Misclassification mistakes — two words that sound almost innocuous, but which could result in substantial fines and legal headaches for a company if they get things wrong.
Put simply, misclassification mistakes arise most often when a company misclassifies an employee as an independent contractor.
Such a misclassification can have a serious impact if that person is, for example, supposed to be covered by insurance. Moreover, it happens more often than many people think.
“Misclassification of employees as independent contractors continues to be rampant, especially in traditionally low-wage industries such as home health care and janitorial services, but also remains prevalent in higher-paying industries such as construction and trucking,” Debra Friedman, a member of the labor and employment practice Group at law firm Cozen O’Connor, told Risk & Insurance®.
A 2000 study by the U.S. Department of Labor (DOL) found that approximately 30 percent of companies misclassify workers. Some of them may simply be ignorant of the law (although ignorance offers no legal defense).
More often, though, companies deliberately misclassify workers to save money. This is because companies do not pay Social Security and Medicare taxes, unemployment insurance tax, or workers’ compensation insurance for independent contractors, nor do they provide independent contractors with employee benefits such as health insurance, pensions or 401(k) matches, and paid time off.
Significantly, these costs can represent 20 percent to 40 percent of an employee’s total compensation.
Also, said Friedman, “independent contractors, unlike employees, are not protected under federal or state minimum wage or overtime laws or anti-discrimination statutes, and do not have the right to bargain collectively and join unions or obtain job-protected leave.”
Stakes Are High
Some recent cases have shown a wide variety of companies and plaintiffs.
In July of this year, FedEx Ground drivers won summary judgment in their misclassification lawsuit brought against FedEx under the Massachusetts Independent Contractor Act, with the judge ruling the workers were, in fact, employees.
And in October 2013, the Penthouse Executive Club in New York reached an $8 million settlement with a group of adult dancers who had complained that they had been misclassified as independent contractors and had not been properly compensated as a result.
“Historically, misclassification mistakes have been a very big issue in the trucking industry, or especially if you are dealing with contractors,” said Eric Silverstein, senior vice president and leader of Lockton’s risk management team.
“As a result, the trucking industry has put together the blueprint for how to deal with this. If you’re providing insurance for an owner/operator fleet, or you’re dealing especially with subcontractors, then there needs to be a clear contract and an arms-length agreement. From a risk management perspective this can be a lot of work — it must be very clear who’s working under contract.”
According to Friedman, misclassification of employees has serious implications for companies, as they are at risk for investigations and lawsuits from both federal and state governments, as well as private lawsuits from individuals or classes of individuals.
“Federal and state governments have been losing billions of dollars each year due to misclassifications and therefore have been putting more resources into identifying and prosecuting misclassifications.” — Debra Friedman, labor and employment practice group, Cozen O’Connor
In addition to taxes and benefits (including the value of lost benefits), a company may be liable for penalties (such as fines, liquidated damages and/or punitive damages), costs, interest, and attorneys’ fees, she said.
Companies also may be required to post notices about their wrongdoing in their workplaces, and, in California — even on their company websites.
“Importantly, federal and state governments have been losing billions of dollars each year due to misclassifications and therefore have been putting more resources into identifying and prosecuting misclassifications,” said Friedman.
“In 2011, the U.S. Department of Labor and the IRS entered in a Memorandum of Understanding [MOU] to share information for the purpose of identifying and reducing misclassifications of workers. Since that time, at least 14 states also have entered into MOUs with the U.S. Department of Labor to share information and reduce the incidence of worker misclassifications.”
The IRS also has an employment tax initiative in place to audit more than 6,000 employers, selected at random, with the objective of finding and correcting worker misclassifications.
Friedman pointed out that this increased government focus is resulting in millions of dollars in back wages and penalties.
In May 2013, for example, the DOL obtained a consent judgment against Bowlin Group LLC and Bowlin Services LLC, providers of infrastructure solutions, for more than $1 million in back wages and damages covering 196 employees.
Seventy-seven of the workers had been misclassified as independent contractors.
“On the state level, New York should serve as a cautionary tale,” Friedman added. “In 2013 alone, New York identified almost 24,000 instances of employee misclassification, uncovered more than $300 million in unreported wages and assessed nearly $12.2 million in unemployment insurance contributions.”
Other states also are getting increasingly tough on misclassification.
Massachusetts announced that in 2013, it collected more than $15 million in back taxes, unpaid wages, unemployment insurance contributions, fines and penalties related to employer fraud and misclassification. Earlier this year, a California state labor board ordered a logistics company to pay more than $2.2 million in back pay to seven drivers it misclassified as independent contractors.
