Know the Rules to Avoid Costly Workers’ Compensation Risks
By DAVID MOTOSKY, CRMThere is no doubt that the cost to employers of providing workers’ compensation insurance benefits for their employees can be a significant budget line item. Just as significant can be the potential cost to employers when they hire non-employees within the usual course and scope of their business operations who might be uninsured for workers’ compensation, without even knowing it.
Whether an employer hires casual labor to help complete a specific project, contracts with a subcontractor to provide specific services to the employer, or hires an independent contractor to perform direct work for or on behalf of the employer, workers’ compensation laws are pretty clear. In the vast majority of cases, an employer will be held responsible for workers’ compensation benefits payable to uninsured ‘contractors.’ But there is an easy way for employers, regardless of their business or industry, to practice sound risk management and avoid the potential of having their loss experience and workers’ compensation insurance costs negatively impacted by workers who aren’t on their direct payroll.
Requiring a current and valid certificate of insurance evidencing proof of workers’ compensation insurance from anyone who does work for you is a simple and practical way to reduce your potential exposure in this area.
In Massachusetts, it is presumed that any person performing services for another is an employee unless the employer can meet the following three-part test:
• One, the individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact;
• Two, the service is performed outside the usual course of business of the employer; and
• Three, the individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed. An employer’s failure to demonstrate all of the above sufficiently establishes an employer/employee relationship under the law.
Let’s first get a clear understanding of the two basic components that directly impact an employer’s workers’ compensation expenses: the direct insurance premium cost to the employer, and the employer’s loss experience. In theory, there is a direct correlation between the two. To the extent that loss experience is favorable, the premium cost will be low. Conversely, to the extent that loss experience is poor, the premium cost will be high.
There are three premium-bearing components that directly impact an employer’s workers’ compensation insurance premium cost: annual payroll, manual-class-code rates, and the employer’s experience-modification factor (and its companion ARAP surcharge, if applicable).
The annual payroll amount is initially estimated by an employer prior to the inception date of the policy, and is subject to audit at the end of the policy term. Payroll includes salary, wages, two-thirds of overtime expenses, casual and temporary labor costs, and payments made to subcontractors that are uninsured for their own workers’ compensation exposures. There is a direct correlation between payroll and premium — the higher the payroll, the higher the premium; the lower the payroll, the lower the premium.
The manual-class-code rates are set and established by the Mass. Workers’ Compensation Rating and Inspection Bureau, and subject to approval by the Mass. Division of Insurance. There are hundreds of class codes, each assigned to a specific classification, that recognizes the predominant work functions of an employee. At the inception of each policy term, the manual class-code rates are applied to the annual payroll amount per classification of employees, per $100 of payroll, to calculate the manual premium. At expiration of each policy term, the insurance company will perform an audit of the payroll to determine the actual classification and payroll exposures during the policy term.
The insurer will charge additional premium if payroll was underreported, or refund premium if payroll was overestimated, subject to any class-code minimum premium. There is a direct correlation between the manual-class-code rates and premium — the higher the rates, the higher the premium; the lower the rates, the lower the premium.
Insurance companies can file for approval of rate deviations from the established manual rates. In what is referred to as the voluntary insurance market, deviated rates are readily available and plentiful. Policies written through the Mass. Workers’ Compensation Assigned Risk Pool (MWCARP), the market of last resort in the state, are written with only the manual rates applied, without the potential for savings of deviated rates, or premium discounts, for that matter. In general, employers with favorable loss experience have many options available in the voluntary market, whereas employers with poor loss experience or high hazard operations end up in the pool.
