The SCIF assessed an additional premium of $555,327.53 based on its determination that ReadyLink’s per diem payments to traveling nurses counted as payroll. The Insurance Commissioner upheld the assessment, finding that ReadyLink’s per diem payments were not “reasonable” and therefore not exempt from payroll because they could not be substantiated and were designed to camouflage the assignment of income.

On appeal, ReadyLink contended: (1) the trial court incorrectly applied the substantial evidence standard of review rather than its independent judgment; (2) the Commissioner’s decision is preempted by federal tax law; (3) the Commissioner’s decision improperly created a new regulation without public hearing, comment and notice; and (4) equity dictates that the Commissioner’s decision should not apply retroactively.

FACTUAL BACKGROUND

ReadyLink is a private healthcare staffing agency that provides temporary traveling nursing personnel to hospitals and other acute care centers throughout California and other states. Nurses register with ReadyLink, which verifies the nurses’ credentials, notifies them when shifts are available and pays their wages. The SCIF is a quasi-public company created by the Legislature to ensure that mandatory workers’ compensation insurance will be available to California employers.

In September 2000, the SCIF issued a workers’ compensation insurance policy to ReadyLink. The policy was renewed annually until ReadyLink cancelled it in March 2007. At the end of each policy year the SCIF reviewed ReadyLink’s payroll records to determine the amount of wages paid that year to ReadyLink’s employees, because premium rates are largely based on the employer’s payroll.

The SCIF conducted its final audit of ReadyLink in 2007 for the policy period of September 2005 through September 2006. While reviewing ReadyLink’s payroll registers, the SCIF’s senior auditor in the special risk division discovered that ReadyLink was paying nurses a minimum wage of approximately $6.75 per hour plus a much higher stipulated per diem amount. The auditor had conducted dozens of audits of nurse staffing agencies and registries during her employment with the SCIF and had never seen such an agency pay more than 50 percent of wages in the form of per diem payments or pay hourly wages that were significantly below the average hourly rate typically paid to trained, licensed, registered nurses in California.

She questioned ReadyLink about its per diem payments and requested documentation to substantiate these payments. ReadyLink responded that it had been audited by the Internal Revenue Service (IRS) in 2008 for the premium year in question and the IRS found that ReadyLink was in compliance with the federal per diem tax rules. ReadyLink did not provide any additional documents to the SCIF. Based on the lack of supporting documentation, the SCIF determined that the per diem amounts should be included as payroll. This increased payroll had the effect of increasing ReadyLink’s workers’ compensation insurance premium by $555,327.53, for a total annual premium of $800,106.00.

THE ISSUE

The Commissioner’s Decision phrased the issue presented as follows: “For policy year 2005, did SCIF properly include per diem payments made to registry nurses as ‘payroll’ or ‘remuneration’…?” The Commissioner noted this was “a matter of first impression.” Subsistence Payments are considered to be reimbursement for additional living expense by virtue of job location. Stipulated per diem amounts are not considered payroll if the “amount is reasonable and the employer’s records show that the employee worked at a job location that would have required the employee to incur additional expenses not normally assumed by the employee.”

After a lengthy analysis, including review of federal tax law, the Commissioner determined that a per diem payment is reasonable if it comports with common sense, is not lavish or extravagant, and is not made for the purpose of circumventing per diem regulations. The Commissioner also determined that an employer must provide records proving that each employee receiving per diem reimbursement worked at a location that required the employee to incur additional duplicate living expenses and that such expenses were mitigated by per diem reimbursement.

The Commissioner concluded that ReadyLink failed to prove that its per diem payments were reasonable because it paid “a below-market hourly wage for the type of work being performed” and then used the per diem payments to increase its nurses’ income while avoiding payroll tax liabilities for itself. The Commissioner expressly rejected ReadyLink’s contention that its per diem payments were reasonable because they comported with the federal per diem amounts for the Continental United States listed in 41 Code of Federal Regulations, Chapter 301, Appendix A (CONUS). The Commissioner found that ReadyLink failed to prove the per diem payments reflected the traveling nurses’ anticipated living expenses, failed to show that its nurses worked at locations that required additional duplicate living expenses beyond normal commuting expenses, failed to monitor employee eligibility for per diem payments, and failed to require its employees to substantiate their per diem expenses.

