Audit Problems Leading to Additional Premiums

Let’s dispense with the niceties and all attempts to eloquently ease into a discussion on the troubles surrounding workers’ compensation audits. Rather let’s jump right into the problem — assignment of “employee” status to non-employees. This is not the only problem, but this is where most additional premium headaches seem to originate.

Statutes in most jurisdictions are rather clear regarding who is and is not an employee, but auditors have taken it upon themselves, on many occasions, to assign an individual “employee” status in direct contradiction to statutory language; particularly when it comes to sole proprietors, partners, corporate officers, properly insured subcontractors and true independent contractors. Worse yet, different carriers’ audit departments treat the same exposure in different ways, which leaves agents to guess on the outcome. Guessing usually ends with the client being stuck with an additional premium bill and the loss of a client.

In one instance, an agent was sued by his insured to recover the amount of the additional premium audit (in the neighborhood of $75,000 to $80,000) resulting from independent and statutorily exempt subcontractors being assigned “employee” status. The insured claimed the agent never advised him which workers might and might not be considered employees and thus the agent erred in his professional responsibility and duty to the insured. Even if no lawsuit had been filed, the client will likely move his coverage at renewal (or sooner), even if the audit is right.

Challenging an auditor’s ruling seems to be a no-win proposition akin to tilting at windmills. Some underwriters have stated that they cannot overrule the auditor; and even the states seem to be or choose to be impotent in a classification dispute.

Before completely ripping auditors apart, let’s agree that good auditors can be a valuable resource when working on a difficult account. Some company auditors will even take the time to help agents classify the insured (which could possibly help win an account). I have had occasion to establish an up-front agreement with the auditor regarding a particular insured’s classification at audit. Auditors who go above and beyond need to be recognized to their managers and the manager’s manager. Bosses generally hear nothing at all or bad reports, a good report will stand out in their mind and the auditor will be an ally later.

To be fair, the auditor’s job is not always easy, and sometimes it is hard. Judging who is and is not an employee is not always clear. When there is a gray area, the auditor generally takes the conservative approach and assigns “employee” status. The bad part is the agent doesn’t generally find out until receiving the angry call from the insured holding the audit bill in his hand. How the auditor is approached once the audit is contested goes a long way towards amiably rectifying any problems.

Regardless, the agent needs to protect himself or herself from the sufficiency of gray area that may lead to an additional premium audit. Employee status in workers’ compensation is a function of law, not a function of the policy, and since agents are not generally lawyers, the best they can do is make an educated interpretation — but even that might be wrong.

Stuart Powell, CPCU, CIC, CLU, ARM, ChFC, AMIM, AAI, ARe, former vice president of Insurance Operations for the Independent Insurance Agents of North Carolina, crafted a letter for agents to send to their clients upon purchase or renewal of a workers’ compensation policy. This well-written letter explains to the client what workers’ compensation is, how it is priced, how employee status is determined and what will happen at audit.

The Letter

Insured Addressee Business Name Street Address City, State Zip

Re: Workers’ Compensation Policy

Dear Client:

You recently purchased (or renewed) a Workers’ Compensation and Employers’ Liability Insurance Policy. This policy is designed to support and comply with (this state’s )Workers’ Compensation Laws and to provide benefits as prescribed by statute to any injured employee whose injury or disease “arises out of and in the course and scope of” their employment.

Payroll generally determines the ultimate cost of coverage. Estimated payroll supplied by you at the beginning of the policy year determines the deposit premium. An audit of actual payrolls is completed by the carrier at the end of the policy period to determine the final premium. If actual payroll is less than your estimate, a premium refund may be sent. Likewise, actual payroll higher than estimated results in an additional premium bill.

Today’s business climate makes it difficult to determine who qualifies as an “employee;” the use of leased employees, subcontractors and independent contractors contributes to the confusion. Employment contracts, statute or common law usually establish employment (and employee) status. Calling a worker by a name other than employee (i.e. “subcontractor” or “independent contractor”) does not overcome the facts. Additionally, how compensation is reported to the IRS (use of a 1099 Form) is not sufficient to establish that the individual is not, in fact, an employee.

Workers’ compensation pays benefits to injured “employees;” any individual determined by statute or the court to be your employee is entitled to benefits. Because benefit payments are the responsibility of the insurance carrier, they are becoming very aggressive in making sure you pay the proper premium for the benefits they must provide. Insurance company auditors have traditionally allowed the use certificates of insurance to establish exemption from “employee” status. Recently, auditors have begun to disregard these certificates particularly in cases of workers’ compensation “ghost” policies (a workers’ compensation policy written for an unincorporated business with no employees and which does not extend coverage to the business’ owner(s)).

Additionally, workers that perform the same tasks employees perform or would perform may lead the auditor to define such individuals as employees, resulting in additional premium based on the individual’s compensation. These are workers you might label as “independent contractors” or “subcontractors.” Depending on the number of workers in question, the premium adjustment could be substantial.

An opinion from an attorney trained in employment law is required to answer any questions about the status of a particular worker or group of workers. We as your agent appreciate the opportunity to assist you in your workers’ compensation insurance program; however, we are not attorneys and are unable to provide a legal opinion as to whether a particular worker is or is not a statutory or common law employee.

Sincerely yours,

Your Agent

Conclusion

Keeping other agents and clients informed allows a better system to be built. Communicating with clients up front also avoids some heartburn in the end.

Workers’ Compensation Series

This is the last in a series of articles on workers’ compensation. The series is taken from the book, “The Insurance Professionals’ Practical Guide to Workers’ Compensation: From History through Audit.” The articles in this series are:

• Workers’ Compensation History: The Great Tradeoff
• Benefits Provided Under Workers’ Compensation Laws
• Second Injury Funds: Are They Still Necessary or Just a Drain On the System?
• Employees Exempt from Workers’ Compensation
• Nonemployee ‘Employees:’ The Borrowed Servant Doctrine
• Work Comp for PEOs and Their Client/ Employers
• Combinability of Insureds
• Audit Rules and Guidelines
• Audit Problems Leading to Additional Premiums

Topics Agencies Workers' Compensation Contractors