Employer Premium Fraud Is Hurting Everyone — Including Honest Businesses

Insurers are prosecuting premium fraud, because it’s creating unfair competition for honest businesses unable to compare with cheats reducing their expenses by failing to care for their workers.
By: | October 15, 2018

Prosecuting employer premium fraud can be a delicate subject for workers’ compensation insurers.

Some insurers look the other way rather than help prosecute premium fraud because of the effort and expense investigations require. Insurers’ financial recovery, meanwhile, and the punishment premium fraud offenders receive are both typically negligible.

“Keep in mind that an insurance company is turning in their policyholder,” said Dale Banda, VP of the Anti-Fraud Alliance, which represents insurance investigators and law enforcement personnel.

So some insurers opt for attempts to collect additional premium even when they suspect a policyholder purposely underreported their payroll or misclassified workers. Or they help build criminal cases only when policyholders have moved on to obtain coverage elsewhere, Banda said.

“Sometimes they’ll say, ‘It’s just not worth it to spend a bunch of money and time investigating this when they are no longer our policyholder,’ ” Banda elaborated. “They will ask, ‘Why should we spend more money investigating when we are not going to get that money back anyway?’ ”

When to Take a Stand Against Fraud

Banda is not alone in noticing reluctance to investigate workers’ comp premium fraud. Some insurers see premium-fraud losses as the cost of doing business, observers said.

A December 2017 state auditor’s report on California workers’ comp insurance found significant variation in insurer rates for reporting fraud. Some insurers’ reporting rates are so low or non-existent that the auditors suspect the underwriters fail to report it.

Even those insurers with a reputation for taking action against premium fraud must tread cautiously to avoid targeting customers who have perhaps made a mistake rather than crossed the line into illegality.

“It’s a delicate investigation process, because you are investigating your customers and it’s definitely a small number who we determine are committing premium fraud, so we have to be very careful,” explained Grace Nicholas, senior manager of Texas Mutual Insurance Company’s special investigations department, which includes a unit specializing in premium fraud.

Paul H. Sighinolfi, executive director and chairperson, Maine’s Workers’ Compensation Board

No doubt though, some workers’ comp insurers, like Texas Mutual Insurance, do take a stand against premium fraud, particularly when policyholder behavior proves egregious.

In one case, for example, a landscape operation’s ruse unraveled in a Texas court. Employees, who were shown a building schematic, testified that a reported address for the company led only to an equipment storage closet, Nicholas said.

Creating shell companies to hide a poor experience modification and payroll used to calculate premium is a recurring tactic among employers looking to cheat workers’ comp underwriters, Banda explained.

In the Texas case, the landscape employer was unhappy with the quoted premium required to secure insurance coverage. The employer claimed it planned to fire its workers and replace them with independent contractors.

The employer instead created a second company and declared that company to be operating under Texas’ non-subscriber law, which allows employers to opt out of purchasing workers’ comp insurance. The Texas Mutual policyholder also moved its employees from the original company to the second without telling the workers their jobs moved to another operation.

In reality, though, the employees continued performing the same work, under the same foreman, employed by the original company, which essentially retained control of all their work conditions.

That meant the workers legally remained employees of the original company, and Texas Mutual Insurance, as that operation’s insurer, would be on the hook for their workplace injuries. The scheme denied the underwriter the ability to collect adequate premium for the risk.

“We write a policy [and] we can’t deny a claim just because the employees were not reported to us or the premium wasn’t paid,” Nicholas said.

“We have a duty to do the right thing and take care of that worker and worry about the premium after the fact.”

Mislabeling Workers Hurts Honest Businesses

Several experts cite construction operations’ misclassifying of workers as independent contractors or subcontractors as the most common scheme for perpetrating premium fraud nationwide.

Entities hiring drywallers, framers and other trades workers often operate under highly competitive conditions. The worker-classification codes insurers apply to calculate their premiums are at the high end to offset construction’s operational risks.

A certificate of insurance is often required from employers bidding on construction projects. Pricey premiums and mandatory coverage can result in attempts to game the system.

