E&O Insights: How Well Do You Know Your Workers’ Compensation Risk?

The workers’ compensation class of business results in upwards of 10 percent of all errors and omissions (E&O) claims every year. While this may not seem like a lot, it is a class agents must be sensitive to for a variety of reasons.

Different Standard Because of Compulsory Coverage?

In most, if not all, states, the legal standard of an agent is to provide the coverage the client specifically requests. When dealing with the issue of workers’ compensation, consider a Massachusetts court case in the 1980s – Rae vs. Air Speed – that seemed to put a slightly different spin on this.

The case involved the death of an agency customer’s employee and a resultant claim for workers’ compensation benefits. The problem was that there was no workers’ compensation coverage in effect. The deceased’s estate made a claim against the agent for failing to procure the workers’ compensation coverage for the agency’s customer. There were some significant legal questions in the 1980s regarding whether an estate could bring this type of legal action because it was believed that the agency technically owed no legal duty to the estate. The agency’s legal duty was only to the agency business customer.

When the estate attempted to make a claim directly against the agency, pursuing claims in negligence and breach of contract, the trial court dismissed the claim on the grounds of “lack of legal duty.” The case was then appealed to the Massachusetts Supreme Judicial Court, which reversed the decision, setting forth two critical rulings:

• The estate could bring a direct action in contract against the agency as a third-party beneficiary of the agreement between the agency and its customer to procure workers’ compensation coverage; and
• The estate could also bring an action in tort, because of the mandatory nature of workers’ compensation

While this case was in Massachusetts, it has been referenced in court decisions in other states. Thus, the essence of this case is that if the coverage at issue is compulsory, an injured third party can assert a negligence claim against the tortfeasor’s agent.

What does this mean for insurance agents? Agents should know the customers they are dealing with (or looking to deal with) and whether there is a workers’ compensation exposure that needs to be addressed.

Potential Fraud Issues

As agents are aware, when it comes to workers’ compensation there are a variety of factors that go into the calculation and determination of the appropriate premium. These involve job classification codes, experience modifications, payroll, SIC codes, etc. Insurance carriers expect that the application will reflect the correct information.

This is where the agent must perform the appropriate due diligence. The determination of these factors (or the intentional misclassification of these factors) has been a central issue for fraud. Agents must be aware of this to avoid becoming an unknowingly participant in any fraud scenarios.

When applying for workers’ compensation coverage, businesses are required to provide the necessary information. This involves business class information as well as payroll, job class/employee classification information, experience modification details, etc. This will be the basis of the application that will go to the carrier to determine acceptability, coverage specifics and the quoted premium. It is generally believed that when business owners seek to secure a lower premium through the misrepresentation of the nature or class of the business, employees’ specific duties, or under-reporting payroll, they are committing premium fraud.

Perhaps the most widespread fraudulent activity involves the misclassification of workers. Since the purpose of Job Classification Codes is to identify the type of employee working for a particular business, a misclassification can have a significant impact on the rates used in the premium calculation. Common techniques businesses could use that agents must be on the lookout for include:

• Misclassifying an employee’s position with the company. This would involve taking employees that are assigned a higher rate and reclassifying them to a classification with a lower rate. Needless to say, the premium impact can be significant.
• Classifying the employee as an independent contractor. Essentially, a business is stating that the individuals are not employees and that there is no employment relationship. This is an area where the federal government is strongly focused. If one of these “independent contractors” is subsequently injured on the job, there is no workers’ compensation coverage that will respond. This has the potential to result in criminal charges against the employer.

Various “right to control” standards have been established to help determine whether an individual is “an employee” or “an independent contractor.”

If these actions are taken knowingly and with intent to defraud, a premium fraud is being committed. Agents obviously need to be sensitive to these and ensure they do not actively engage in this endeavor. The last thing an agent/broker wants is to be viewed as part of the “scheme.”

Understand the Issues

Workers’ compensation is a class of business that has the potential to cause some issues of concern. It is important that agents understand these issues to avoid any part of E&O litigation.