Whether you're in business or starting a new business you need to know the basics of workers' compensation insurance. Virtually every business that has employees other than the owner is required by state law to carry workers' comp. But you need to be careful in choosing a policy. The fact is many insurance companies can get remarkably tricky when it comes to writing policies - in their bag of tricks are such ploys as classifying the type of work your employees do incorrectly, miscalculating so-called modification factors, and making a variety of other types of errors which, oddly enough, result in insurance costs to you that are higher than they need to be.

Beyond needing to hold your own against your workers' compensation insurance agent, there's another reason to take a few minutes to learn more about this type of insurance, namely, fraud. Workers' compensation fraud is the second largest category of white-collar fraud in the United States today, second only to income tax evasion. According to industry observers, fraud occurs in almost a fourth of all claims. It can take the form of employee fraud (an employee who's been in an accident claiming to be injured more seriously than he/she really is), employer fraud (harassing employees who put in claims or trying to deceive the insurance company regarding the number of the company's employees), or insurance company fraud (wrongfully denying legitimate claims).

In a lot of businesses, such as manufacturing and construction, workers' comp is a major expense item - and also a major source of friction and confusion. But most business owners know little or nothing about how it works or how rates are calculated. It's too complicated to cover in detail here, but I'll try to touch upon most of the basics in this brief article.

Workers' Compensation Basics

If you are in the type of business that is mandated by state law to purchase workers compensation benefits, this is something to take seriously. In some states, notably Florida and California, businesses are getting shut down and owners prosecuted criminally for failure to carry this type of insurance. In most states you need it if you have one or more employees - California being one of the few that requires it even for one-person businesses.

In most states you can purchase an insurance policy from a workers' comp insurance company; however in five states (ND, WV, WA, WY, OH) you must obtain coverage through that jurisdiction's state-operated fund. These state operated funds are called "monopoly state funds."

Note that thirteen states maintain state funds which compete with private insurers. So in those thirteen, you can buy your policy either from a private insurance company or from the state fund (CA, AZ, CO, MD, ID, MI, MN, MT, NY, OR, OK, PA, UT).

If for some reason your business is found to be particularly risky, you will have to get your insurance from an "assigned risk" fund, and it costs considerably more.

Workers' compensation is regulated primarily by the states (and Washington DC) so there are 51 separate sets of rules which govern benefits, premiums, and coverage. However, a so-called "rating bureau" called the National Council on Compensation Insurance, NCCI, has developed a manual used by many states to regulate how insurance companies calculate your rates. NCCI states rely almost completely on this manual, while some other states have developed their own manuals. For example, Nevada sticks closely to the NCCI manual, whereas California has developed its own manual.

Workers' comp policies tend to appear complex and abstruse to the uninitiated. In addition, you can't rely entirely on your insurance agent to decipher the technical terms, options, and requirements - remember, he/she has a vested interest in selling you as expensive a policy as possible. So if your premiums turn out to be fairly considerable, it's a good idea to have your policy reviewed by a lawyer with workers' comp experience or a consultant specializing in this field.

For example, you might ask whether you need a guaranteed-cost policy (a policy whose premiums remain the same no matter how many claims you file) or a loss-sensitive plan. The latter alternative will cut your costs but increase your exposure.

The basic formula nearly all insurance companies utilize to calculate your policy is to multiply a rate times hundred dollars of payroll. But what is this "rate"? Where does it come from? It is based on the classification of your company's type of work performed. It's always to your advantage to be in a relatively "safe" classification, such as clerical work, as opposed to a more injury-prone classification, such as construction. Experts warn that you should be vigilant that the insurance agent does not mis-classify your company - such a "mistake" can easily double your premiums.

What's more, insurance companies inevitably apply an "experience" factor to your premiums. This is a circumlocution for a multiplier calculated on the basis of your company's claims history. The more or larger your claims, the larger the experience factor.

Explaining Assigned Risk Plans

What can you do if every private insurer in your state turns down your insurance application? In that case, you have to utilize the state's assigned risk plan. This is expensive insurance. Yet, I'm told, many agents sell assigned risk insurance without bothering to mention it's assigned, and the words "assigned risk" appear nowhere on the policy. Generally, rates and service are said to be better in NCCI states. However, even if your company is in an NCCI state you will probably get lower rates if you move to "voluntary" (i.e., not assigned risk) coverage as soon as possible.

