By Dominic Dugo | July 26, 2022
Workers’ compensation premium fraud costs the U.S. $25 billion a year, reveals a new report by Coalition Against Insurance Fraud.1 This new national fraud estimate says much about the numerous premium cases prosecuted around the U.S., their large dollar losses, and massive tax evasion occurring within the nation’s thriving underground economy.
Lying to an insurance carrier to illegally buy workers’ compensation coverage at less than the proper rate is called premium fraud. In California, this felony is punishable up to five years in prison and a fine of $50,000 or double the cost of the fraud. In many other states, premium fraud is also a felony with punishment usually based upon the value of the fraud. Suspects include business owners, bookkeepers, supervisors and office personnel.
“Premium fraud is a serious problem throughout the nation. The schemes are deeply unfair to honest employers who play by the rules,” says Matthew J. Smith, Esq., the Coalition’s Executive Director. “This crime leads to higher workers’ compensation premiums that, unfortunately, are passed along to honest consumers in higher prices.”
Premium Scam Goals: Lower Expenses
Labor-intensive industries such as construction and agriculture are common sources of premium scams. The work can be dangerous and injuries are frequent. Workers’ compensation premiums in these sectors thus can be high, creating a regrettable incentive for some employers to illegally lower expenses by defrauding their insurer.
Dishonest employers typically pay employees in cash in the underground economy. Often they use colluding check-cashing services. This allows the employers to avoid paying taxes. They are not likely to truthfully report this cash payroll to the workers’ compensation insurer. These employers illegally reduce costs by committing premium fraud and payroll tax evasion. This enables them to underbid honest competitors for contracts and steal jobs from honest employers. This unfair business practice ultimately can drive honest companies out of business.
To illegally reduce costs, “scofflaw contractors intentionally misclassify employees as independent contractors … or simply pay them off-the-books by check or cash with no reporting to state or federal taxing authorities or workers’ compensation insurers,” says Matthew Capece, Representative of the General President of the United Brotherhood of Carpenters & Joiners of America. “This results in crooked contractors skimming 16.7% to 48.1% off their labor costs,” adds Capece, an expert in wage theft and premium fraud in the construction industry.
Sam King, is a 30-year fraud-fighting veteran, and Vice President of Fraud Investigations for Employers Insurance Group. “Premium fraud cheats honest policyholders and creates an unfair business advantage for the perpetrator. This creates a bidding advantage or lower product and servicing offerings due to their reduced operating costs,” King notes.
Premium fraud damages the entire workers’ compensation system and businesses within a state. “Underfunded claims cause individual job-class rate increases for all businesses. Overall rate hikes cause states to become less-competitive in attracting and retaining businesses,” says King.
Workers’ compensation premiums are a significant cost of doing business. When combined with payroll tax requirements, some employers may incur costs of 60% to 70% of their payroll for insurance and taxes.2 The temptation to cheat is compelling to some employers.
“With the economy in a downturn due to the pandemic, many businesses are looking for ways to cut expenses and misrepresent job classifications or not list all their employees. These are common mechanisms to commit fraud,” observes Frank Sztuk, a 40-year anti-fraud veteran and now Senior Vice President of Delta Group.
Employers engaged in premium fraud also often evade payroll taxes by paying employees under the table in cash. This is known as the underground economy, a large and secretive employment sector that is rife with fraud and corruption. In the U.S., the underground economy comprises more than $2 trillion a year.3 When payroll and income tax evasion are combined, the annual national tax loss is between $700 billion and $1 trillion a year.4
Harm is seriously pervasive
Premium fraud is a major economic crime that causes significant harm to society. Employee wages are stolen. Employers, employees and consumers are harmed by higher prices directly caused by premium fraud. Employees also are denied workers’ compensation benefits to which they are legally entitled. Thus, they are prevented from returning to work in a timely manner due to lack of medical treatment. They may be denied an opportunity to earn a living, and suffer medical consequences if not properly treated.
Employers who follow the rules cannot fairly compete for contracts against dishonest employers who lowball bids by passing along their illegally lowered costs. Some honest firms even go out of business or have to move out of their state.
Losses from premium tax scams deprive state and local governments of valuable tax dollars they need to provide proper services to taxpayers at a time when many jurisdictions are struggling to fund operations.