After ReadyLink filed a notice of appeal in the Court of Appeal it filed a class action lawsuit in federal district court against the SCIF and the Commissioner seeking a declaratory judgment that the Commissioner’s Decision is preempted by federal law. The SCIF and the Commissioner filed motions to dismiss the federal complaint. The day after ReadyLink filed its opening brief in this Court, the federal district court issued an order granting the motions to dismiss.

DISCUSSION

A trial court’s review of an adjudicatory administrative decision is subject to two possible standards of review depending upon the nature of the right involved.

1. If the administrative decision substantially affects a fundamental vested right, the trial court must exercise its independent judgment on the evidence. The trial court must not only examine the administrative record for errors of law, but must also conduct an independent review of the entire record to determine whether the weight of the evidence supports the administrative findings.
2. The administrative decision neither involves nor substantially affects a fundamental vested right, the trial court’s review is limited to determining whether the administrative findings are supported by substantial evidence.

The Commissioner’s Decision does not frustrate federal law or create an obstacle for employers to comply with both federal and state regulations on the treatment of per diem allowances. The Commissioner’s Decision merely determined that under his subsistence payments rule, a per diem payment is reasonable “if it comports with common sense, is not lavish or extravagant, and is not made for the purpose of circumventing per diem regulations.” Furthermore, an employer must provide records proving that each employee receiving a per diem reimbursement worked at a location that required the employee to incur additional duplicate living expenses and that such expenses were mitigated by per diem reimbursement.

ReadyLink presented no evidence that compliance with regulations is an ‘administrative burden. Employers routinely compile information for regulatory purposes and already comply with incongruent tax rules and regulations. Given the various laws governing employer recordkeeping and given that the USRP rules do not require any novel recordkeeping.

The Court of Appeal concluded that ReadyLink’s federal preemption argument is nothing more than a red herring and a distraction from the real issue of whether the Commissioner exceeded his authority in determining that ReadyLink’s per diem payments constitute payroll for workers’ compensation premium purposes and the Commissioner’s Decision is not preempted by federal law.

The Court of Appeal agreed with the Commissioner that the employer must provide records proving that each employee receiving per diem reimbursement worked at a location that required the employee to incur additional living expenses. The USRP also mandates that an employer’s records must demonstrate the employee incurred additional duplicate living expenses and that such expenses were mitigated by per diem reimbursement. ReadyLink cannot claim any confusion or surprise with respect to the record-keeping obligation given that the SCIF repeatedly asked ReadyLink for documentation verifying its per diem payments both during and after the audit.

ZALMA OPINION

ReadyLink, by paying its nurses on an inflated per diem basis rather than salary reduced its Workers’ Compensation premium obligation by almost two thirds. It was caught only in the last year of its policy and assessed an additional premium to more accurately represent the risk that it asked the insurer to take. It was lucky that the only dispute is over the amount of premium. If the scheme to reduce premium was found to be intentional ReadyLink could have faced criminal charges for premium fraud.

© 2012 – Barry Zalma

Barry Zalma, Esq., CFE, has practiced law in California for more than 40 years as an insurance coverage and claims handling lawyer. He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally, for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.

He founded Zalma Insurance Consultants in 2001 and serves as its only consultant.

Mr. Zalma recently published the e-books, “Zalma on California Claims Regulations – 2013″; “Rescission of Insurance in California – 2013;” “Random Thoughts on Insurance” a collection of posts on this blog; “Zalma on Insurance Fraud – 2012″; “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Arson for Profit” and others that are available at www.zalma.com/zalmabooks.htm.

Mr. Zalma can also be seen on World Risk and Insurance News’ web based television program “Who Got Caught” with copies available at his website at http://www.zalma.com.