Notice that if you're in a "monopoly" state - i.e, a state where there are no private insurers and you must use the monopoly state fund - you can still get put in an assigned risk plan. You should discuss this with your agent.

A Few Tips Regarding Workers' Compensation Insurance

- Your agent, working with his/her company's underwriter, decides what classification codes to utilize in developing your premium rates, as well as the various other risk factors. Reportedly, mistakes and oversights are legion in these types of policies (usually favoring the insurance company), so review your policy carefully, preferably with the assistance of a professional who has experience in this field.

- Be sure to read your policy's Information Page in detail - it contains the most important details you need to check.

- You should be particularly careful when your company hires independent contractors. If the independent contractor does not carry workers comp and is injured, you will be held responsible for all costs connected with the claim.

- Always make sure you indicate as named insured all legal entities which are in any way connected with your business. For example, if you own the building it's in, you should be named on your policy as legal owner of the property, as well as owner of the business.

- Also you should be cognizant of federal workers' comp exposures. In addition to state requirements, some federal legislation also imposes liabilities on employers. You can add coverage for acts such as the following to your workers' compensation policy by endorsement (i.e., by adding a supplement): Federal Coal Mine Health and Safety Act (benefits to miners who contract black lung disease; Longshore and Harbor Workers Compensation Act (benefits to employees injured in maritime employment); and Migrant and Seasonal Agricultural Worker Protection Act (housing and safety benefits to migrant and seasonal agricultural workers).

The NCCI Manual is not used for calculating rates in: Delaware, California, Indiana, Massachusetts, Michigan, Minnesota, New York, New Jersey, North Carolina, Pennsylvania, Wisconsin, and Texas. (All other states use it.)

If either you or a consultant you hire feels that your premium rates are not what they should be, based on the rules and specifications in the NCCI Manual (or other state rating manual), your initial step should be to contact your agent, say the experts, and request changes; if this doesn't work, then you should directly contact NCCI or the appropriate state rating bureau and point out the errors in your policy as it is written.

- Is your company required to pay workers' compensation benefits to illegal immigrants? According to experts, the answer depends on whether the illegal alien qualifies under your state's statute as an "employee" working "in the service of" another under a "contract of hire." So far, New York and Ohio courts have upheld the right of aliens to receive benefits; Wyoming, Virginia, and Florida have not.

- Note that only Texas, among all 50 states, does not require employers to carry WC insurance.

Workers Compensation Fraud

Workers' comp is a no-fault system for providing financial benefits to injured or ill workers while at the same time shielding their employers from lawsuits. But the system is wide open to fraud on a number of fronts. Employers, attempting to reduce premiums, may understate their total number of employees or misrepresent the type of work they do; workers may claim benefits they're not entitled to, for example, by exaggerating the seriousness of an injury; even insurers themselves may intentionally miscalculate premiums and this is, unfortunately, not uncommon.

Surprisingly, it's employer fraud that is the major type of workers' comp fraud. According to a recent study reported by the National Commission on State Workmen's Compensation Laws, over 13% of employers studied were operating without legally required workers' compensation insurance. In addition, others were found to be cheating the system by intentionally misclassifying or underreporting their payroll or by falsely representing employees as independent contractors.

Of course the best-known type of workers' comp fraud - the kind most often covered by the media -- involves workers claiming disabilities that don't exist. Most insurance companies have in recent years set up internal Special Investigative Units (SIU's) to deal with this type of fraud. Claims adjusters report suspicious cases to their company's SIU's, which then use surveillance, background checks,videotaping, medical records checks and other tools to document fraud, then turn the cases over to the Attorney General for prosecution. Criminal penalties to workers trying to game the system can be severe.

Here's an example of how the SIU investigation system works. Recently, CompSource Oklahoma investigated a female claimant who was receiving permanent total disability benefits for back injuries from a slip-and-fall accident. The company's SIU team found that while receiving these benefits she was listed on the Internet as an officer of an outdoor recreational club. Surveillance was set up and it was found that she was engaged in mountain hiking, carrying heavy items and other activities suggesting she was not disabled. Criminal charges were filed and a conviction obtained, resulting in a lengthy prison term.

What's the moral of the story? Simply this. Don't commit workers' comp fraud. Insurance companies now employ teams of specialized investigators who will doggedly pursue a any suspicious claim and, if fraud can be proven, will press charges without any hesitation whatsoever.