Saturday, November 14, 2020

Staffing Companies and Workers Comp Classifications and Premiums

 Recently, I was approached by a staffing company looking for assistance in figuring out correct Workers Compensation classification codes for the workers they were placing at a variety of client companies all across the U.S. I can certainly understand why this staffing company is seeking such assistance, as figuring out correct Workers Compensation classifications can be vital for a staffing company's financial well being. Staffing companies have some unique exposures to serious problems with Workers Comp insurance costs, mainly due to issues involving determining correct Workers Comp insurance classifications.

The staffing industry in the U.S. is composed of two distinct kinds of labor placements and it is not uncommon for a single staffing company to blend and blur those two kinds of labor placements in a single business enterprise.

The first is the sort of temporary labor placement that has historically been common--supplying workers on a "temporary" basis to third party employers. Originally such labor placements were truly temporary, providing "temps" to replace workers on vacation or for similar short-term engagement. In more recent years such placements have commonly involved providing workers for longer periods of time, sometimes as a trial period before selecting workers to become permanent additions to an employer's workforce, but sometimes serving as a more long term source for outsourced labor, although the individual workers provided may typically change over time. One common example of this kind of labor placement is where a staffing company provides warehouse workers to a client company on an ongoing basis. The individuals making up that outsourced labor force may vary over time but the contractual relationship between the staffing company to the client company can be a long-standing one.

The second kind of labor placement in the staffing industry is what has come to be called a PEO arrangement--a Professional Employer Organization, in the parlance of the staffing industry. This is an arrangement where existing employees of a client company contractually become "co-employed", at least on paper, with an outside staffing company. This contractual arrangement provides a legal basis for the staffing company to be able to provide Workers Compensation insurance coverage to workers at a client company, as well as the basis for the staffing company to provide other services such as withholding and reporting taxes for those workers. But the provision of Workers Compensation insurance to client companies is often the most important service provided by a PEO type staffing company.

In a typical PEO arrangement, the PEO staffing company charges fees for their services that are based, in large part, on the cost of providing Workers Compensation insurance (along with costs of providing other services that may be part of the contract, and provisions for overhead and profit for the PEO.)

But this means the PEO staffing company must anticipate what their cost of Workers Compensation insurance actually is for workers at a client company. And since the fees charged to those client companies are a separate contractual arrangement from the insurance coverage purchased by the PEO, a potential exists for a dangerous mismatch to occur (dangerous from the point of the view of the PEO and also from the point of view of the insurance company.)

This same kind of dangerous mismatch can apply to the more traditional "temp' type of staffing company as well, because the fees charged to clients typically also include a significant component for the cost of Workers Compensation insurance.

If the staffing company operates on the assumption that workers being provided are doing clerical work, and thus should be classified in the inexpensive clerical class for Workers Compensation insurance, but the insurance company later concludes that those workers actually belong in a more expensive classification, the staffing company can be left in a position where it cannot retroactively adjust the fees it has charged the client, but the insurance company can (and often does) retroactively adjust the premium charged for those workers.

I remember a case where the staffing company classified workers as clerical, because they were doing things like collating printed documents together and stapling those pages together. But at the end of the year, when the insurance company did the premium audit for the Workers Compensation insurance policy purchased by the staffing company, the insurer's auditor learned that those workers were doing that collating work not in an office environment but in a warehouse area at the client company. The insurance company decided this meant those workers properly did not qualify for the inexpensive clerical class but instead in a significantly more expensive class for warehouse workers.

This left the staffing company in a difficult position. Since insurance companies often only really determine classifications after the insurance policy has ended, when an audit is done, the staffing company had priced their fees to this client based on using the clerical rate for Workers Comp insurance. By the time the insurance company performed the premium audit, a year had passed with the staffing company charging fees that turned to be inadequate to cover the cost of Workers Comp insurance. Overnight, this turned a profitable account into a very unprofitable account.

A staffing company can often have hundreds of different client companies, each one carrying the potential for such a classification error.  Under the rules that govern Workers Compensation insurance, workers provided by a staffing company are supposed to be classified based upon treating those workers as if they were direct employees of the client company. So a staffing company needs to try and determine the correct classification for all those client companies. And often those client companies may be scattered across different states--and the classification definitions can sometimes vary significantly between states. What is a correct class in one state for a type of business might not be the correct class in another.

Complicating things even further, some staffing companies in recent years have engaged in a controversial practice of providing "staffing on staffing" coverage, where one staffing company enters into a PEO style contractual arrangement with another staffing company, and it is this second staffing company that actually places workers with client companies. This practice increases the chances of a classification mismatch occurring, as the staffing company obtaining the Workers Comp insurance does not have a direct relationship with the client company and thus can lack a proper understanding of the nature of the client's business operations.

Insurance companies, in my experience, do not wish to insure staffing companies engaging in this kind of "staffing on staffing" business but it can be difficult for the insurer to determine if this practice is happening, at least, not at the time the policy is being "underwritten" and produced. Such issues are typically only uncovered at the time an audit is conducted, after a policy has expired.