An experience-modification factor, and any companion ARAP surcharge, is calculated on an annual basis by the Mass. Workers’ Compensation Rating and Inspection Bureau (WCRIB) for each employer, prior to the inception of each policy term. The experience-modification factor is applied to manual premium to calculate standard premium. Any applicable ARAP surcharge is then applied to the standard premium to calculate the additional surcharge. Those employers that operate in multiple states in addition to Massachusetts have their calculations performed by the National Council on Compensation Insurance (NCCI), using the same basic formula. For smaller employers that aren’t eligible for experience rating, a merit-rating calculation is performed by the WCRIB. Merit rating acts in a similar fashion to experience rating.
In very basic terms, an experience-modification factor, and any companion ARAP surcharge, rewards an employer that has favorable loss experience by applying a credit to their premium, and penalizes an employer which has negative loss experience by applying a debit to their premium. There is a direct correlation between the experience-modification factor and premium — the higher the experience-modification factor, the higher the premium; the lower the experience-modification factor, the lower the premium.
An experience-modification factor of 1.0 is neutral, with no credit or debit applied. An experience modification factor of 1.1 applies a debit of 10% to premium. An experience modification factor of 0.9 applies a credit of 10% to premium.
Prior to Oct. 23, 2002, sole proprietors and partners of legal partnerships were unable to cover themselves as employees under a worker’s compensation policy that they purchased. The change to M.G.L. Chapter 152 allowed a sole proprietor or partner to elect coverage; otherwise they would not be covered under the policy for any work-related injury. If coverage election is made, the minimum payroll for premium computation purposes for each respective employee is set by the state on an annual basis, based upon the state’s average weekly wage (AWW). Currently, this minimum payroll amount for policies effective Oct. 1, 2011 and after is $41,300, even if the actual payroll is less.
At the same time, the change to M.G.L. 152 made it possible for certain corporate officers and directors to exempt themselves from coverage by applying to the Mass. Department of Industrial Accidents (DIA) for approval. If approved by the DIA, the payroll of the respective officer or director would not be included for premium-computation purposes. The officer or director must own at least 25% of the issued and outstanding corporate stock. If the corporation has no employees, other than those officers that have exercised their right of exemption, the corporation is not required to carry workers’ compensation insurance. If the corporation has other employees, or subsequently hires an employee, they must secure coverage in compliance with M.G.L. Chapter 152.
Any newly formed corporations are encouraged to consider the right of exemption and file Form 153 with the DIA for approval in a timely manner. Otherwise you run the risk of being issued a stop-work order (SWO) by the DIA. Over the past several years, the DIA has been aggressively investigating employers to ensure the existence of valid insurance in compliance with the law, issuing SWOs and assessing fines for noncompliance.
In January 2004, the DIA clarified that legal partnerships include LLCs and LLPs, and therefore the members of an LLC and the partners of an LLP may also elect to carry workers’ compensation insurance coverage for themselves. As is the case with sole proprietors, if coverage election is not made, there will be no coverage under the policy for any work-related injury.
Certificates of insurance evidencing workers’ compensation that are issued to sole proprietors and legal partnerships should list on them whether or not the sole proprietor or partners have elected coverage or not. If the certificate of insurance you are provided is silent as to the election of coverage, you are encouraged to contact the insurance agent or insurance company that has issued the certificate for clarification.
A word of caution when it comes to certificates of insurance and your reliance upon them — they may not be worth the paper they are printed on. They only provide a snapshot of the insurance coverage in force at the instant ‘print file’ was hit. Since that time, the policy could have been cancelled for misrepresentation or non-payment of premium.
The bottom line is that every employer should require, track, and maintain on file certificates of insurance from any person or employer that they enter into contracts with. Otherwise, a potential work-related injury to an uninsured employee will negatively impact your loss experience, increase your experience modification factor, and certainly increase your workers’ compensation insurance cost for years to come.
If you ever have any questions or concerns regarding the validity of a certificate of insurance, or how hiring a subcontractor or independent contractor might impact your own workers’ compensation insurance policy and its cost, your best bet is to rely upon the advice of your local independent insurance agent.
David Matosky is operations director for First American Insurance Agency in Chicopee, and has earned the designation of certified risk manager;