Author: J. Alan Johnson, CPCU, ARM-P, AIS, AINS
Editor’s Note:
The following is an article written by Tennessee Big “I” member (and the very first VU newsletter subscriber) Alan Johnson, CPCU, ARM-P, AIS, AINS about a recent Tennessee Court of Appeals case that ruled that, even if all parties agree that someone is an independent contractor, the GC’s workers compensation insurer can still charge premium for them on the premise that the NCCI policy provides a defense if the independent contractor later sues for employee status. The court ruled that the insurer is entitled to premium for this exposure even though all parties agree that the contractor was not an employee. The court does not address the issue of whether the insurer should be able to charge FULL premium given that the coverage is only for defense and not for statutory benefits.
At the end of Alan’s article, we provide more information from our Iowa association related to this issue and how this is more than an isolated problem.
I OWE HOW MUCH??
Tennessee Legal Decision on WC Blurs the Definition of “Includable Remuneration”
By: J. Alan Johnson, CPCU, ARM-P, AIS, AINS
Workable solutions to perceived problems are generally the result of compromise. This was true in the early years of the 20th Century when business owners and organized labor sat down with government leaders and negotiated the U.S. version of our Workers Compensation system. Payment for workplace injury was guaranteed by business in return for employees giving up the right to sue their employer. And employers traded the uncertainty of medical and legal costs resulting from an employee’s injury for the certain payment of a premium for insurance that would cover those costs.
However, in the past few years, actions taken by insurers to take advantage of what appears to be a ‘loophole’ in the standard workers compensation contract, threaten to unravel this compromise and throw the stability of the current system into chaos.
Based on the insurance company’s assertion that they could sustain some degree of loss by defending the position that an uninsured subcontractor or independent contractor is not covered for workers compensation benefits, several companies are attempting to include at audit, the payments made by a general contractor to subcontractor/independent contractors. Since all state workers compensation laws are in general agreement that WC benefits are payable only to employees, and most all states specify the difference in employment status and subcontract status, there has been general agreement in cases thus far made, that no coverage is afforded under the WC policy for subcontractor/independent contractors.
However the courts are being asked to allow the inclusion of “payroll and other remuneration” made to uninsured subcontractor/independent contractors because payment to these parties could, “make us liable under Part One (Workers Compensation) of this policy.” [wording found in: Part Five-Premium, C. Remuneration, 1. / NCCI Workers Compensation and Employers Liability Insurance Policy, Ed. 7-11.] And a recent decision from the Tennessee Court of Appeals in Continental Casualty Company, et al. v. Theraco has affirmed the company’s assertion.
The facts heard in a recent Tennessee case are illustrative.
Theraco, Inc. contracted with home health agencies to provide physical therapy (PT) to home bound patients. Theraco carried WC coverage for their administrative employees and did not employ PTs, preferring to sub-contract that work. In an audit performed by CNA in the third year of coverage, the auditors included the amount paid to the sub-contracted PTs, and billed for a substantial additional premium. Theraco disputed the audit and CNA amended it to bill for only the current year, stating that they would include the sub-contract payroll in calculating future premium basis. Due to the dispute, Theraco cancelled their WC coverage with CNA and took out coverage with Travelers. CNA’s audit of their short term coverage prior to cancellation, which included payment made to PTs, resulted in an additional premium exceeding $44,000.
Travelers, in a mid-term audit, also included the amount paid to the sub-contract PTs, and billed for additional premium exceeding $130,000. Theraco again disputed the audit and terminated their policy with Travelers. Theraco filed an administrative appeal with the Tennessee Department of Commerce and Insurance (TN-DCI) for determination of the status of the contracted PTs as sub-contract/ independent contract workers and as defined under TN Statues, not covered by the WC contract. TN-DCI found in favor of Theraco, stating that the PTs were not employees and therefore any payment to them should not be included in premium determination.
CNA and Travelers filed a petition for review of the TN-DCI administrative decision in Chancery Court, and the trial court also found in favor of Theraco. The insurance companies appealed the trial court’s decision to the Tennessee Court of Appeals.
In January 2014, the Appeals Court decision affirmed the trial court’s finding that the PTs were not employees however, they reversed the finding that the amount paid to the sub-contract PTs could not be included in premium determination and entered judgment that Theraco was liable for a combined total of $141,611 to the insurance companies. The Appeals Court decision was based on their reading of the WC contract that the possibility exists of an uninsured sub-contractor making a claim for WC benefits and the legal costs to defend against such claim would constitute a “risk of loss” to the company. In the Court’s opinion, that “risk of loss” would trigger the provision in the WC contract defining “Remuneration,” thereby permitting the insurance companies to include payment made to the uninsured sub-contractor in their determination of premium.
The Tennessee Supreme Court declined to hear the Appeal.
This decision presents a conundrum since Tennessee WC Statutes allow some specific exemptions from mandatory WC coverage, while the Theraco decision appears to require coverage for everyone. Further, the decision allows insurance companies to charge the full rate when including payments made to uninsured subcontractors/independent contractors, even though that rate is promulgated based in large part on payment of WC statutory benefits and there is general agreement that subcontractors/ independent contractors are not eligible to receive those benefits (creating an unfair rate discrimination situation).
Though this question has come before the Courts in several states (Iowa and Connecticut have heard similar cases thus far), it appears that the Tennessee Court of Appeals is the first to hold in favor of allowing inclusion of payments to uninsured subcontractors/independent contractors in determination of premium. And based on this decision, it is probable that other insurance companies will begin to include these payments in audit calculations, resulting in substantial additional WC premium increases and an increasing number of very upset employers.