With such high financial stakes it makes sense to avoid making these mistakes in the first place.
“Employers should keep in mind that whether an individual can work for their company as an independent contractor is not the employer’s decision,” said Sheryl Jaffee Halpern, labor and employment attorney at law firm Much Shelist. “It’s the government’s decision. The challenge is that the tests used by the IRS and the U.S. Department of Labor are not identical. And the agency responsible for administering unemployment benefits in the worker’s home state may apply yet a different test — which in many states is more stringent than the IRS’ and Department of Labor’s tests.”
Employers should become familiar with these tests, she said, and then use the relevant factors to assess on an individual basis whether a worker can properly be classified as an independent contractor.
That classification should come at the outset of the business relationship, Friedman said. Generally, she said, independent contractors have specialized skills that are not focused on the company’s core business functions. If in doubt, classify the worker as an employee or consider working through a workforce management or staffing company and have them make the classification determination.
“Employers should keep in mind that whether an individual can work for their company as an independent contractor is not the employer’s decision. It’s the government’s decision.” — Sheryl Jaffee Halpern, labor and employment attorney, Much Shelist
If such a mistake is made — and identified quickly — then what should a company do?
“Naturally, it’s best not to use the ostrich approach if a mistake has been made,” said Halpern. “That said, because reclassifying a worker can have unintended consequences, we recommend that an employer work with their legal counsel to devise the best strategy for correcting the mistake in a way that does not create additional exposure.”
Friedman said companies have various options for correcting misclassifications.
“If a company is acting on its own, a key consideration is whether to address the classification mistake retroactively by voluntarily paying back taxes or taking other remedial actions.
“Any decision on how to handle the mistake retroactively has risks of opening the door to employee claims and/or government investigations,” said Friedman.
If a company decides to voluntarily pay back taxes, it may want to consider working with the IRS, and possibly any applicable state governments.
Since 2011, the IRS has had a Voluntary Classification Settlement Program that is available to companies that voluntarily seek to reclassify independent contractors as employees and that are not under audit for misclassification by the DOL or a state agency, or under an employment audit by the IRS.
Under this program, companies have significantly reduced federal payroll tax liability, and no interest or penalties are assessed.
While this program clearly has some benefits for addressing misclassifications, Friedman said, companies may be exposed to lawsuits for unpaid wages (minimum wage and overtime) and benefits, as well as fines and penalties under other federal and/or state laws.
There may be companies that believe a misclassification mistake is not all that important.
But the growing number of firms that have been forced to pay substantial fines would loudly disagree.
In mid-August, Boart Longyear Co., a global mineral exploration company, removed nine employees from Liberia after the Ebola virus broke out in a nearby village.
“Our customer shut down operations, and we’re evacuating,” said Rob Osha, global director of risk management at the company in August.
“There’s a lot of talk about closing borders and not letting air travelers out, so we’re working right now to make sure our crews leave Liberia.”
Video: The Ebola crisis continues to worsen, with a “best case” estimate of 500,000 dead by end of January 2015.
It’s not just deadly diseases that worry risk managers.
“A few years ago,” said Jan Randolph, director of sovereign risk at IHS Country Risk, “I was stuck in Qatar, due to go to Bahrain to visit some banks. This is when Bahrain had quite a lot of demonstrations and rioting going on.
“We checked our website, and there was a UK travel government advisory that advised all UK nationals not to travel to Bahrain. That means if we went, our insurance cover was potentially not valid.
“In practice, it probably would have been okay, but that advisory made it a no go,” he said.
As economies become more interconnected, businesses expand globally and more employees are sent abroad, scenarios like Osha’s and Randolph’s may become the norm. Yet too many risk managers may be unaware of the risks involved with global travel or take the proper steps to ensure employees’ safety.
Growth of International Travel
According to the Global Business Travel Association, U.S. spending on international travel may jump as much as 6.6 percent, to $289.8 billion in 2014, while total person trip volume is expected to increase 1.7 percent, to 461 million trips for the year.
“In this world that is smaller and more mobile, emergency evacuations happen more often than they did 10 years ago,” said Charlie LeBlanc, vice president of security services at UnitedHealthcare International (formerly FrontierMEDEX).
“That also has a lot to do with the fact that the world, politically, is much more volatile than in the last 20 or 30 years. We have to be able to react quickly.”
Steve Kellner, global head of intelligence and risk assessment for Verizon International Security Group, said: “I saw a news article recently that said there are only 11 countries not at war. The same article also said roughly only 60 percent of companies monitor their employees’ travel. It’s a big world, and a lot to keep up with.”