Workers sometimes are grievously injured in falls from scaffolding or other painful incidents. They then find themselves without workers’ compensation coverage.
The Three Most-Common Premium Cons
Premium schemes are limited only by the imagination of dishonest employers, however, the vast majority of the scams occur in one of three primary forms.
Payroll fraud. First, employers intentionally underreport their payroll to insurers. A company with $600,000 of annual payroll may falsely report only $200,000 to the insurer. Workers’ compensation premiums are thus reduced. The employer hides payroll by paying employees in cash, falsely claiming employees are independent contractors, or concealing employees in shell companies. Underreporting payroll is the most-common type of premium fraud.
Misclassifying jobs. Employers misclassify to their insurers the type of work that employees do. A company may say its tree trimmers are landscapers or construction workers are clerical staff. Since tree trimmers and construction workers are more likely to suffer injuries than landscapers or secretaries, the employer has illegally shifted workers to a lower class of insurance with lower premiums.
Delta recently investigated a food manufacturer that claimed 104 workers on its workers’ compensation policy, 98 of whom were supposedly clerical. Delta’s spot visit found the vast majority of the workers were on the more dangerous production floor, Sztuk recounts. There was only one clerical person in the company, with the rest being food-production workers.
In California, misclassification also includes employers lying about hourly rates paid to certain employees. For example, a roofer or carpenter earning $50 an hour will have lower premiums than employees paid only $15 an hour.
Higher-paid employees tend to be more-skilled and are less likely to be injured than lesser-skilled, lower-paid employees. For example, a dishonest employer will claim all its roofers earn $60 an hour when in fact they earn $20 an hour. The employer will produce false time cards to the insurer showing only one-third of the true hours worked.
Experience modification. A third premium scheme is “experience modification (“x-mod”) evasion. Much like auto insurance, workers’ compensation premiums increase after many worker injuries or accidents. Employers thus receive a premium surcharge or high x-mod. To illegally avoid the higher cost, dishonest employers do not report injuries. They also may change the company name, and buy insurance for a “new” company without an x-mod on its records. Nothing has changed except the company name.
Stopping Premium Scams: Collaboration is Key
Since 1996, premium fraud has slowly revealed itself to be a serious economic crime throughout California and the U.S. Most premium fraud cases involve under-reporting or misclassifying payroll. The most common scheme is cash pay. When cash payouts are present, you often see payroll tax evasion and wage theft. By combining these related crimes into one prosecution, especially wage theft, a stronger case exists for jurors and judges to hold perpetrators accountable for their actions.
The San Diego County District Attorney’s office led the nation by placing a major emphasis on investigating and prosecuting premium fraud. Without any premium fraud studies and only a “gut” instinct based upon studying the economy, the DA formed the nation’s first premium fraud task force in 1996. The DA is joined by investigators from the California Department of Insurance, Employment Development Department (payroll tax), Franchise Tax Board (state income tax) Labor Commissioner’s Office (wage theft, worker abuse), Contractors’ State Licensing Board, and assisted by the State Compensation Insurance Fund (State Fund) — California’s insurer of last resort.
Together, they have successfully prosecuted hundreds of fraudsters involving millions of dollars in premium fraud, tax evasion and/or related charges. “The San Diego Premium Fraud Task Force has been a national pioneer in proactively attacking and training agencies,” insurance fraud veteran King points out.
A sample of the hundreds of defendants San Diego has successfully prosecuted for premium fraud includes the following.
Misclassifying — large roofer (Southern California)
Prosecutors obtained felony convictions against a large roofing company operating in San Diego and throughout Southern California. The roofer systematically falsified time cards to show higher hourly wages for employees in order to misstate their payroll under the high-wage roofing classification and obtain coverage at less than the proper premium. The defendants paid more than $3.1 million (including investigative costs) to the State Fund in court-ordered restitution.
Misclassifying — painting company (San Diego)
An adjuster, who had recently received premium fraud training from the San Diego DA’s Office, noticed during an evening television news show that a truck that went down an embankment had the insurance policyholder’s name on it. This company described itself as a painting company when buying its workers compensation policy. Yet the news story showed large amounts of roofing materials had fallen out of the “painting company” truck. The alert “fraud spotter” led a premium fraud investigation against the company for misrepresenting the type of work it performed. Thereafter, a premium fraud prosecution and conviction were obtained. The court ordered approximately $400,000 of restitution.
