How Workers Comp Insurance Gets Weaponized Against Small Biz
I get calls and emails just about every day from small businesses around the country, desperately seeking help. Many of them are facing the financial ruin of their company. That’s because they’ve just gotten a bill for their Workers Compensation insurance that is far, far higher than they ever expected, for a policy that has already expired. Around our office, we call this a Shock Audit. And they’re a particularly common (although not exclusively) scourge of small businesses.
A recent call was from a small roofing contractor in the Chicago suburbs. The owner was Hispanic and his English skills were a little limited (but far, far better than my Spanish) so his local accountant was my interface for communications. This roofer had purchased Workers Comp insurance for three years, with each year’s premiums around $1,500. But recently, his insurer had taken a closer look at things, and had just sent him a bill for additional premiums for those three years. A bill for over $200,000.
In my line of work, this is a fairly routine call. I’ve worked with Workers Comp insurance for over forty years, and for more than thirty years I’ve specialized in double-checking how insurance companies calculate those Workers Comp insurance premiums, in order to find and correct overcharges. Increasingly, I’ve been getting those calls and emails from small businesses, from all over the country. They’re often in the construction trades, with similar horror stories about a Shock Audit.
Workers Compensation insurance premiums are based on payroll, so the initial premium has to be estimated, by definition, because payroll cannot be exactly known in advance for the coming year. That also means that, after the policy ends, the actual payroll has to be determined, and premiums get adjusted based on that actual payroll. But for a lot of small businesses, Workers Compensation insurance (which is essentially required for a business to operate in most states) can get weaponized by a system that’s dominated by insurance companies. That’s how my Hispanic roofer bought three policies for $1,500 apiece and ended up with a $200,000 bill.
Heck, that case wasn’t even the most egregious one we’ve seen recently. We just finished making a bill for $700,000 disappear for another small business client. We were able to do that because the insurance company had made a fundamental error in how that premium charge had been computed, and once we pointed it out they were cooperative in fixing things. Insurers aren’t always so quick to fix these mistakes, but they often are, once things are explained and documented properly.
Part of the problem is that insurance agents are typically compensated by commissions. So a small business account doesn’t generate much income for an agent, and it is difficult for agents to justify spending too much time and effort on small accounts. And in the construction business, a lot of small companies end up in what is called the Assigned Risk plan, a pooling arrangement that makes sure every business can get Workers Comp insurance (because it’s required, remember) even when insurers aren’t much interested in voluntarily underwriting very small accounts.
These small businesses are often sold what are known as Minimum Premium policies. That’s why my roofer paid only $1,500 a year. But no one explained to him about how that was just an initial estimate, and that the insurer would be entitled to figure out the actual premium, based on payroll, after the policy ended.
The insurance company had never done any underwriting of this Assigned Risk account when the policies had been issued. Nowadays, a lot of the big insurers who issue Assigned Risk policies don’t do any underwriting at all. As one underwriter put it, in a deposition, “Any errors, we figure we’ll catch them at the audit.”
The problem is that such a system relies on the agent doing a competent job of telling these small business accounts about all these potential changes at the audit, after the policy has ended. And often they don’t. So the small business owner thinks their small initial premiums are the total premiums. Until they get one of those Shock Audit bills, for far, far more than the initial premium. A common cause of Shock Audits is the insurance company picking up, on the audit, independent contractors who lack their own Workers Comp coverage. In many states, uninsured independent contractors or subcontractors get treated the same, for Workers Comp, as regular W-2 workers — at least, as far as the insurance companies are concerned. More on that later. But small employers often misunderstand this, and it often isn’t explained when their buy a small Assigned Risk policy.
And to make matters worse, a lot of those Shock Audits are greatly and improperly inflated by technical errors. That’s how I make my living — catching and correcting those technical errors. In a perfect world, I like to say, I shouldn’t be able to make my living fixing such mistakes.
It’s not a perfect world.
The Cat People
It’s not just things like independent contractors that trigger these Shock Audits, of course. I often refer to a recent past case of mind that involved a unique small business-a travelling troupe of trained house cats. These rescued animals would perform clever little tricks on stage (they even appeared on Letterman once!). Unsurprisingly, the Workers Comp insurance for this unusual business came through the Assigned Risk plan.
When the policies were first purchased, premium were very low — around $1,100 per year. But then the insurance company decided to retroactively change the classification code for this business to the classification used for rodeos and circuses. And then sent them a classic Shock Audit bill. For around $30,000 a year, and they billed them for three years worth of revised policies.
This wasn’t some easily-corrected oversight or misunderstanding, either. In Workers Comp insurance, the classification sets the rate that’s applied to your payroll, so a change to a more expensive class can make a huge difference in premium.
The rate for this client was originally $0.30 per hundred dollars of payroll. The insurance company retroactively changed them to a class with a $7.54 rate.
