your premises, the resulting claim will affect your experience modification factor and premium for years. 

Working with your agent to stay protected 

Your insurance agent can help you understand how changes to your business will impact your work comp coverage needs. 

Be prepared to provide documentation to your agent, including W-3s, 940s, 1099s, and subcontractor certificates of insurance. These help the agent ensure the accuracy of your named insured and payroll. 

When changes require immediate attention 

Some business changes seem minor but can invalidate your coverage. 

Legal name changes, new business entities, or big payroll changes can affect your policy. “Someone will change their name and not think about changing it on their insurance policy,” Canton noted. “Really, we don’t have coverage for that entity any longer.” 

☑️ The solution: proactive communication. If there are changes, it’s good to catch them sooner than later to avoid problems down the road. 

Checklist: Notify your agent of these business changes 

Be sure to get in touch with your agent if your business experiences any of these changes: 

✅	Legal business name changes
✅	New subsidiaries or entities are created
✅	Payroll responsibility shifts between entities
✅	Significant payroll increases (25%+ growth)
✅	Major workforce reductions
✅	New business locations open
✅	Business structure changes (LLC to corporation, etc.)
✅	Acquisition or merger activity
✅	Adding or removing business partners

Protect your business: essential payroll and coverage verification 

Getting payroll right from the start prevents costly surprises down the road. 

Here are the key actions you should take: 

• Verify your policy’s named insured(s). Make sure the entity on your policy actually pays your employees. Check pay stubs against your policy documents. 
• Plan for changes. Whether you’re growing rapidly or facing seasonal fluctuations, work with your agent to adjust coverage before problems arise. 
• Document everything. Keep W-3s, 1099s, and certificates of insurance organized and accessible for audits and renewals. 
• Communicate proactively. Don’t wait for renewal time to update your agent about business changes that could affect coverage. 

Remember, work comp isn’t just about having a policy. It’s about having the right coverage for the right people at the right time. 

Not sure whether your policy ticks all the boxes we’ve discussed? Ask your agent to review your policy and payroll setup to make sure everything is aligned. 

For more insights on workers compensation fundamentals, check out our complete guide to work comp basics.