The Under-Appreciated World Of Premium Audits

Most of us give no thought to workers’ compensation premium audits. Who would have thought they are so important and the hand maiden of controversy?

Premium audits check the insured company’s records to confirm the payroll that the insurance policy covers. One step is to make sure that workers are properly recorded as employees rather than independent contractors. 

That process may be from routine to contentious, since the auditor’s finding can result in a demand for more premium. Step back and look at the collective impact of all audits. When we do that, we see how audits figure into a much larger canvas. They serve, in effect, to enforce a web of employee protections, one of which is access to workers’ comp coverage.

This broader purpose is easy to miss.  And as we look more carefully, the independent contractor standards under workers’ comp begin to appear like crooked timber.

States and federal agencies apply a welter of disconnected employee tests without anyone one trying to make coherent sense of them as a whole.

States are responsible for designing their own test for workers’ comp coverage. The NCCI and other private actors have no legal standing to do so. States also mandate a separate test for unemployment compensation coverage. The IRS applies its own test. The U.S. Department of Labor, which enforces wage and hour protections, uses its own “economic realities” test.

Further adding to the confusion is the state political climate. Special interests can capture and divert state law and regulation to meet their parochial ends.

Illinois provides an example. Trucking companies and unions had a running battle over which drivers were to be deemed employees. Eventually they got together, drafted, and had the legislature enact a 3,000 word law which in excruciating detail defines 12 factors to take into account, complete with examples. However, for all other workforces, the legislature has never enacted a test for workers’ comp, leaving it to the courts to compile a trail of court decisions.

To grasp how alternative tests can be in conflict, let's look at what may be the “loosest” and the “tightest” tests in play today.

An example of a “loose” test, which would permit many more independent contractors, is that proposed by Handy. The company describes itself as the “leading platform for connecting individuals looking for household services with top-quality, pre-screened independent service professionals.” In contrast with Uber, Handy wrote for its own purpose a specific test which it has tried to induce a number of states to pass.

Handy has proposed a gig economy system. The worker is an independent contractor if they and the “platform” (i.e. Handy) agree, the platform does not prescribe specific hours, does not do on-site supervision, does not provide supplies or equipment, and does not bar the worker from other business. Imagine not just Handy, but any drywall company, law firm, or trucking firm deciding to configure itself as a platform company rather than a normal employer. It would attempt to do this without losing any effective control over its workers. 

At the opposite end of the spectrum from the Handy test is the Department of Labor’s “economic realities” test. The Obama administration issued in 2015 an “administrator’s interpretation” of this test, which the Trump administration has withdrawn. The Obama document showed its very “tight” view in saying that “each factor [in the analysis] should be considered in light of the ultimate determination of whether the worker is really in business for him or herself (and thus is an independent contractor) or is economically dependent on the employer (and thus is its employee). 

This language would effectively bar independent contractor status for low wage workers who are dependent on one major source of their income – such as Handy – regardless of formal contracts and work rules.

In sum, states don’t strive hard to have a coherent vision of what makes a worker an employee. That means that any particular test, such as for workers’ comp, escapes the limelight. This helps to explain how peculiar these audits can be.

Many states have adopted for workers’ comp the so-called ABC test. A worker is deemed an employee if any of the three criteria apply:

(A)The worker is free from the control and direction of the hirer in relation to the performance of the work, both under the contract and in fact.

(B) The worker performs work that is outside the usual course of the hirer’s business.

(C) The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hirer.

Instead of this test, some states have their own complicated, home-grown versions. And some states pretty much allow any worker to declare themselves independent contractor through a simple process of personal attestation, a method which is vulnerable to employer influence.

States could be a more constructive in their oversight. The legislature in my state of Vermont has reviewed violations of independent contractor standards (it uses the ABC test) without even being aware that insurers routinely perform audits.

Auditors can rely on oral tradition about how to interpret a state’s statute. I talked with an independent auditor with years of experience, who told me that he relies on a NCCI guide to premium auditing despite NCCI telling me that it has never issued a guide on independent contractor determination. A consultant to employers complained to me that auditors have begun to apply a test that a recent California court decision endorsed, despite the fact that the decision had nothing to do with workers’ comp and was, of course, limited to California.

Premium audits are important. But we are complacent about them. They form part of an employee classification system which is vulnerable to special interests, hearsay and inertia.  

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