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Mention workers' compensation fraud and images of videographers lurking in the bushes to catch some schemer in the act of peeling off his neck brace for a game of tennis might spring to mind. That scenario outlines what is commonly known as claimant fraud.

But there remains another and some say much more costly form of workers' comp fraud that involves plenty of lies but not all that much videotape.

The practice, for example, involves falsifying employment records to show that the company employs 100 file clerks instead of, say, roofers or perhaps labeling employees as independent contractors when they are anything but. And while technically not engaging in premium fraud, there remain those businesses who simply forego purchasing comp coverage altogether.

While the schemes may vary, the goal remains the same: either drastically reducing or totally eviscerating the premiums insureds pay to their workers' compensation carrier in order to obtain that critical certification necessary to do business.

Putting a dollar figure on the amount honest policyholders and taxpayers pay to subsidize the fraud purveyors remains as much an art as a science for all lines of insurance. In the case of premium fraud it remains an even tougher thing to do for any number of reasons.

THE TIP OF THE ICEBERG?

Neil Johnson, who for the past 13 years has headed the premium fraud special investigations unit for Boston-based Liberty Mutual Group, likens the situation to trying to figure out how many drunken drivers are out there on the road at any given time.

"We really have no idea," he says. "The only way you know they are drunk is when you pull them over and give them a Breathalyzer test."

James Quiggle, director of communications for the Washington, D.C.-based Coalition Against Insurance Fraud, says experts estimate that workers' compensation fraud costs consumers about $6 billion a year.

"And premium fraud schemes are likely to cost about half of that," he says.

Johnson says that while certain agencies act as a clearinghouse for claimant fraud activity, the same cannot be says for premium fraud because of anti-trust issues.

"You just can't share information related to premium fraud with other carriers," he says.

But he did assert that while any one claimant fraud case could cost in the tens of thousands of dollars, a premium fraud case toll could run in the millions. But some dollar figures are starting to emerge and they point to a situation far more costly than previously believed.

CALIFORNIA SCHEMIN'

Dominic Dugo, head of fraud grants for the San Diego County District Attorney's office and one of the nation's experts on premium fraud, says that a recent study by researchers at the University of California at Berkeley found that employers in high-risk California industries may hide 75 percent of their payroll for certain dangerous jobs.

"This would cost insurers about $3.8 billion in premium," Dugo says.

At the same time, he noted that a comparable study in New York found that a similar percentage of about 20 percent of comp premium involved fraud. "As a prosecutor I found it significant that two different studies in different states found roughly the same percentage of fraud."

Rick Plein, the fraud bureau chief for California's state run workers' compensation insurer says he is currently overseeing 109 premium fraud investigations and prosecutions with more than $100 million in premium losses on the line.

Quiggle says that states used to ignore premium fraud "because the schemes were so large and complicated that it intimidated many of them."

"But as officials start to get their arms around how large the damages are they have become much more sophisticated and aggressive in rooting out premium scams," Quiggle says. "States are no longer sweeping this crime under the rug. They are exposing it to the harsh glare of public scrutiny because the losses are becoming so large and intolerable."

Quiggle says states such as California, Florida and New York are creating multiagency task forces "that are literally gang-tackling the problem."

High density, high growth states with booming construction industries are going after a problem in which not only the carriers but state and local tax collectors are also deprived of revenue.

Those officials want to maintain a competitive environment that can disappear if contractors or other businesses evade their fair share of premium taxes.

"When a crooked premium business evades millions of dollars in comp premium, that employer can use the savings to low-ball contracts in product and service pricing," Quiggle says.

DIRTY SECRETS AND LIES

Dan Shaw, president and chief executive officer of Associated Builders and Contractors Inc., a Coconut Creek, Fla.-based trade group representing contractors, subcontractors, material suppliers and related firms, says reforms passed earlier in the decade by state lawmakers cracking down on the labeling of certain workers as independent contractors has had an important impact in the competitive environment in the state.

"Workers' comp fraud by employers had been the construction industry's dirty little secret for too many years," Shaw says of employers labeling their workers as independent contractors. "This fraudulent act lines the pocket of construction employers but it comes at the expense of their ability to get care and compensation if injured."