I put "underwriting" in quotes because I have learned that some insurance companies perform little or no actual underwriting for staffing companies (and even other kinds of companies, particularly in the assigned risk plans) in the sense of expending any effort whatsoever to determine correct classifications at the time the policy is issued. 

Another complicating factor is that many staffing companies find that "voluntary market" Workers Comp insurance is only available through a Large Deductible policy. That introduces additional levels of complexity to determining the ultimate cost of Workers Comp insurance, with complicated side agreements and the significant potential for unexpected additional costs based on the ultimate cost of claims under the policy. Under such policies, getting classification correct is still important, but it is coupled with the very significant possibility of very large additional premium charges becoming due years after a policy has ended. Many staffing companies, in my experience, purchase such policies without fully understanding the potential for significant additional premium charges down the road, simply because they are the only alternative available to Assigned Risk policies (which can have their own drawbacks for a staffing company.)

Such Large Deductible polices can appear to be attractive at the outset, only to later generate very significant additional premium charges years after the policy has ended, additional premiums that have been calculated according to arcane and complicated formulas that were poorly understood at the time the insurance was calculated. Often, those additional premium charges are based, at least in part, on changes in classifications done at the time of the audit.

In short, determining correct Workers Comp insurance classifications at the outset is vital for staffing companies, but it is also challenging to do because of the complexity of the rules that govern Workers Comp insurance.

Monday, November 2, 2020

A Triple-Whammy Shock Audit For California Contractor

 So I just finished looking over a Workers Comp Shock Audit for a small California contractor. For those who came in late, a Shock Audit is where the audited premium for a Workers Comp insurance policy is unexpectedly much higher than the original policy premium.

Turns out, it looks like this is one of those frustrating times when it doesn't look likely I can help reduce this Shock Audit. But it is nonetheless an illustrative case study of how employers, particularly small employers, can get clobbered by one of these Shock Audits.

In fact, this case illustrates three different ways in which employers, particularly California contractors, can get blindsided about the cost of Workers Compensation insurance. 

A triple-whammy of premium traps, you might say.

First off, this employer was puzzled because the policy had been one of those "pay as you go" setups, where premium gets calculated monthly based on actual payrolls. These programs are often touted as providing a solution for the problem of unexpectedly high audit bills--you know, Shock Audits--so this employer was puzzled as to how he could be getting a Shock Audit. So that's the first element of our triple whammy case study--the "pay as you go" fallacy that it solves the problem of Shock Audits.

The second part of the triple whammy comes in because this Shock Audit is an 'estimated audit". I know, I know, a classic oxymoron like jumbo shrimp, but the COVID-19 pandemic has made these "estimated audits" more common, as field auditors were unable to get out into the field to conduct real audits. So forms were sent out to employers, many of which were themselves shut down or disrupted by the pandemic, and many smaller employers were unsure of how to complete the forms, or were just too disrupted by the pandemic and the associated business crisis to respond.

An estimated audit isn't really an audit at all--it's the insurance company's educated guess (and often a bit of a worst-case-scenario guess as well) about what the final premium should be. But rest assured, if an estimated audit isn't paid on a timely basis, an insurer will send it out for collection efforts, just like was the case with this small contractor.

But the final blow of our triple-whammy came thanks to a unique California trap for contractors: Dual Wage Classifications.

California has a unique bunch of Workers Compensation insurance classification codes that apply for construction work in that state. These classifications are bound pairs, so, for example, this client had two carpentry classes shown on the policy, a cheaper class with rates just over $8.00 (for workers paid $32 per hour or more) and a much more expensive class, with rates over $22 per hour, for workers paid less than $32 per hour.

Both classes were on the original policy, this "pay as you go" policy, but all the policy's estimated payroll was the cheaper class, with the more expensive class shown with "If Any" for the remuneration.

So month by month, under the pay as you go system, this employer reported actual payrolls and they got applied under the cheaper class.

The audit, however, put all of the "estimated audit" payroll into the much more expensive class and rate. Hence, a Shock Audit. It wasn't that payroll was different from what had been reported month by month, it was that all that payroll got switched, on the estimated audit, to a vastly more expensive class.

This happens because the rules for these Dual Wage Classifications are detailed and a bit onerous and often not well explained when the policy begins. But auditors are trained and motivated to enforce these rules on the audit;

I've written in more detail about the problems with the Dual Wage Classifications before. It can be a nasty problem because many small contractors don't learn about the rule requirements until it's too late to do anything about it.

I've explained the situation to this particular small contractor, and if he can produce the required time records then I can definitely help reduce this Shock Audit. But if he didn't keep sufficiently detailed time records, as I fear he may not have, there may be no recourse here.

This one is a very frustrating example of a Shock Audit that exemplified multiple problems with Workers Compensation insurance. Fingers crossed, perhaps I will be able to help these folks, if they kept detailed time records.