The Audit Trap

By: Mark Webb

For many, 2016 seems a long time ago. In legislative time it is. But some of us remember the profound disruption caused by Assembly Bill 2883 (Insurance Committee), which changed the process whereby corporate officers could exclude themselves from workers’ compensation coverage. The bill and its clean-up measure the following year, Senate Bill 189 (Bradford), was more complicated than that. But while underwriters and brokers struggled to implement the new law, one consistent theme emerged – “Well, we’ll catch it at audit.”


If we move forward a few years, we have Assembly Bill 5 (Gonzalez), the so-called codification of the holding in Dynamex Operations West, Inc. v. Superior Court of Los Angeles (2018) 4 Cal.5th 903.


Dynamex adopted the “ABC Test” for purposes of specific employment laws to provide a clearer definition of independent contractor. The case did not apply to workers’ compensation, nor did AB 5. But, it would later when, after a series of laws excepting and clarifying, Assembly Bill 2257 (Gonzalez) chaptered in 2020. It is an understatement to say the adoption of AB 5 has and will continue to have, a highly disruptive effect on underwriting, claims, and placement of insurance for employers.


But, as some have noted – “Well, you can catch that at audit.”


The premium audit function is vital for the financial integrity of the workers’ compensation insurance system. I know this is hard to believe, but some employers will go to great lengths to shield their actual exposure while trying to maintain valid insurance coverage, and those lengths sometimes include premium fraud.


When the Legislature makes complex laws governing who is an employee – a core issue in workers’ compensation – they also create new opportunities for conflict and illegalities. If you question that premise, take a peek at the other side of the ledger and look at the Division of Labor Standards Enforcement (DLSE) enforcement actions on classification issues and unpaid wages.


The question of unscrupulous activities of largely unregulated PEOs and staffing companies adds to this environment. That is not an indictment of that entire industry, but it is axiomatic that these companies cannot exist unless there are employers who are willing and incentivized to game the system and hope they do not get caught.


Premium auditors certainly have a role to play in detecting and deterring fraud. But they should not be considered the first line of defense when it comes to payroll manipulation. They are the first line in confirming a policyholder has paid premium commensurate to their exposure. Giving these people better tools to perform the latter will help them assist in the former. At some point, this should be a topic of discussion in Sacramento.


Note: The opinions expressed herein may or may not be those of Workers’ Comp Executive. Mark Webb is a former Arizona insurance regulator, insurance company chief compliance officer, and is an expert in corporate governance, risk and compliance. He is the owner of Prop 23 Advisors.