While different factors motivate employers to commit premium fraud, it often comes down to gaining a competitive edge, said Neil Johnson, VP and manager of the commercial premium fraud special investigations unit at Liberty Mutual.

“These companies call [their workers] independent contractors, and when you do the analysis of who [legally] is an employee and who is an independent contractor … These guys are clearly employees.” — Paul H. Sighinolfi, executive director and chairperson, Maine’s Workers’ Compensation Board

“For the most part they are trying to compete economically, and they will do whatever they can,” Johnson said.

Misclassification of employees and other types of workers’ comp premium fraud are also commonly found in janitorial services, home health care, trucking, employee leasing and restaurant work, observers said.

“We had a restaurant with 34 people working, and the owner tried to convince me that everybody was an independent contractor, including the busboy,” said Paul H. Sighinolfi, executive director and chairperson of Maine’s Workers’ Compensation Board.

The amount of cash restaurants handle provides opportunities to pay workers without it registering as a payroll expense, added Matt Zender, VP, workers’ comp product manager at AmTrust.

The practice is so common in New York, for example, that Zender said he suspects underwriters make up for it by “baking” it into the rates applied when calculating premiums for the city’s restaurants.

Sighinolfi added that about twice a month, union executives tip him off to construction employers misclassifying employees as independent contractors.

Neil Johnson, VP, manager, commercial premium fraud special investigations unit, Liberty Mutual

The unions tip him off because the scheme cheats union members out of performing work for honest employers who can’t compete against operations ducking their legal obligation to purchase workers’ comp insurance.

“These companies call [their workers] independent contractors, and when you do the analysis of who [legally] is an employee and who is an independent contractor, it’s not even close,” Sighinolfi said. “These guys are clearly employees.”

In addition to assessing penalties, “we try to get the attorney general’s office to prosecute under misclassification,” Sighinolfi explained. But the crime is a misdemeanor in his state, and Sighinolfi believes it needs upgrading to a felony to discourage the behavior, “because we have repeat offenders,” he said.

Minor punishments for premium fraud are common nationwide. In the Texas landscaper case, the convicted employer’s punishment amounted only to paying restitution.

Depending on the jurisdiction, some prosecutors aggressively pursue premium fraud while others don’t assign resources to combat it. Those who do prosecute workers’ comp fraud may focus more on claimant fraud, because it typically requires less investigation and is easier to prove than employer premium schemes.

Yet premium fraud generates larger losses than claimant fraud, Johnson said.

Employers, meanwhile, may view premium fraud as a victimless crime that only harms a powerful insurer. That attitude ignores the damage to honest businesses that can’t compete against cheats, reducing their expenses by failing to care for their workers.

And it’s still theft, Johnson said.

Efforts Growing to Stop Premium Fraud

Despite the challenges to prosecuting premium fraud, there are signs that efforts to eradicate the practice are improving, Nicholas said. She is hearing more insurance industry discussions about the need to take countermeasures.

And Banda said that over the last decade or so, California stepped up efforts to combat premium fraud.

“In California, the prosecutors are getting better at it, because they know there is a lot of money involved,” he said.

“If you talk about a construction company [for example] that has lots of payroll, and they have been doing it for a number of years, you can run into thousands and thousands of dollars the insurance company would have received.” &

This article is part of a three-part series on The Changing Landscape of Workers’ Comp Fraud.

Why Physician Fraud Rings Are a Major Workers’ Comp Issue And What You Can Do About Them explores the perils of provider fraud and the changing landscape of the obstacles investigators face.


Employer Premium Fraud Is Hurting Everyone — Including Honest Businesses addresses the various types of premium fraud, and why insurers are reluctant to investigate most offenders.


Why Are You Wasting Money on Pointless Workers’ Comp Claim Investigations? dives into the need for industry-wide investigative standards and how the trend toward worker advocacy is impacting the way employers approach worker fraud.

Roberto Ceniceros is a retired senior editor of Risk & Insurance® and the former chair of the National Workers' Compensation and Disability Conference® & Expo. Read more of his columns and features.

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