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Category: Work Comp

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


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

About Christopher J. Boggs

Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS, is a veteran insurance educator. He is Executive Director, Big I Virtual University of the Independent Insurance Agents and Brokers of America. He can be reached at chris.boggs@iiaba.net. More from Christopher J. Boggs

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Combinability of Insureds

Consolidating separate legal entities’ loss experience to develop a common experience modification factor has the potential to cause confusion for the client and sometimes the agent. Clients may view such mixing of loss experience due simply to common majority ownership/interest as less than reasonable, especially if the commonly-owned entities substantially differ with regard to the relative hazard presented (i.e. the owners of a heavy equipment contracting company purchase a marina).

Combinability rules do not merely marry the experience of entities that are currently in operation and related via common majority ownership, they also assure that owners do not avoid their historically poor loss records simply by closing down one entity and reopening and operating under another corporate name. Most agents would agree that such a stunt is unethical at best and may actually be considered fraud. Changing the name of the operation does not change the operational methods of the owner(s).

Understanding combinability rules necessitate a basic understanding of the theory and practice behind the calculation of experience modification factors. Following is a brief synopsis of experience modification calculations.

Calculating Experience Modification Factors

Workers’ compensation loss costs are calculated and charged based on the average expected losses for that particular business classification. All insureds in the same hazard class (based on the assigned code) are charged the same basic loss cost (individual carriers apply conversion factors to these loss costs to develop individual rates). However, not all insureds within a particular hazard class operate in the same manner, nor does each experience the same losses. To adjust for these differences in operation and loss histories, a method had to be created allowing for premium/rate differentiation between the above average, average and below average insureds within any particular hazard class code.

Experience modification factors (experience mods) allow such “customizing” and individualization of the workers’ compensation premium. Basing the standard premium on the insured’s unique loss history allows the class’ average rates to remain relatively constant and the subject insured to be rewarded or punished based on its own experience (rather than be subject solely to the experience of the group).

“Stop loss” limits used as part of the experience mod calculation makes loss frequency weightier than loss severity. One large claim will not damage an experience mod factor as drastically as three small claims in a single experience period (the “experience period” is usually the three years ending 12 months prior to the policy effective date — a 6/1/15 mod would apply the experience for the three years ending 6/1/14).

Calculating experience modification factors is far more complicated than presented in three short paragraphs. Mod calculations are a function of expected losses, actual losses, payrolls, class averages, loss limits (medical only vs. medical plus indemnity) and formulary factors applied by NCCI (or the applicable rating bureau) to all such collected data.

Knowing and understanding that experience modification factor calculations allow for the reward or punishment of individual employers allows one to more clearly view the need for loss experience combinability. Employers should not be freed of their premium responsibility simply due to legal structure. And rarely are majority-owned entities not interrelated such that employees work for multiple entities even though they appear to be operating for just one employer in the course and scope of their daily duties (combinability avoids some of the problems created by the borrowed servant doctrine).

A Case for Combinability Rules

Owners theoretically run each and every operation (past and present) in essentially the same manner and with the same attitudes. An employer that is concerned with safety and strives to provide the best equipment and training will likely always act the same with each entity. Likewise, employers looking for the easiest and cheapest way out will likely continue down the same path in the future. Combinability rules are, to some extent, based around the theories:

  • Employers that operate in the supposed best interest of their employees should have all their entities (current and future) rewarded due to such attitude. Commonly-owned operations will likely be managed in the same manner and the same care and concern is expected to be showed for all employees (regardless of the hazard of the operation).
  • If an employer allows unsafe operations in one entity, it is reasonable to postulate that such attitude will carry over to the new entity and all commonly-owned entities (current and future). Employers not operating (or not appearing to operate) in the best interest of their employees should be subject to their past (or current) experience.

Past actions are not a guarantee of future actions, but they stand as a very good indicator. To not reward or punish allows employers/owners to act with impunity, knowing that as long as no law is broken, all that is necessary to escape a poor loss history is the killing off of an old and birthing a new corporation.

Without the ability to combine loss histories, workers’ compensation carriers would potentially be victims of inadequate premiums. In like manner, average and above average risks would be victimized by higher premiums than necessary. The “average loss cost” balance would be tilted and all employers would likely see an increase in their rates rather than just the ones that “earned” the increase. Rate predictability and possibly rate adequacy may be compromised without combinability rules.

