Among the many obligations employers face is securing workers’ compensation insurance in the event employees are injured in the course and scope of their employment.The price of workers’ compensation insurance is a concern for all employers and can have a significant impact on a business’s operating costs. The three predominant factors that determine the cost of the premiums charged by the insurance carriers are:
- employee’s classification;
- employees’ pay rate; and
- employer’s claims history.
The misrepresentation of any of these factors by an employer to an insurance company for the purpose of being charged a less expensive premium is a form of insurance fraud commonly referred to as “premium fraud.” Misrepresentation of an employee’s pay rate and an employer’s claims history are self-explanatory. What happens if the misclassification is deliberate? What are the potential repercussions?
The rates for workers’ compensation insurance charged by insurance companies vary by the nature of the work performed by the subject business. For instance, a high-rise window washing company is going to pay higher insurance premiums for its workers than a movie theater owner who pays its employees for selling tickets. In this comparison, the factors considered by the insurance company are two-fold: the risk of injury faced by each employee and the pay rate of the particular employee. Accordingly, insuring the high-rise window washer will cost more than insuring the ticket taker. There is greater risk of injury to the window-washing employee, as well as a higher rate of pay.
For construction contractor, the cost of workers’ compensation insurance is factored into each bid they submit for a job as a factor of their overhead. Each contractor can be bidding against many other contractors for the same job. The price of the bid is generally the most important part considered by the developer or general contractor in determining which contractor will be awarded the bid. It is therefore incumbent upon contractors to trim their costs as much as possible to keep their bids as low as possible, while at the same time maximize their profit margins.
It may be tempting for an employer to misrepresent the classification of an employee or his pay rate in order to lower the rate for workers’ compensation insurance. What many employers do not realize, however, is that the act of deliberately misrepresenting such information to an insurer is a crime known as premium fraud. In California, for instance, deliberately making false statements to the State Compensation Insurance Fund, the largest provider in the state, is outlawed under Insurance Code §11880 and provides for a punishment of up to five years in jail and up to $50,000, or double the value of the fraud, whichever is greater.
Consequences for Premium Fraud
In one instance, a couple who owned a tree trimming company and a separate gardening company classified their tree trimmers as gardeners to save a significant amount of money, as the premiums for tree trimmers were much higher than gardeners. In July 2009, SCIF audited one of the couple’s businesses and found that vast sums of money were being transferred from the tree trimming company to the gardening company to pay expenses and payroll. In November 2011, the couple pleaded guilty to 29 counts of misrepresenting facts to SCIF, five felony counts of misrepresenting facts to a workers’ compensation insurance company, with sentencing enhancements for a loss more than $100,000, and a taking involving more than $500,000. The couple also pleaded guilty to multiple tax evasion-related counts that were uncovered after the SCIF audit. The couple was given 10 years of probation and ordered to pay $3.4 million in restitution, plus penalties and interest. The judge ordered that the couple would be sentenced to five years in prison if they fail to fulfill these terms of probation.
In addition to the criminal penalties discussed above, some states are taking additional punitive measures. In California, for instance, another consequence for an employer convicted of premium fraud is that all of the pertinent information associated with the crime is published on the California Department of Insurance’s website.
There are also incentives for both the insurance industry and state governments to aggressively pursue criminal prosecution against those companies that they perceive as committing workers’ compensation insurance premium fraud. According to a study published by Insurance Services Offices titled, “Insurer Financial Results: 2010,” the U.S. property/casualty insurance industry’s net income after taxes was $34.7 billion in 2010. This is just more than half of the industry’s net income after taxes for 2007. This represents a drop in rate of return on average net worth of about five percent. From 1983 to 2010, that rate averaged eight percent. This significant drop in income is not surprising considering the recent state of the economy, but the tightening of profit margins could also be serving as an incentive for the industry to become more aggressive in pursuing recompense from those it perceives as committing insurance fraud.
Avoiding Criminal Penalties
There are several steps employers can take to avoid the criminal penalties associated with premium fraud. Employers must be certain they can justify the classifications of each of their employees. For instance, are the employees classified as machine operators or millwrights? In determining such distinctions, consider not only job descriptions but industry standards such as union membership or trade association membership. These factors may be used as circumstantial evidence down the road. Additionally, the employer should be diligent in reporting to their insurer instances of reclassification, such as when an employee is promoted from a clerical position to a position that requires field work that could expose the employee to additional risk of injury.
The standard workers’ compensation insurance policy will contain a provision allowing the insurance company to conduct an audit of the insured’s records at its discretion. If an audit is requested by the insurer, the employer should cooperate with the insurance company. If the auditor finds what he perceives to be irregularities, the employer’s cooperation will typically result in a simple reassessment and correction of the premium actually owed.
The results of being perceived as dishonest or obstructive in the context of the audit can have serious consequences. It is important to keep in mind that this is not like a civil fraud situation where the injured party’s main recourse is taking the offending party to civil court. In this circumstance, the insurance industry has the police power of the state at its disposal by way of criminal investigation and prosecution. The insurance company does not necessarily have to sue the insured in civil court, obtain a judgment and then incur further expense in an effort to enforce a judgment against the insured. Instead, the insurance company can simply report the alleged fraud to the state and the state can coordinate the criminal investigation and prosecution of the insured, the cost of which, at least in California, will be paid for by the statewide assessment imposed on all workers’ compensation policies. Then, upon conviction, the state can impose an order that the insured pay the insurance company restitution, plus penalties and interest. Finally, if any employer finds itself in the unfavorable position of being prosecuted for insurance premium fraud, the employer should retain a criminal attorney who specializes in white collar crime and has experience in fraud-related cases.
A mere charge of insurance premium fraud can take a substantial toll on a business, its operations and the employees. However, with knowledge on how to avoid such circumstances and how to handle disputes when they arise, costly consequences can be prevented.
Reprinted from The Contractor’s Compass (January 2014) with permission from the American Subcontractors Association.