Kellner’s team monitors 15,000 to 18,000 employee trips per year.
Many smaller businesses or nonprofit organizations don’t have the budget for a security department that can educate their travelers [about security risks], so they depend on others, Kellner said. Problems can easily arise with “the little things that you don’t plan on.”
“Mining and oil and gas people have this buttoned up pretty tight,” Osha said. “They work in some of the most remote, tricky areas of the world.
“But there are a lot of companies that send a lot of business travelers that don’t necessarily work in the field. Even if you’re just traveling for a business meeting, things can change on a dime,” he said.
Pre-Travel Risk Mitigation
Travel preparation should begin before a flight is even booked.
“For very high risk countries, it’s a no go unless you get approval from the executive committee,” Osha said.
“I would do research on the security environment where they’re going, what I think the relative risk is and what the mitigations might be. Is the trip business-critical? Do we need to put that person at risk? Are there other ways to mitigate or not?”
“The most important asset you can have is information intelligence,” Randolph said.
“You need to know if the risk level is green or yellow or red, or if a developing scenario could reach a flash point.”
Video: The families of expat employees may be more at risk than the employees themselves.
Bob Gill, vice president of global security for Quintiles, a consulting firm for the life sciences industry, said his team develops risk profiles for every country they visit or may visit in the future.
“We cover security and safety, health and medical situations, medical infrastructure, regulatory issues, human rights issues, economic sanctions, bribery and corruption. Those are the key areas,” he said.
Even when companies give the green light, travelers should receive safety and awareness training tailored to the area they’re visiting.
“We have to look at risk from a variety of angles,” LeBlanc said.
“We look from the perspective of, when do our travelers start to feel uncomfortable? What are their risk tolerances?”
Political stability, crime, and cultural differences should all factor into a risk assessment, he said.
“As companies and economies are growing, their workforces are going to countries they didn’t go to five years ago,” LeBlanc said.
“That means a lot of novice travelers. For some, it may be their first international trip. And it’s not to London; it’s to Bangkok.”
Pre-travel training should cover basic “Safety 101” principles — like moving in groups and not opening the hotel door if no visitors are expected — but it should also include general background information on the destination country.
Travelers should know everything from what weather to expect, to what behaviors are acceptable in different cultures, to what inoculations they may need. Gender-specific training may also be necessary; women face greater risk in certain places, LeBlanc said.
“We have a traveler tracking system that is tied into our corporate reservation system,” Kellner said.
“When employees book travel, my group is alerted two weeks to 30 days ahead of time. We meet with them, whether they’re a naïve traveler or a group that goes constantly.”
At Verizon International Security Group, the company organizes a “meet and greet” program through its local offices to pick up incoming travelers or arrange transportation for them. Boart Longyear coordinates with their customers to see if they can provide transportation.
Some risk management and security departments utilize traveler tracking software to centralize employees’ flight and hotel reservations, so they always know who is in what part of the world.
Being able to locate people anywhere in the world in real time allows risk managers to focus their attention and resources where they’re needed. Ensuring safe travel on the ground requires coordinated efforts and constant communication.
For example, if 18 out of 20 employees are accounted for in a region hit by an earthquake, more time and energy can be devoted to tracking down the last two, instead of everyone in the group. If no employees are in the area, then attention can be focused elsewhere, to the next evolving crisis.
Travel assistance companies like UnitedHealthcare International (UHI), iJET and Europ Assistance offer software programs that not only track where employees are, but can push out automatic communications notifying them of potential threats in the area — like earthquake or tsunami warnings — or reminding them to check in.
Typically updated at least once per hour, the systems provide real-time data that is so crucial to crisis response.
“In the really risky countries, we establish check calls,” Osha said, “where an employee checks in every few hours to our outsourced security company’s operations team.
“In some places in Africa, they actually hire military to follow their company convoy,” he said, “or we see if they can fly point-to-point to cut out some of the risk of traveling on the ground.”
The advent of advanced cell phone technology has made the job of employee monitoring and communication much easier.
“As little as 10 years ago,” LeBlanc said, “I’d be carrying four or five different cell phones depending on what country I was going to. Now I just need one. That kind of power is extremely beneficial; risk managers need to be able to account for their people in a very short period of time.”
Call centers that operate 24 hours a day — also manned by third party travel assistance providers — help ensure that employees can always reach someone if they run into trouble.
“Communication is your lifeline in many cases,” Randolph said. “You have to think, as an employee, what would you expect from your company? Who would you want to contact in an emergency?”