Granted, there are exceptions to every rule such as is demonstrated by the employer that had a hiccup in its loss history not indicative of its past. Not every injury can be avoided, even with top-notch safety and training, bad “things” sometimes just happen. This is why there is underwriting discretion and the availability of rate credits and debits. A historically above-average employer with a bad year or two in their experience modification calculation can have the debit mod negated by a rate credit.

Conversely, an average or below average employer that has been fortunate can be debited to account for the increased hazard presented to the insured. Employers that do not practice or refuse to comply with recommended safety practices, as reported by the loss control department, can see their rates increased by a debit factor in anticipation of the increased potential for employee injury.

Combinability Guidelines

Common majority interest is the basic rule of combinability. When the same person, group of persons or a corporation owns a majority interest in another entity, the owned entity’s loss experience is combined with the owning entity to develop a common (combined) experience modification factor.

The combinability concept seems simple enough, however achieving “common majority interest” can be accomplished in one of several relational constructs:

  • The corporation (a “legal person”) owns a majority interest in other entities. When Corp “A” owns a “majority interest” (this term will be defined in upcoming paragraphs) in Corp “B,” the loss experience of both corporations is pooled to produce a single, combined experience modification factor;
  • The business’ owner(s) (“natural person(s)”) individually or collectively maintain majority interest in more than one entity. If John holds majority interest in Corp “A” and he individually gains majority interest in Corp “B,” the two entities are combined for experience rating. However, if John has majority interest in only one of the two entities, they are not combinable (i.e. John maintains 75 percent interest in Corp “A” but only 25 percent in Corp “B”). To continue, assume that John and Joe combine to own majority interest in Corp “A” and Corp “B;” common majority ownership exists and the experience is combinable;
  • The corporation combines with some or all of its owners to hold a majority interest in another entity. Corp “A” (again, a “legal person”) maintains 30 percent interest in Corp “B;” John and Joe (100 percent owners of Corp “A”) hold 25 percent of Corp “B.” The combined ownership of the legal person and the natural persons result in common majority ownership (55 percent) of Corp “B” making the two entities combinable ; or
  • The business owns a majority interest in another entity which, itself, owns or owned a majority interest in a third entity currently operating or which operated in the last five years.

This is not an exhaustive list of relationships that can lead to combinability of loss experience; it is but a representation of the most common. These guidelines are subject to NCCI and/or individual state rating bureau interpretations. Agents, brokers and carriers should use these descriptions only for informational purposes as final determination rests in these other advisory bodies.

Natural and Legal Persons

Notice the repeated use of the natural and legal person(s) concept in the above paragraphs. Common majority interest can be created when a single “person” or a group of “persons” combine to hold a majority interest in multiple entities. It matters little whether the owners of other entities are natural persons, legal persons or a combination. Nor does it matter how they combine to create common majority interest between or among two or more entities.

Legal persons are generally created by the actions and desires of natural persons. Some legal persons are owned by one or only a few natural persons (a small business) while some are “owned” by many shareholders (traded on the stock exchanges). Natural and legal persons are defined as follows:

  • Natural person: A flesh and blood human being. In workers’ compensation the employer is a natural person(s) in sole proprietorships and partnerships. Managers and members of an LLC are viewed as natural persons in a majority of states making these persons the employers.
  • Legal person (a.k.a. juridical person): A legal fiction, a “person” created by statute and born with the filing of articles of incorporation. These legal persons are given the right to own property, sue and be sued. Corporations are legal persons and several states consider LLCs a legal person.

‘Majority Interest’

Majority interest is created when the same person or group of person(s) combine to “own” more than 50 percent of an entity. But majority interest can be created in many ways. NCCI lists the following:

  • An entity or persons (as detailed above) owns the majority of the voting stock of another entity; or
  • Both entities share a majority of the same owners (if there is no voting stock). Generally these are natural persons that own multiple entities.
  • If neither of the above applies, majority interest is created if a majority of the board is common between two or among several entities;
  • Participation of each general partner in the profits of the partnership (limited partners are excluded); or
  • When ownership interest is held by an entity as a fiduciary (excludes a debtor in possession, a trustee under an irrevocable trust or a franchisor).

