Workers’ Compensation policies are usually written on the basis of “estimated premiums” that can be changed — often by an increase and sometimes by many multiples of the “estimate” – and retroactively billed to the policyholder long after the policy expires.  Can you really be forced to write a big check for insurance coverage that no longer covers you for anything?

Most of us never actually read our insurance policies when they come in the mail.  If we’re especially conscientious, we might look at the declarations page to see if the coverage limits look right, and we’ll check the premium to make sure that we haven’t been charged more than we expected to pay.  But then, as often as not, we simply put them in a file drawer and hope never to have to make a claim.  Insurance policies are long, dense, wordy contracts that few people are capable of truly understanding in any event, so why bother?  Policyholders large and small have this view of insurance.

The problem with this approach is that an insured’s relationship with its insurance carrier, more than perhaps with any other commercial partner, is fraught with nasty surprises that, when discovered, usually inure to the benefit of only one of the parties: the insurance carrier.  Here’s a hidden policy time bomb that many insured’s will not discover until after it’s too late.

Workers’ Compensation insurance policies are commonly written on the basis of an estimated premium.  The standard language that provides for this is as follows:

The premium shown on the schedules is an estimate. The final premium will be determined after this policy ends by using the actual, not the estimated, premium basis and the proper classification and rates that apply.  If the final premium is more than you paid to us you must pay us the balance.  If teh final premium is less, we will refund the balance to you.

If the premium changes, it will be as the result of an audit of the company’s books and records after the policy expires (possibly years after) either by the carrier, itself, or by a state “rating agency.”  A common reason for an adjustment to the premium is the size of the company’s actual payroll.  Premiums for Workers’ Compensation are based upon the number of employees, the kind of work those employees do, and the rates charged for each category of employee.

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An insured’s relationship with its insurance carrier is fraught with nasty surprises that usually inure to the benefit of only one of the parties: the insurance carrier.

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State rating agencies use complex formulas and “rating manuals” that list just about every conceivable kind of work a company could employ a person to perform.  Those who do particularly danagerous work — construction workers on skyscrapers, for example — will be assigned a rating for which the premium will be much higher than for, say, a law firm receptionist.  If the insurer and the insured both estimated at the beginning of the policy period that the company was going to employ 100 people and it turns out that it employed 150, instead, an audit may result in a higher actual premium, which the carrier will bill retroactively.

So far, so good.  Few companies will be terribly surprised by the fact that they employed more people in a given year than they estimated would be employed at the start.  The truly nasty surprise can come from a rating reclassification.  Here’s another piece of that puzzle from standard policy language:

The rates and rating methodologies used to calculate the premium charged for this coverage are subject to change.  This means that the rates and rating methodologies applied when your policy was issued may be different from those applied when computing your premium after the issuance of the policy, for example, at time of audit.

What happens at the beginning of the policy period is that the carrier consults with the insured about the kind of business the insured conducts and the kinds of work its employees perform.  The carrier consults the rating manuals, which are established and published by an organization called the National Counsel on Compensation Insurance, or NCCI, and picks the classification code for the vairous employees that the carrier believes most closely corresponds to categories into which the work of the employees fits.  The state rating agencies assign a premium rate for each NCCI code and the rest is just multiplication to figure out the estimated premium for a particular insured.

Sometimes, however, a state rating agency will audit an employer and decide that the wrong code was used for some, most, or all of the employees.  If that happens, it will issue a directive to the carrier to change the rating classification.  The carrier will then charge a retrospective premium according to the new rate.  The problem is that the change in classification can easily result in a premium that is many multiples of the rate on which the estimated premium was based.

So, a policyholder that believed its Workers’ Compensation premium was, say, $250,000, can be staring at a premium bill two years later that seeks an additional $700,000.  For big employers, the number can be breathtaking.

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To the aggreived policyholder, this can feel suspiciously like the old bait-and-switch ploy.

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Once a class of workers has been reclassified, a number of judicially created impediments pop up that can make it difficult for the policyholder to fight the change.  Depending on the facts and on state law, there may be an administrative appeal process for the review of rate classifications.  This typically involves going to the rating board that made the change and trying to convince its members that they were wrong to reclassify.  One can imagine how frequently this works.  Who among us likes to be told that we don’t know what we’re doing?

If the first level of appeal fails, there may be additional steps that can eventually get the policyholder in front of a judge to review the reclassification.  The courts, however, often have a policy of showing deference to administrative agencies.  So there may be decisions out there that impose hurdles in the way of a policyholder getting an agency decision overturned.  Sometimes that deference is stated as the need to show an “abuse of discretion,” a pretty high legal standard.  Other courts may express it as a “substantial evidence” standard, which means that the court will not change the agency’s decision as long as it was supported by “substantial evidence.”  This is a somewhat more forgiving standard than “abuse of discretion,” but it is still quite deferential to the agency.

The real kicker here is that these “rating agencies” are often not creatures of the state at all.  They are … wait for it … associations of insurance companies.  The New York Compensation Insurance Rating Board, which sets the rates in New York, is, for example, a non-profit association of dozens of insurance carriers, many of them in the business of selling Workers’ Compensation insurance and, of course, collecting premiums for that coverage.

You don’t have to be a hopeless cynic to suspect that a group of insurance carriers that make money (a lot of money) by collecting as much in premiums as possible are likely to have an unsympathetic view of a policyholder’s attempt to reduce its premium obligations.  Foxes and hen houses come to mind.  And, of course, the carrier that sold the policy is going to have no incentive whatsoever to go to bat for the policyholder in a challenge to a rate re-classification.

To the aggreived policyholder, this can feel suspiciously like the old bait-and-switch ploy.  The carrier obtains the account by offering the policy for a reasonable premium.  A year — or two, or even three — later, the premiums turn out to be a great deal higher.  And this arrangement is not only set out, right there in the policy language, but it is often enforced by the insurance industry, itself.  That’s awfully good work, if you can get it.

For the truly egregious re-classifications — and I’ve seen some — a policyholder might be able to get directly into court for a review, again, depending on the facts and circumstances.  For others, getting relief may require persuing an appeal as aggressively as possible.  This may involve retaining an expert with knowledge of rating classifications.  It may involve conducting a survey of other companies in similar businesses, to determine how their employees have been classified.  And it may require taking any adverse administrative decisions through the entire appeal process into court, if that’s what state law permits.

Read your policies.