Boart Longyear’s crisis hotline, provided by iJET, routes employees’ calls to the appropriate department, whether it’s a medical emergency, security issue or internal problem. More often than not, though, simple text messages or emails suffice to keep everyone connected.
“The best part of working for a telecommunications company,” Kellner of Verizon said, “is that most of our travelers go with a global phone. We can always text or call them to check on them and make sure they’re safe.”
Sometimes, no amount of intelligence can prevent simmering tensions from bubbling over, and no amount of monitoring can keep employees away from a natural disaster. Travel risk management should include policies and plans for when companies need to pull their people out of harm’s way quickly.
The most common reason for evacuations is a medical issue, rather than violence or political unrest. Travelers, rather than their employers, usually make the call as to whether they will abandon their travel due to a health issue.
“In medical situations, there tends to be a wider circle of hesitance to go,” LeBlanc said. Potential for violence doesn’t seem to stop travel as surely.
The Ebola outbreak in West Africa, for example, posed a relatively small risk to Western travelers but still sparked a worldwide scare. Flying out of the affected countries of Liberia, Nigeria, Ghana and Sierra Leone became more challenging as other countries were unwilling to take on the risk of accepting any visitors from those areas.
Luckily, governments rarely set strict travel restrictions in such situations, so while evacuations can get tricky when a pandemic hits, it is still possible to leave the country.
“In today’s world, economies are so interconnected that complete isolation isn’t feasible,” said Nita Madhav, analyst and researcher at catastrophe modeling firm AIR Worldwide.
“The best way for companies to mitigate is to stay aware of the global situation and which countries may be at risk for circulating diseases, and make sure that employees are up to date on vaccines,” she said.
Madhav identified the Middle East and Brazil as up-and-coming markets for air travel, which could make them riskier from a health perspective as business travel picks up.
Political and social tensions also pose an evacuation threat, though those risks are more rare than a medical threat.
Maintaining intelligence and proactively removing employees from potentially dangerous areas allows employers to avoid last-ditch evacuations. Government advisories, data from third party security firms, input from local employees and even social media trends help to paint a picture of emerging threats and areas to watch.
Still, things can change in an instant.
“We had to evacuate our expatriate staff out of Mali when they had a coup,” Osha said. “You do have to watch country elections, because violence and protests could follow.”
“In Libya,” Randolph of IHS Country Risk said, “they’re having a drawn-out civil war, and oil and gas companies have been involved in drawing out their staff, leaving behind only key personnel.
“You have to maintain your asset and your security as well as you can, but otherwise de-operationalize. You have a duty of care,” he said.
The Trickiest Risk
Natural disasters pose the trickiest travel risks to mitigate and often require the immediate, emergency response that risk managers try to avoid. Once tracking systems identify who’s in danger, it’s up to crisis management teams to get them to safety.
“You really need the right people in the room that are experienced with the global operations of their company,” said LeBlanc of UHI.
“They need the authority to make decisions quickly, whether they’re legal, financial, or human resource related. And they have to work well as a team.”
When UHI trains its clients on crisis management, it typically spends half a day on team-building alone, and keeps the core team limited to about 10 people.
Rapidly growing companies will face challenges learning how to manage increased travel to all parts of the world, but the realities of travel risk cannot be ignored. The consequences of shrugging off safe travel preparations are too great.
“Colleagues I work with have a keen sense of how travel has changed since 9/11,” Gill of Quintiles said.
“That was the issue that brought travel security and safety to the forefront.”
But others say more progress is needed.
“I’ve given travel risk presentations at RIMS for a few years now,” Osha said, “and I’m shocked by the people who approach me after the sessions — large, brand name companies — saying their programs aren’t robust enough.
“It makes me think that there are a lot more companies out there that need to start working on this than you may expect.”
A Renaissance In U.S. Energy
America’s energy resurgence is one of the biggest economic game-changers in modern global history. Current technologies are extracting more oil and gas from shale, oil sands and beneath the ocean floor.
Domestic manufacturers once clamoring for more affordable fuels now have them. Breaking from its past role as a hungry energy importer, the U.S. is moving toward potentially becoming a major energy exporter.
“As the surge in domestic energy production becomes a game-changer, it’s time to change the game when it comes to both midstream and downstream energy risk management and risk transfer,” said Rob Rokicki, a New York-based senior vice president with Liberty International Underwriters (LIU) with 25 years of experience underwriting energy property risks around the globe.