Combinability Conclusion

Based on and applying the above common majority interest rules, the possibility exists for more than one combination of common related entities. Deciding which combination of entities applies is based on the following two rules (presented in order of importance):

  1. Which combination involves the most entities?
  2. If the above does not apply, the combination is based on the group that produces the largest estimated standard premium.

Regardless of how a group is created and combined, no entity’s experience will be used more than once.

Finally, although separate entities may be combinable for experience modification calculation, this does not preclude each from having separate workers’ compensation policies. Separate legal entities are entitled (and really required) to be written on separate workers’ compensation policies; combinability rules exist merely to assure that loss histories are not escaped by the creation of multiple legal entities or the closing of one and opening of a new one.

Workers’ Compensation Series

This is the eighth 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

About Christopher J. Boggs

Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS, is a veteran insurance educator. He is Executive Director, Big I Virtual University of the Independent Insurance Agents and Brokers of America. He can be reached at chris.boggs@iiaba.net. More from Christopher J. Boggs

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Work Comp for PEOs and Their Client/ Employers

Professional employer organizations (PEOs) began their rise after the adoption of the Tax Equity and Fiscal Responsibility Act of 1982 cleared a path for the creation and expansion of such entities. Between 700 and 900 professional employer organizations operate in all 50 states. According to the National Association of Professional Employer Organizations (NAPEO), between two and three million employees work under a PEO arrangement and PEOs as an industry earned $92 billion in gross revenues in 2012 (gross revenues are the total payrolls plus the fees charged by the PEO).

PEO contracts are co-employment arrangements whereby the professional employer organization and the client with which it contracts both retain some right of control over the individual worker or workers collectively. Such relationship is wholly different than a leased employee or the use of a borrowed. Leased employees and borrowed servants are under the absolute control of the special employer. Co-employment vests responsibility and control with both parties to the contract.

NAPEO (http://www.napeo.org) explains these responsibilities in their Web site as follows:

The PEO relationship involves a contractual allocation and sharing of employer responsibilities between the PEO and the client. This shared employment relationship is called co-employment.

As co-employers with their client companies, PEOs contractually assume substantial employer rights, responsibilities, and risk through the establishment and maintenance of an employer relationship with the workers assigned to its clients. More specifically, a PEO establishes a contractual relationship with its clients whereby the PEO:

  • Co-employs workers at client locations, and thereby assumes responsibility as an employer for specified purposes of the workers assigned to the client locations.
  • Reserves a right of direction and control of the employees.
  • Shares or allocates with the client employer responsibilities in a manner consistent with maintaining the client’s responsibility for its product or service.
  • Pays wages and employment taxes of the employee out of its own accounts.
  • Reports, collects and deposits employment taxes with state and federal authorities.
  • Establishes and maintains an employment relationship with its employees that is intended to be long term and not temporary.
  • Retains a right to hire, reassign and fire the employees.

When evaluating the employer role of either the PEO or the client, the facts and circumstances of each employer obligation should be examined separately, because neither party alone is responsible for performing all of the obligations of employment. Each party will be solely responsible for certain obligations of employment, while both parties will share responsibility for other obligations. When the facts and circumstances of a PEO arrangement are examined appropriately, both the PEO and the client will be found to be an employer for some purposes, but neither party will be found to be “the” employer for all purposes.

NCCI and PEO Arrangements

NCCI has continually monitored the workers’ compensation issues and problems created when employers choose to join a PEO. A 2005 report printed in NCCI’s Workers’ Compensation Issues Report delineates and briefly discusses many of the continuing issues. A few of the problems/issues discussed in the NCCI article include:

  • Experience Modification Calculations: Most states require the PEO to individually monitor and report the claims experience of each individual client. The purpose is to thwart the efforts of employers with bad experience to escape their problems by joining a PEO for a couple of years then coming back out and starting over. Since individual experience must be monitored and reported, the employer’s experience mod will be correct based on its experience; it will not get a 1.0 when it leaves the PEO unless that is what it has earned;
  • The ability of executive officers to exclude themselves (if allowed by law); and/or the ability of sole proprietors or partners to include themselves (if allowed by law). The ability to include or exclude members of an LLC (based on the applicable state law);
  • Problems that might arise if the employer/client hires an uninsured subcontractor. Is the PEO’s workers’ compensation carrier required to pay as the statutory employer?
  • Problems that arise out of PEOs being insured in state assigned risk pools; and
  • Are the proper endorsements in place? For example, NCCI states in this article that the Alternate Employer Endorsement is not intended for use in co-employment situations. However, without using this endorsement there is a problem when trying to effectuate and confirm the proper dovetailing of coverage between the employer/client and the PEO (detailed below).