This insurance company didn’t misunderstand the nature of this small business when they issued the policies — they just hadn’t done any underwriting of the insured at all, because it was Assigned Risk. When they finally got around to an audit, though, they genuinely believed that, under the Workers Comp classification rules, this new class, used for circuses and rodeos (and also demolition derbies!) was really and truly the right class for the people who trained and transported performing house cats.
We got that corrected. Eventually. And the insurance company fought every step of the way. They probably still think ill of me for, in their eyes, helping a policyholder avoid proper premiums. Sigh.
My experience with people in the insurance industry has been that these folks are among the most decent, honest, professional, and ethical people I’ve ever known. So these Shock Audit problems don’t arise because of some evil conspiracy to overcharge businesses. Insurance company personnel are rightly concerned about those policyholders who try to cheat the system. It’s a real and legitimate concern, because some employers do try to cheat on their Workers Comp insurance premiums.
But in their zeal to guard against having their pockets picked, insurers sometimes end up inadvertently picking the pockets of innocent small businesses (and sometimes not-so small businesses.) Insurance companies expend significant effort and resources to catch situations where policyholders aren’t paying the fair and proper premiums. And perhaps understandably, they don’t, in my experience, devote anywhere near similar effort and resources to spotting instances where they’ve inadvertently overcharged a business. Human nature, I guess.
So it’s the lopsided system, I believe, that causes these problems. Insurers know these arcane rules well, but lack real motivation to catch errors that overcharge policyholders. Particularly tiny policyholders. It’s a system that, in my opinion, lacks effective oversight and impartial regulation to balance the scales for these small businesses.
Workers Compensation insurance is regulated by state government. And those erstwhile regulators are often understaffed, underfunded, and lack personnel with the particular and unique training to do much about these Shock Audits.
Insurance regulators typically have actuaries on staff, to review rate filings made by insurance companies for Workers Comp. These regulators typically lack personnel with the particular training needed to police premium audits, however. The training and expertise needed by actuaries are fundamentally different than the training and expertise needed by premium auditors. The two professions require entirely different kinds of technical expertise.
So when small businesses get an audit bill for tens of thousands of dollars (or worse) more than the original policy, they often are left feeling frustrated and alone. Insurance agents, even with the best of intentions, can’t usually offer much real help, because insurance companies don’t give agents any real authority about audits — particularly in Assigned Risk policies.
The Sort-Of Secret Rules
There are rules that govern these things, however. It’s just darn near impossible for the typical Workers Comp policyholder to find out what they are. The policies themselves make only vague reference to computing premiums per the insurance company’s “manuals”. But they contain no information about how a policyholder might get a copy of those manuals. In fact, in many states, the pertinent manuals aren’t publicly available — you have to buy access to them.
For those interested, these sort-of secret manuals, for most states, are published by the National Council on Compensation Insurance, Inc. Known in the insurance industry as NCCI. The manual that spells out the rules that govern premium computation is called The Basic Manual.
The manual that details the criteria for the different classifications that establish the rates used is called The Scopes Manual. These are filed with state insurance regulators on behalf of member insurance companies, but in my experience you can’t easily obtain copies of these manuals from regulators. You have to purchase access to them from NCCI. But the policies themselves make no mention of any of these details. And NCCI writes the manuals used in most states, but not all states. The non-NCCI states tend to make their manuals available online, if you know where to look. But NCCI manuals are used in almost 40 states.
But again, the policy gives no information about how to access these manuals. As far as most policyholders know, it would be easier to find a copy of the Necronomicon.
Of course, insurance company premium auditors receive significant training in those manuals, and they absolutely have access to them. So small businesses are typically very outgunned when it comes to disputing one of these Shock Audits.
Worst of all, insurance companies make a fair number of errors in applying these arcane and obscure (at least to policyholders!) manual rules.
That’s why I may be able to help my Hispanic roofer — the insurance company has used a complicated methodology to estimate what they think his payrolls were — because he paid cash to his single worker — and their methodology has come up with payrolls higher than his entire revenue. I think I can reduce his bill significantly. We shall see. This particular insurance company, I know from experience, tends to be kind of hardhearted with Assigned Risk accounts.
Shock Audits for Workers Comp can hit all kinds of businesses, large and small. But small businesses are often hardest hit, and have the least financial cushions to handle such unexpected bills, or to fight them. And the state insurance regulators are simply not doing much, if anything, about the problem. I suspect they’re really not even aware that it is a problem.
But it is a problem. A problem that a lot of folks in the insurance industry seem to be in denial about, judging from the responses I get when I write about this subject. I can think of no other industry where it would be viewed as common business practice to sell a product for $1,500 and then, a year or two later, send a bill for an additional $25,000. Or $50,000. Or $700,000.