Given the current standing, employers are now faced with the loss of a (more or less) “certain” premium in return for payment of benefits—which all have thus far agreed, are not payable. A major component of the original compromise has been broken.
Discussions with NCCI for some type of contractual “fix” have not been fruitful, as it is felt that any change in the current WC policy would create more problems than it would fix. Therefore it now appears that clarification of this matter—if any clarification is forthcoming—will have to come from the legislatures of the various states.
But until clarification is enacted—from whatever authority it comes—we as independent agents and brokers, in our work to represent and advise our clients, must be proactive and sound the alarm. The prudent course at this juncture is to advise our WC clients who use sub-contract/independent contract labor, to contract ONLY with entities or individuals who have valid, in-force WC policies that cover all employees, owners, partners and officers—whether they are legally exempt or not (as some are under TN Statute). In the best interests of our clients, we must saddle up and become Paul Revere, sounding the alarm.
Copyright 2014 by J. Alan Johnson. All rights reserved. Reprinted with permission.
About the time that Alan brought this issue to our attention, we received the following “Ask an Expert” question from an Iowa member agency:
“I have an insured in the WC pool. The insured has several painting, plumbing, etc. subcontractors that he uses, many of them being self-employed subcontractors with no employees. As a result of a recent audit, the pool insurer is including the subcontractors’ own payroll in the insured’s WC payroll. This has created an additional $5,844.57 in premium. Last year the insurer’s auditor did not include the payroll of these independent contractors. This year was a paper audit and, with the 1099 information, the payroll was picked up and charged. Is there anything we can do to get around this? Under the WC/Iowa rules, the subcontractor are not require to carry WC as they have no employees.
We ran this question by our Iowa state association and state exec, Bob Skow, CPCU, CAE, provided the following article from the association’s May 15, 2014 newsletter:
Question - I have been searching through the Workers' Compensation basic rules manual, State of Iowa Code, and everywhere else that I can think of looking for the answer to an audit question.
We have an insured who has employees covered by a work comp policy. In the past year, he has hired a couple of subcontractors. These subs carry their own liability, hold themselves out as contractors for this work, use their own tools, etc. One does carry work comp; one indicates on his liability certificate that he has elected to decline carrying work comp as he has no employees and he is not required to carry workers' compensation as a sole proprietor (85.1A of the Iowa Code); and the other just has a standard liability certificate, but has no employees. These are all independent contractors. I have an auditor who is saying that they are going to charge for the 2 without work comp coverage, which carries a substantial additional premium on the audit. Where can I go to get information to dispute this audit? We have submitted the certificates, and all other information. However, they are insisting that they have to charge this as payroll on the work comp policy, even though there are no employees, and the owners have not elected to cover themselves on a work comp policy.
IIAI Answer - A number of insurance carriers are now charging a premium to the general contractor on audits for any subcontractor who is hired and does not have Workers' Compensation coverage in place during the audited policy term. Historically, they did not charge for the Workers' Compensation exposure if the subcontractor indicated that it did not have employees and they produced a certificate of insurance verifying that General Liability coverage was in place during the audit period. Over the last several years, the courts have increasingly ruled that coverage would be afforded from the general contractor if a subcontractor or their employees were injured while working for the general contractor.
Because of decisions like this, many insurance companies are now charging a premium for the exposures to all uninsured subcontractors. We strongly suggest that you encourage clients who are general contractors that they need to be sure to collect Certificates of Insurance for General Liability and Workers' Compensation coverage for any subcontractor they hire or bring on the jobsite. Subcontractors need to remember that they also become a general contractor as soon as they hire anyone to the jobsite. A good rule of thumb is to hire only insured subs (subs with workers' comp), a good argument can be made to require everyone on the work site be covered by workers' compensation (while it may be true PROPRIETORS, LIMITED LIABILITY COMPANY MEMBERS, LIMITED LIABILITY PARTNERS, AND PARTNERS may not be required to buy coverage, they can, in fact, buy the coverage somewhere in the marketplace - might be assigned risk). The other option is to suggest to your client they have an attorney write a contract for subs that indicates the general will withhold the Workers' Compensation rate times $100 of receipts when no proof of Workers' Compensation coverage is provided.
The NCCI Workers' Compensation policy gives them the rights to charge (page 5 C.2) which states the carry may include remuneration paid or payable for services for "all other persons engaged in work that could make us liable..." When insuring clients who use subs, we encourage you to communicate with the carrier as to what their audit guidelines are involving these kinds of risks and get the response in writing.
The Iowa association also addressed this issue during their summer “town hall” meetings, along with the reference court case linked above. There is also a video on this on the Iowa state association web site.
So what does all of this mean? Apparently where this type of charge is permitted by law, insureds should be advised to make sure that ALL contractors they use carry workers compensation insurance on their employees AND themselves and insist on proof of such coverage.
An addendum from your Virtual University staff below.
Additionally, your insureds should understand the importance of not simply relying on a certificate of coverage they receive from any independent contractors. They should request and review the entire policy, as well as the exclusons, to determine if there are restrictions on types of work performed or other coverage limitations. For example, carriers may exclude "hot work" for roofers, or working on roofs over a certain number of stories. A certificate of insurance is meaningless unless the underlying policy provides the coverage needed at the time of loss.
Updated: December 4, 2014
Updated: December 16, 2024
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