Given the domino effect, whereby critical issues impact each other, today’s businesses and insurers can no longer look at challenges in isolation one issue at a time. A holistic, collaborative and integrated approach to minimizing risk and improving outcomes is called for instead.
Aging Infrastructure, Aging Personnel
The irony of the domestic energy surge is that just as the industry is poised to capitalize on the bonanza, its infrastructure is in serious need of improvement. Ten years ago, the domestic refining industry was declining, with much of the industry moving overseas. That decline was exacerbated by the Great Recession, meaning even less investment went into the domestic energy infrastructure, which is now facing a sudden upsurge in the volume of gas and oil it’s being called on to handle and process.
“We are in a renaissance for energy’s midstream and downstream business leading us to a critical point that no one predicted,” Rokicki said. “Plants that were once stranded assets have become diamonds based on their location. Plus, there was not a lot of new talent coming into the industry during that fallow period.”
In fact, according to a 2014 Manpower Inc. study, an aging workforce along with a lack of new talent and skills coming in is one of the largest threats facing the energy sector today. Other estimates show that during the next decade, approximately 50 percent of those working in the energy industry will be retiring. “So risk managers can now add concerns about an aging workforce to concerns about the aging infrastructure,” he said.
Increasing Frequency of Severity
Current financial factors have also contributed to a marked increase in frequency of severity losses in both the midstream and downstream energy sector. The costs associated with upgrades, debottlenecking and replacement of equipment, have increased significantly,” Rokicki said. For example, a small loss 10 years ago in the $1 million to $5 million ranges, is now increasing rapidly and could readily develop into a $20 million to $30 million loss.
Man-made disasters, such as fires and explosions that are linked to aging infrastructure and the decrease in experienced staff due to the aging workforce, play a big part. The location of energy midstream and downstream facilities has added to the underwriting risk.
“When you look at energy plants, they tend to be located around rivers, near ports, or near a harbor. These assets are susceptible to flood and storm surge exposure from a natural catastrophe standpoint. We are seeing greater concentrations of assets located in areas that are highly exposed to natural catastrophe perils,” Rokicki explained.
“A hurricane thirty years ago would affect fewer installations then a storm does today. This increases aggregation and the magnitude for potential loss.”
On its own, the domestic energy bonanza presents complex risk management challenges.
However, gradual changes to insurance coverage for both midstream and downstream energy have complicated the situation further. Broadening coverage over the decades by downstream energy carriers has led to greater uncertainty in adjusting claims.
A combination of the downturn in domestic energy production, the recession and soft insurance market cycles meant greatly increased competition from carriers and resulted in the writing of untested policy language.
In effect, the industry went from an environment of tested policy language and structure to vague and ambiguous policy language.
Keep in mind that no one carrier has the capacity to underwrite a $3 billion oil refinery. Each insurance program has many carriers that subscribe and share the risk, with each carrier potentially participating on differential terms.
“Achieving clarity in the policy language is getting very complicated and potentially detrimental,” Rokicki said.
Back to Basics
Has the time come for a reset?
Rokicki proposes getting back to basics with both midstream and downstream energy risk management and risk transfer.
He recommends that the insured, the broker, and the carrier’s underwriter, engineer and claims executive sit down and make sure they are all on the same page about coverage terms and conditions.
It’s something the industry used to do and got away from, but needs to get back to.
“Having a claims person involved with policy wording before a loss is of the utmost importance,” Rokicki said, “because that claims executive can best explain to the insured what they can expect from policy coverage prior to any loss, eliminating the frustration of interpreting today’s policy wording.”
As well, having an engineer and underwriter working on the team with dual accountability and responsibility can be invaluable, often leading to innovative coverage solutions for clients as a result of close collaboration.
According to Rokicki, the best time to have this collaborative discussion is at the mid-point in a policy year. For a property policy that runs from July 1 through June 30, for example, the meeting should happen in December or January. If underwriters try to discuss policy-wording concerns during the renewal period on their own, the process tends to get overshadowed by the negotiations centered around premiums.
After a loss occurs is not the best time to find out everyone was thinking differently about the coverage,” he said.
Changes in both the energy and insurance markets require a new approach to minimizing risk. A more holistic, less siloed approach is called for in today’s climate. Carriers need to conduct more complex analysis across multiple measures and have in-depth conversations with brokers and insureds to create a better understanding and collectively develop the best solutions. LIU’s integrated business approach utilizing underwriters, engineers and claims executives provides a solid platform for realizing success in this new and ever-changing energy environment.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Liberty International Underwriters. The editorial staff of Risk & Insurance had no role in its preparation.