Editor's Note: AnthonyNatale III is a shareholder in the Workers' Compensation Departmentat Marshall Dennehey Warner Coleman & Goggin.

Workers' Compensation fraud has reached epidemic proportionswithin the United States, costing legitimate employers, employeesand healthcare providers millions of dollars per year. The landscape of this fraud is ever-changing; no longer is itlimited to employees exaggerating workplace injuries or working forcash while collecting workers' compensation benefits. More recentschemes involve employers under-reporting payrolls to receive lowerworkers' compensation premiums, or incorrectly classifyingemployees to save insurance costs.  Throw in unscrupulousmedical providers billing for services they never performed, andit's no wonder that healthcare and medical care costs are soegregious. 

The result of these and other fraudulent activities is thatbusinesses and much-needed jobs are often forced out of regionsthat operate under high workers' compensation costs. Insome  cases, in an effort to offset these costs,businesses may be forced to increase the price of goods andservices, thus impacting local economies. These activities alsoserve to create an environment that results in unnecessary delaysin the processing of legitimate claims that can affect an injuredworker's ability to obtain crucial medical treatment for trueworkplace injuries.

To effectively compete in this new business world, employers areattempting to shift the burden of workers' compensation costs toentities known as Professional Employer Organizations(PEOs).  According to the National Association ofProfessional Employer Organizations (NAPEO) there are an estimated700 PEOs in operation throughout the 50 states. While PEOsundoubtedly have rescued employers from the high costs associatedwith the administration of workers' compensation programs, theirvery existence has also set the stage for the emergence ofPEO-related workers' compensation fraud. With acknowledgement tothe fact that the overwhelming majority of PEOs are legitimate, lawabiding companies, the emergence of fraud in this arena should putemployers on alert when contemplating entering into the PEOarrangement.

WHAT IS A PEO?

A PEO is an entity that contractually assumes various employerrights and human resources responsibilities through the undertakingof an “employer relationship” with workers either assigned to orhired by its clients (employers).  In short, the PEO andthe employer/client share an employment relationship that allowsthe PEO to handle and manage employee-related matters such aspayroll, benefits, tax matters and, in many cases, workers'compensation programs, thus allowing the employer to concentrate onthe operation and revenue producing aspects of its business. Thisrelationship has become so commonplace that various states actuallyrecognize PEOs and their clients as “co-employers.” 

This co-employment relationship has been summarized by NAPEO, inpart, as a contractual relationship whereby the PEO:

• Co-employs workers at the client locations and assumesresponsibility as an employer for specified purposes;
• Reserves a right to direct and control these employees;
• Pays wages and employment taxes of the employee out of its ownaccounts;
• Reports, collects and deposits employment taxes with the stateand federal authorities;
• Establishes and maintains an employment relationship with itsemployees that is intended to be long-term and not temporary;and
• Retains the right to hire, re-assign and fire theemployees.

Recognizing the potential for fraud that could arise from theco-employer shared relationship, some states have enactedlegislation that further defines a PEO relationship and undertakesmanagement protocols for these entities.  The majority ofstates, however, have failed to enact or enforce legislation thatwould protect employers from PEO fraud or misrepresentation.

POTENTIAL FRAUD ISSUES

When an employer outsources its workers' compensation coverageresponsibility to a PEO, it is entrusting that all insurancerequirements will be fulfilled by the PEO.  This meansthat the PEO will be responsible for classifying employees,communicating payroll to insurers, selecting appropriate coverageand paying premiums. This also presupposes that the PEO is familiarwith the local workers' compensation statutes and regulations.Unknowingly, some employers may willingly shift this burden to thePEO without securing contractual evidence of the PEO's rights andduties. What's worse, these same employers may rely on an ambiguouscontract drafted by the PEO which does nothing to protect theemployer's interests. Unfortunately, the lack of a clearly defined,written contract between the PEO and employer can not only lead tofraud or misrepresentation by the PEO, but also can negate theexistence of a valid PEO relationship in states that require awritten PEO contract. 

When an employer is contracted with a PEO and a workers'compensation claim is filed, questions often arise as to whetherappropriate insurance has been maintained, if there is documentaryevidence available to support the PEO's responsibility to defendthe workers' compensation claim and even, sometimes, whether thePEO is fiscally solvent. There have been cases where a “fly bynight” PEO is saddled with liability by a workers' compensationjudge and simply fails to pay benefits. Under such circumstancesthe employer would likely be liable for the injury and could be putinto a situation where no insurance exists, thus exposing employersto criminal liability in certain states.

The fact that the PEO and its employer-client are viewed asco-employers in the workers' compensation system has a perceivedadvantage. From a theoretical standpoint, an employer can farm outits workers' compensation coverage while keeping the protection oftort immunity. It follows that in the PEO relationship, where thePEO and the employer both share the right to control the employee,both technically possess the right to assert tort immunity.However, this has not stopped a number of lawsuits naming theemployer as a third party tortfeasor after a workers' compensationinjury, which has led some states to create specific statutesrelated to workers' compensation that govern PEO contracts and tortimmunity.  If an employer is unaware of these statutes andif the PEO does not strictly adhere to the provisions of thestatute, the alleged “PEO relationship” may not be binding and theemployer could face expensive litigation to prove that tortimmunity applies or that a PEO co-employer relationship evenexists.

PROACTIVE RISK MANAGEMENT

The emergence of incidents of PEO fraud in relation to workers'compensation matters provides a cautionary tale for employersconsidering entering into the PEO arrangement. Employers should beaware of statutes in certain states that require a PEO to defineits contractual obligations and the protocols by which the PEO isto be managed through a “Professional Employer Agreement.” Foremployers operating in states without such legislation, it isimportant to insist on a written contractual agreement with thePEO, drafted in unambiguous language that is understood and agreedupon by both parties at the start of the co-employmentrelationship.  Within this contract, a  provisionas to the allocation of workers' compensation coveragemust  be included. Further, the employer must have thecontractual ability to request and secure proof of workers'compensation coverage from the PEO. The contract should alsoprovide employers with access to the loss history and total wagespaid for covered employees. Operating in this fashion will ensurethat the employer is engaging in an environment that is free frompotential PEO fraud.

Anthony Natale III is a shareholder in the Workers'Compensation Department at civil defense litigation firm, MarshallDennehey Warner Coleman & Goggin. Resident in the Philadelphiaoffice, Natale has exclusively focused on the defense of workers'compensation claims since 1995. He may be reached at 215-575-2745or [email protected].