Jon Coppelman, a principal in the workers' compensation consulting firm of Wellesley, Mass.-based Lynch Ryan Inc. says states such as Massachusetts have a renewed interest in fighting premium fraud in that uninsured workers on any job site who are injured receive treatment though the state's workers' compensation trust fund, a component of the state's Division of Industrial Accidents, which is underwritten by a surcharge on every comp policy written in the state.

"When these people get hurt, the costs of treatment are ultimately absorbed by legitimately insured businesses," he says.

So just how do carriers working side by side and sometimes in conjunction with state and local officials go about the business of catching premium fraudsters in the act? "You usually catch them because they do something stupid," says Liberty Mutual's Johnson.

Red flags could include a workers' comp claimant who does not appear on the company payroll or another claimant who falls from an elevation but is listed as working in an office.

Another red flag could be a company with only serious claims with permanent injuries. "You don't have the cut fingers and things like that because the company will pay that out of their pocket because we know they will be monitoring that," Johnson says.

Johnson's unit at Liberty consists of five auditors who assist prosecutors in criminal aspects of any particular case as well as cases that may result in civil actions. The unit also has four underwriters who are looking for anomalies that could indicate fraud.

"We might have loss prevention folks who go out there and are told there are 10 people in the workplace and then get a claim from someone who says he has a supervisor with 20 people working under him," he says.

In addition, competitors can often provide tips. "They could call up and say there is no way this guy could bid this price and pay insurance because I know what I pay," Johnson says.

While both carriers and government officials attempt to root out premium fraud, the former remain at a distinct disadvantage in that their targets are their customers, as opposed to claimant fraud, where that is usually less the case.

"We work with the account executives and underwriters," Johnson says. "We try not to go in with both guns drawn, but instead work diplomatically to look at inconsistencies and try and figure them out. It is a very slow process because you don't want to alienate your customer."

Because sometimes where there is smoke there is not always fire, he adds.

"We just can't go in and demand records where we can see everything and drill down to what we are looking for," Johnson says. "A lot of this is the honor system and we have to rely on what the customer tells us."

WAYS TO FIGHT BACK

Johnson says that carriers such as Liberty have a number of options when they encounter premium fraud. The first thing of course is to cancel the policy. "We generally don't like to do business with people who are lying to us."

The company could also take civil action. "That decision is on a case-by-case basis. We could have a person who is out of the country and never find him so there is no point in suing since all we will get is a default judgment," he says.

And finally there is criminal prosecution. In that case the carrier has to sell its cause to some state or municipal authority. "Somebody on the criminal side has to like it. There are some states where premium fraud is not even considered a felony on the state level."

San Diego County's Dugo says that his office will recommend civil action if he believes it cannot meet the criminal burden of proof, which is guilt beyond a reasonable doubt as opposed to the civil test of preponderance of the evidence.

"If there are certain evidentiary problems we will prosecute the case on a civil basis," he says. "But our main emphasis is on criminal prosecution."

In the 10-month period from July 1, 2007, through April 30, 2008, the San Diego district attorney's office prosecuted 83 employers for operating a worksite without workers' insurance and 10 employers for cases of premium fraud involving the falsification of employment records and the like.

But Dugo has no illusions about the number of employers who are getting away with fraud. "If we doubled our resources I am sure we could easily double the number of cases," he says. "After all, fraud is a hidden crime and the first thing you have to do is uncover which is a lot different than something like a robbery at 7-Eleven."

Officials with statewide jurisdiction also keep a sharp eye on the situation since many employers operate in multiple jurisdictions in any given state.

Geoffrey Branch, an investigator with the fraud unit of Florida's Department of Financial Services, says premium schemes represent "the largest organized financial crime in the state of Florida."

Nina Banister, spokeswoman for the DFS, which houses the units that bring both civil and criminal actions against premium fraudsters, says DFS officials show up on worksites "and see that everyone is accounted for on the policy."

"They may set themselves up in a county and just drive around for three days or so just looking for a site, usually construction," she says.