One solution would be to force insurers to do reasonable underwriting, even for Assigned Risk policies, by limiting their ability to bill for additional premium charges that are more than, say, three times the premium communicated to the policyholder within the first three months of the policy. That would give the insurer time to adequately price the insurance realistically and let the policyholder know, early on, what the insurance is going to cost, rather than allowing the insurer to send one of these Shock Audits a year later, or two years later, or even further after the policy has ended.
The rules that are used to compute Workers Compensation insurance premiums are a bit complicated — complicated enough that a lot of insurance agents don’t really understand them well. That leaves a lot of small business owners with painful and costly misunderstandings about how the insurance will ultimately be priced, misunderstandings that only get corrected after the policy ends.
As mentioned earlier, it’s not uncommon for small business people think that their Workers Compensation insurance premiums are based only on payroll for W-2 type workers, not “independent contractors” whose pay is reported on form 1099. Agents don’t always make it clear that this is likely not the case. But on the audit billings, insurers routinely charge for those 1099 workers, even in states where the Workers Comp Act says “independent contractors” are excluded from Workers Comp coverage. (I told you these rules can get complicated.)
States like Florida and Georgia explicitly state that “independent contractors” are excluded from Workers Compensation. Yet I just finished testifying in a court case in Georgia, where the dispute was over just such an independent contractor. That’s because what isn’t so explicitly known is that to be excluded, an “independent contractor” in that state has to meet certain specific criteria to be genuinely considered an excluded “independent contractor”. And there exists, in that state, no authority that can rule, in advance of a claim for injury, whether a particular “independent contractor” is truly independent enough to be excluded. So insurance companies routinely charge for 1099 workers, in spite of a lot of small business people thinking that “independent contractors” are excluded.
Like I said, the rules that govern how Workers Compensation insurance premiums get calculated are a bit complicated — and they can vary, in significant details, from one state to another. The insurance industry uses specially-trained premium auditors to make sure those complicated rules are followed — after the policy has ended. Nowadays, those same insurers just aren’t always communicating those same rules at the time the policies are purchased, setting up businesses for these Shock Audits.
Plus, because almost all of the people who are trained in those complicated rules work for the insurance companies, it can be very difficult for employers to figure out if a Shock Audit contains significant errors. (They often do contain such errors, in my experience.) Agents aren’t typically trained in these complicated rules, so they are often of very limited help in finding or correcting such errors. Those agents who do have some understanding of these rules typically aren’t dealing with small accounts in the Assigned Risk plan. The licensing requirements just don’t require insurance agents or brokers to get the same kind of specialized training that premium auditors do.
And insurance regulators typically aren’t able to help much with disputes over these Shock Audits. Workers Comp premium charges involve complicated and technical rules and insurance regulators nowadays often don’t have the trained personnel to handle such disputes.
There are dispute resolution processes available, though, but insurance regulators often use a process that is overseen and administered through review boards established through insurance industry organizations (like NCCI. More about them in a bit.)
And even though those organizations are technically independent of the insurance companies, there are significant financial — and other — ties with the insurance companies. The majority of the board of directors of NCCI, for example, are insurance company executives. And most of NCCI’s revenue comes from insurance companies.
The existing dispute resolution processes for Workers Comp premium disputes are often limited in the time they can give individual disputes and also often have insurance company representatives sitting as voting members. And while I’ve often seen such boards provide relief to policyholders (and frustration for insurance companies) the nature of the process still leaves something to be desired, I fear.
To make matters worse, the insurance industry has developed a new tool — getting special “insurance fraud” prosecution units started, funded often by special surcharges on the policies. Such funds get channeled through the insurance companies that collect the premiums, so the insurance companies, in essence, fund these prosecutors’ offices. And if an insurance company can’t collect an audit bill, they may well refer the case to one of these prosecutors, alleging that the business owner deliberately tried to cheat the insurer on premiums, rather than just being blindsided by an unexpectedly high audit bill.
Now don’t get me wrong — such prosecutors go after a lot of real crooks. And such efforts are vital in protecting the Workers Compensation system from fraud that would otherwise bleed money out of the system that protects injured workers. But given the complicated rules that govern Workers Comp insurance premiums, I fear those prosecutors sometimes get sold a bill of goods by some insurance companies, who try to use the prosecutors as a collection tool for some Shock Audits they can’t otherwise get paid. And given the arcane nature of the rules about Workers Comp insurance premiums (which are not spelled out in the policy itself) it’s easy for a small business owner to innocently get caught up in one of these Shock Audit situations.
Like I said, it’s not a perfect world. But it could be, and should be, a little closer to it, in this regard. Since most businesses are required to buy Workers Compensation insurance, and for good reason, it shouldn’t be something that so often gets turned into an existential threat to the continued existence of those businesses, especially small businesses.
But it’s not a perfect world.