The report from NCCI specifically lists and highlights more problems than those listed above.

Insuring PEOs

Four endorsements are available for use in co-employment situations (an additional form may be necessary depending on the jurisdiction). Two are client-specific and two are designed to be attached to the PEO’s policy. Contractual agreement between the PEO and the employer regarding which entity is responsible for providing workers’ compensation benefits govern which endorsements are used.

Employer/Client is responsible for providing workers’ compensation.

When the employer/client is contractually responsible for providing benefits, two endorsements dovetail to provide the necessary or required workers’ compensation benefits:

  • Labor Contractor Endorsement (WC 00 03 20 A). This endorsement is attached to the client’s (the leasing employer’s) policy. Attachment of this endorsement extends benefits to the leased employees from the employer’s policy and essentially provides additional insured status to the scheduled PEO. The use of this endorsement is coupled with the …
  • Labor Contractor Exclusion Endorsement (WC 00 03 21). Attached to the PEO’s workers’ compensation policy, this exclusionary endorsement excludes coverage for employees leased to the client(s) scheduled in the form. This endorsement is used when the client leases employees on an “other-than-short term” basis and such client is charged with providing the workers’ compensation benefits.
PEO is responsible for providing workers’ compensation protection.

As above, at least two endorsements, one attached to the employer’s/client’s policy and the second to the PEO’s, work in tandem to assure that coverages mesh as per the contractual agreement that the PEO will extend workers’ compensation benefits to the workers.

  • Employee Leasing Client Exclusion Endorsement (WC 00 03 22). Attach this endorsement to the employer’s/client’s workers’ compensation policy to exclude the extension of workers’ compensation benefits to employees leased on a long-term basis from the labor contractor (PEO) scheduled in the policy. Only used when the PEO is responsible for providing coverage. The employer/client must confirm that the PEO attaches the …
  • Professional Employer Organization (PEO) Extension Endorsement (WC 00 03 20 B). Workers’ compensation and employers’ liability benefits extend exclusively from the PEO when this endorsement is attached to the PEO’s policy. This extension only applies to employees leased to the client(s) listed on the schedule.
  • Alternate Employer Endorsement (WC 00 03 01 A). Although NCCI states that this endorsement is not properly used in co-employment situations and even the form itself does not contemplate its use in these relationships; if the insured is located in a state that has not approved the PEO Extension Endorsement discussed above, this may be the only way to extend coverage from the PEO’s form to protect the employer/client. This endorsement is attached to the PEO’s policy naming the employer/client as the alternate employer. The use of this form in co-employment contracts is not recommended and should be avoided if possible.

Workers’ Compensation Policies for Employers in PEOs

As evidenced by the previous discussion, it is absolutely essential that the employer/client have in place a workers’ compensation policy even when the PEO is contractually providing coverage. Since both entities are legally employers and in fact are the “employers of record,” such contractual arrangement does not preclude the necessity of coverage.

Exposure to a workers’ compensation claim still exists if an uninsured subcontractor is hired, if there are employees hired outside of the leasing contract (temporary workers, etc.) and other potential gaps in protection as studied and monitored by NCCI. And while it may seem like a weak argument, without a workers’ compensation policy in force, the employer/client has nothing to which these endorsements can attach attesting that coverage is extended from another party.

Lastly, if the PEO loses its coverage or suddenly goes out of business, the employer is in violation of the law until coverage can be placed. Certainly many employers have received notice that the PEO with which they were contracted is no longer in business.

Employers should carry the workers’ compensation policy even if it must be set up using “If Any” payrolls. The cost is very low for the protection it provides. A central theme of risk management is “don’t risk a lot for a little.” The small premium may avoid big problems.

Workers’ Compensation Series

This is the seventh 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

About Christopher J. Boggs

Boggs, CPCU, ARM, ALCM, LPCS, AAI, APA, CWCA, CRIS, AINS, is a veteran insurance educator. He is Executive Director, Big I Virtual University of the Independent Insurance Agents and Brokers of America. He can be reached at chris.boggs@iiaba.net. More from Christopher J. Boggs

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