Underreporting Payroll – janitorial company (Southern California)
A large janitorial company working for most of the best hotels in Southern California was caught hiding up to 800 workers in more than 20 shell companies in order to evade paying proper workers’ compensation premiums and payroll taxes. This “systematic shell game with straw owners” resulted in millions of dollars in premiums stolen from Travelers, Norguard, Preferred Employers, AIG, Southern Insurance, State Fund (CA), Everest National, and Employers Compensation Insurance. As a result of a referral from the Maintenance Cooperation Trust Fund (Janitorial Watchdog Group), San Diego prosecutors obtained convictions against 19 defendants. The leader of this criminal enterprise was sentenced to eight years prison and ordered to pay $6.6 million in restitution. The Coalition recognized the outstanding work of the San Diego prosecutor with a National Award of Excellence.
In the past, aided primarily by the State Fund, and most recently by most of the other insurers, prosecutors in California also are forming task forces or working groups to successfully combat this crime. Premium fraud prosecutions have taken place in nearly all District Attorney offices in California over the last 10-15 years.
Cal-SARA was formed in California in 2020 to combat widespread premium fraud in the staffing industry. “Premium fraud is the greatest challenge to staffing agencies and Professional Employer Organizations,” says Michael LoBue, Executive Director of Cal-SARA. LoBue encourages all stakeholders to work jointly to combat this crime and “don’t let the bad actors take your bright business opportunities from you.”
Jill Nerone is a 30-year prosecutor who manages the Insurance Fraud program for the Alameda County DA’s office in California. “It literally takes a village to consistently put together impactful premium fraud prosecutions. We need trained prosecutors, investigators, and paralegals, working right along with experienced and knowledgeable insurance SIUs,” notes Nerone.
“Creating a Northern California Consortium among the DA’s offices and the Department of Insurance has been critical to our successes in the Bay Area.” Their strategic partnerships, along with the state tax agencies, the Labor Commissioner’s Office and the business community “let us know who we should investigate.”
Prosecutions spreading nationally
Premium fraud prosecutions recently are surfacing throughout the U.S. To name just a few: In Florida (two construction cases with losses of $9 million); New York (three cases involving construction and landscaping with losses of $4 million); Massachusetts (three construction cases with losses of $3 million); South Carolina (twelve construction companies with losses of $3 million); New Jersey (two cases involving home improvements and trucking with losses of $2 million); and a construction case in Pennsylvania.
Premium fraud prosecutions also continued taking place last year throughout California — one of the nation’s hotbeds of premium scams. A sampling from at least nine counties showed premium fraud with farm labor, landscaping, medical services, construction, food processing plant and flooring installation. Combined, they show losses exceeding $37 million.
Ways to take action
Pooling resources and knowledge is key to identifying, investigating and holding premium fraudsters accountable for their actions. It’s also critical to educate law enforcement (investigators and prosecutors) and judges on the current workers’ compensation premium, tax, and wage fraud schemes and their severe impact on the community, employees, and honest employers within their jurisdictions. Premium scams can be far too complex and numerous. No single agency, insurer, or other stakeholder can succeed acting alone. The nation should replicate the successful San Diego approach begun in 1996 to attack the serious crime of premium fraud.
About the author: Dominic Dugo, who retired after 33 years as a San Diego Prosecutor, is Vice President, Fraud Division, at the Delta Group and an Outreach Coordinator for the Coalition Against Insurance Fraud.
Endnotes
- Coalition Against Insurance Fraud Workers’ Compensation Fraud Task Force Report, 2022.
- For example, a roofing company engaged in high risk work with a high experience modification paying proper payroll taxes could have to pay 60% to 70% of their payroll to pay for workers’ compensation insurance and taxes.
- Understanding the Shadow Economy, article by Dickson College, June 28, 2020.
- Washington Center for Equitable Growth, article by Corey Husak, 2021. US Treasury Secretary Janet Yellen puts tax evasion at $700 billion a year. See also the LA Times, April 13, 2021 article by Laura Davison which states that IRS Commissioner Chuck Retting puts tax evasion at $1 trillion a year in the United States.