On such sites general contractors and subcontractors can play off one another each claiming the other was responsible for comp coverage, Banister says.

In the last time period for which statistics are available--the fiscal year that ended June 30, 2007, the DFS issued 666 criminal complaints for employer premium fraud and related crimes such as violation of stop work orders and working without coverage. Those complaints resulted in 372 prosecutions and 112 convictions.

In addition, the DFS maintains a database of all employers and workers' compensation coverage status so not only fellow contractors but consumers can see if a contractor is covered properly.

Banister also says criminal workers' compensation fraud investigators work closely with special investigation units of carriers to root out premium and all other kinds of insurance fraud.

Violations can result in civil fines if they are, for example first offenses or lack any evidence of a widespread scheme. "The penalty would be 1.5 times the evaded premium amount for up to three years," Banister says. "So it can be costly if you have messed up for some period of time."

Coppelman says Massachusetts has set up a hotline for tips involving premium fraud which has resulted in as many as 2000 calls per month.

"State investigators may winnow the tips down to about 20 stop-work orders a month, which in turn may lead to criminal complaints," he says.

While they operate on different coasts, and one in the private and public sectors respectively, the story of both Johnson and Dugo indicates that premium fraud came on the radar screen in a big way in the mid-1990s.

Johnson joined Liberty Mutual in 1992 and likes to say he pursued premium fraud cases "as a hobby."

That year he went to the FBI Academy in Quantico, Va., as part of a special program of the U.S. Attorney's office to combat healthcare fraud. The program also encompassed workers' comp malfeasance.

For two years, Johnson pursued premium fraud cases on an ad hoc basis until he and his colleagues realized the scope of the problem and decided to form their own dedicated unit. "We then realized this was a full-time job," he says.

Dugo has also prosecuted insurance fraud since 1992 and four years later set up the first premium fraud task force in the nation that included representatives from the state's labor department and taxing authorities. "We saw back then how serious the situation was," he says.

Any employer's workers' comp premium depends on three factors, according to Johnson.

-- Differences in premium cost that depend on the danger level of the position. A roofer, for example, is charged a higher premium than that for a file clerk.

-- Total payroll for each job classification.

-- Employers with fewer claims and safer work environments getting rewarded over time.

So the incentive remains to not only classify the roofers as file clerks but label them all as independent contractors.

Coppelman says that states and carriers are currently engaged in crackdowns on the practice by general contractors of hiring so-called independent contractors as subcontractors but who are failing to meet the standard test for such independence. "Premium auditors are routinely adding the costs of uninsured subcontractors to the payroll of fully insured general contractors," Coppelman says.

A study by the Fiscal Policy Institute estimated that one out of four construction workers in New York City alone--or at least 50,000--were employed off the books or misclassified as independent contractors, Quiggle notes.

"These cons milked $489 million in comp premiums, taxes and other expenses in 2005 and could reach $557 million this year," he says.

Coppelman says undocumented workers are another area of concern. "It's pretty obvious that workers' comp coverage will be rare among employers of undocumented workers," he says.

Nonetheless courts have ruled that even undocumented workers are entitled to comp benefits. While construction remains a top industry when it comes to premium fraud, it is not alone.

Johnson says other industries such as temporary employment agencies or others where payroll figures are relatively easy to manipulate will be prone to such crimes. "These are businesses of a more transient nature. After all, if an insurance company auditor goes onto a factory floor and they tell you they don't have any employees it is pretty easy to figure that out," he says.

As for size, many small companies will fall under an insurance carrier radar screen and will just face audits by mail form. But some fairly sizable enterprises and even some publicly traded companies have engaged in such fraud, Johnson adds.

Both insurance company and public officials will maintain the battle against premium fraud, which in Massachusetts led to an ultimately unsuccessful effort to revoke driver's licenses and vehicle registrations for noncompliant employers.

"State regulators owe legitimate businesses a credible and full-scale effort to ensure that all employers carry comp coverage," Coppelman says. "As we see in the Massachusetts model, it is not easy but it can be done."

September 1, 2008

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