Workers' Compensation Premium Fraud

A Vicious Cycle

Premium fraud is unique in that it tends to be self-perpetuating. Corrupt employers commit fraud to reduce or totally avoid paying workers' compensation premiums. This practice results in disproportionately higher premium-to-loss cost ratios for insurers and ultimately increases premiums for those employers that pay premiums appropriately. The act of raising premiums results in the prior year's legitimate employers no longer being able to afford workers' compensation premiums without raising the prices of their goods or services. The employer is then faced with three choices, none of which are very enticing: Go out of business, raise prices to absorb increased workers' compensation premiums, or commit premium fraud by engaging in any of a number of schemes we'll discuss later.

No one is in business to go out of business. No legitimate business owner initially sets out to commit fraud. However, when legitimate businesses have no other options but to raise prices, they have difficulty competing successfully against illegitimate competition. The competition may very well be able to offer lower pricing by not paying workers' compensation premiums appropriately or at all. As a result, last year's legitimate employer may then become this year's under-reporting, illegitimate employer, servicing a market that will not bear high prices.

The cycle continues as higher premiums unfold during following period. This puts employers that were not previously at risk on the cusp of committing fraud. Combined with weak sales, a weak dollar, and a lagging economy, workers' compensation premium fraud becomes the path of least resistance and, eventually, an appealing solution to some employers.

The Foul Four

The unfortunate truth is that this cycle of fraud causes the employer that complies with the law to carry a heavy burden. There are four fundamental fraud schemes related to workers' compensation insurance premium fraud or payroll fraud. They include: Under-reporting payroll; misclassifying employees; inaccurately reporting claim history; and failing to obtain workers' compensation insurance when required to do so by law.

Payroll fraud is also unique in that the "victim," the insurer, may be receiving some monetary benefit from the perpetrator (the employer). Under-reporting payroll is perhaps the most commonly employed scheme. Simply put, it is reporting to the insurer payroll amounts less than those actually paid to employees. With under-reporting, employees are paid either entirely or partially in cash or some other unaccounted-for benefit. Auditors may conduct mid-term and renewal audits to see if the books and payroll records reflect what was reported upon application and inception of the policy. If a discrepancy is found, the employer committing fraud may claim that a bookkeeping or reporting error was made, and an adjustment to the previous policy period premium may be collected. Bookkeeping errors are construed as just that — errors. However, when a pattern is recognized, the "error" may be evidence of fraud.

Under-reporting payroll is most often discovered as the result of a claim filed against the policy. During the course of conducting an AOE/COE investigation, the applicant and coworkers may report receiving cash payments "under the table." This may stem from benefits calculations being challenged by the applicant. The fraudulent employer will often remind unwitting employees that it is to their benefit to stay quiet about the cash payments, as they are not paying taxes on that portion of their incomes.

Employees may initially agree to this arrangement, as their net incomes are more than they would otherwise take home. However, if a worker suffers an work-related injury or illness, benefit calculations are based on the under-reported payroll. As a result, temporary total disability (TTD), permanent partial disability (PPD) or permanent total disability (PTD) may be substantially less than that to which the employee is entitled. In light of diminished benefits, the motivation to remain quiet subsides. At this point, employees may be eager to advise the claim administrator of the cash portion of their earnings.

Misclassifying employees transpires in two forms. Employees may be classified as performing low-risk functions rather than higher-risk activities. A roofer, for example, may be classified as a maintenance worker, never working more than three feet above the ground. Or the employer may claim that this roofer is an office worker. Naturally with lower risk, this misclassification results in an inappropriately lower workers' compensation premium.

An employer might also inappropriately classify a worker as a 1099 subcontractor. However, if the employer has control over work times and days, the scope of the work, how the work is to be performed, and provides tools and equipment to perform the work, the worker is likely not a subcontractor. Again, this misclassification results in an inappropriately low premium. During the review process, an auditor may see possible evidence of this in the form of an excessive number of employees with apparently nothing to do in the office areas during an audit. This can be difficult to sort out when administrating claims involving construction and maintenance, agricultural, or landscape workers, among others. As in the prior scheme, this is often discovered after a claim and subsequent AOE/COE investigation.

Partners in Crime

A dishonest employer may affect the claim experience by entering into agreements with illegitimate medical service providers that do not report work-related injuries. The employer then directs its employees to these facilities for treatment. The fraud scheme may be as simple as the employer paying for medical treatment of an industrial injury out its own pocket and therefore not reporting a claim.

Employers may even intimidate, coerce, or threaten employees with termination should they choose to file a workers' compensation claim. Because some workers may be uneducated or uninformed of their rights, they may feel at the mercy of the employer for treatment.

Coercion may result in an injury being reported to the treating physician inaccurately. For example, laborers injured while loading materials on a dock may report to their personal physicians that they were injured while working in the garden at home. This fraud scheme may be revealed should an injured worker require surgery or a hospital stay for which they are personally responsible.

Premium fraud may also take the form of misrepresenting the true nature of the business. A sign company, for example, may claim to only manufacture signs and untruthfully deny that it installs them. Again, a claim related to an injury inconsistent with the nature of the business may reveal this scheme. Forged certificates of insurance may be used to avoid premiums for subcontractors. A claim is ultimately filed, and it is then discovered that no policy was in effect.

Audit mechanisms are in place to verify the information provided by an employer. However, the auditor is limited in his ability to identify misrepresented payroll because the documentation audited is, in fact, supplied by the insured employer. Payroll records can be weighed against state unemployment insurance records. If an employer is defrauding the insurance carrier, however, it is likely defrauding the government, as well.

Monetary gain drives fraud, but astute claim professionals and policy application processing personnel who recognize and respond to red flags will expose it.

David M. Bogan CFE, CFS, CWCP, FCLS, is president of Bogan Fraud Consult, a firm that provides fraud consulting and investigative services to the insurance industry. He may be reached at 858-610-6012, dave.bogan@boganfraudconsult.com, www.boganfraudconsult.com.