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Workers’ Compensation Audit Hurts Contractor. Drywall company lucky not to be prosecuted for workers' compensation insurance fraud.
By Barry Zalma - July 15, 2013

Because of the ever-changing nature of a business, the policy premium for a workers’ compensation policy usually cannot be determined until after the policy has expired. For this reason, the insurer, applying the covenant of good faith and fair dealing, relies on the insured to maintain the necessary documentation for calculating the premium.

The failure to present records can be very costly...

T & S Drywall Finishing, Inc. (T&S), acquired workers’ compensation insurance from The Travelers Indemnity Company (Travelers). After the policy period terminated, Travelers audited T&S to determine the actual premium as provided by the policy. During this audit and the audit of the following policy period, Travelers concluded that T&S owed additional premiums because it had hired subcontractors that did not have workers’ compensation insurance covering their employees. T&S disputed the increased premiums, and Travelers brought an action against T&S in the district court for Douglas County. Following a bench trial, the district court entered judgment in favor of Travelers.
In Travelers Indemnity Co. v. T & S Drywall Finishing, Inc., A-12-833 (Neb.App. 07/09/2013) T&S challenged the finding that it is liable for additional premiums. The Nebraska appellate court was called upon to resolve the dispute.
Other than its president and owner, Terry Winn, T&S has one other employee, Julie Schafer, who manages the office and handles the bookkeeping. T&S submitted an assigned risk application for workers’ compensation insurance to Travelers through one of Travelers’ agents. In its application, T&S disclosed that it subcontracted 100 percent of its work and indicated that it did not sublet any work without first having received a certificate of insurance from the subcontractor. Along with the application, T&S paid $750 as prepayment of its premium. This prepayment was later increased to $850. Upon receiving the application and premium, Travelers issued T&S a policy with an effective policy period beginning on February 19, 2005, and terminating on February 19, 2006. When this initial policy period expired, a renewal policy was issued with an effective date of February 19, 2006.
As permitted by the policy, Travelers audited T&S’ records a few months after the first policy period expired. Based on the information it received from the audit, Travelers also concluded that these subcontractors employed additional workers. As a result of this audit, Travelers adjusted T&S’ final premium to $103,544.
Travelers also attempted to audit T&S’ records during the renewal policy period, but T&S did not provide the necessary records. As a result, Travelers used the previous audit results to estimate T&S’ premium for the partial renewal policy period. Travelers adjusted T&S’ premium. When T&S refused to pay the adjusted premiums, Travelers filed suit in the district court for Douglas County.
At trial a Travelers’ premium auditor, testified that the initial premium for a workers’ compensation policy is an estimate based upon an insured’s payroll projections for the policy period. The final premium is based upon an insured’s actual payroll during the period.
Travelers charged T&S the additional premiums after the audits because T&S could not provide documentation showing that all subcontractors were covered by workers’ compensation insurance policies. T&S paid the subcontractors directly and did not issue payment to any employees of the subcontractors. However, there was no evidence presented to indicate that T&S required certificates of insurance from all of its subcontractors who had employees before subcontracting work as it promised.
After a bench trial, the district court entered judgment in favor of Travelers. Finding that T&S failed to require its subcontractors to furnish proof of workers’ compensation coverage for their employees, the court found that T&S became liable as an employer under Nebraska statutes. Because T&S intentionally failed to maintain the records necessary for an audit, the district court accepted Travelers’ premium calculations. T&S was ordered to pay $137, 892, along with any applicable prejudgment and post judgment interest.
T&S contends that the insurance policy does not constitute a valid and enforceable contract.
The court of appeal concluded that the insurance policies in question were clearly enforceable contracts. Travelers agreed to provide workers’ compensation coverage for T&S for the operative periods in exchange for T&S’ payment of the initial premiums. T&S accepted the policies and was insured during the policy periods until cancellation. The fact that T&S disputes its responsibility for additional premiums following the audits does not render the contracts unenforceable.
Is Travelers Permitted to Increase Premium After Conducting Its Audit?
Contrary to T&S’ argument the clear and unambiguous language of the Travelers’ policy in this case gives Travelers the authority to perform inspections and audits to determine the correct premium to be charged after the policy period ends.
In this case, the materials T&S received from Travelers, including the final policy, clearly explained that the initial premium was only an estimate.
The plain language of the insurance policy provided that the final premium was to be determined after the policy ended. Specifically: “The premium shown on the Information Page, schedules, and endorsements 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 classifications and rates that lawfully apply to the business and work covered by this policy.”
Did Travelers Properly Calculate Retroactive Premium?
T&S also argues that Travelers did not properly calculate the revised premium in this case. T&S contends that none of its subcontractors are employees of T&S and that Travelers did not provide any evidence to support its conclusion that these subcontractors had employees. Finally, T&S claims that it would be inequitable to allow Travelers to change the premium as it did because no claims were ever made under the policy.
Travelers argues that it was permitted to increase T&S’ premium because it had increased risk exposure during the policy period due to T&S’ having hired subcontractors with employees that were not otherwise covered by workers’ compensation insurance. The Nebraska Supreme Court has long held that an employer who employs an independent contractor to do work which is in the usual course of business of the owner, and who fails to require the independent contractor to procure workers’ compensation insurance, is liable as a statutory employer. The Supreme Court has also extended this rule to the contractor/subcontractor relationship. When a contractor fails to require a subcontractor to carry workers’ compensation insurance and a subcontractor’s employee sustains a job-related injury, the contractor may be a liable statutory employer.
The Travelers’ policy insures all persons engaged in work that could make it liable under the provision of the policy requiring Travelers to pay benefits required of T&S by the workers’ compensation law. It also provided that if the insured did not have payroll records for such persons, the contract price for their services and materials may be used as the premium basis. That part of the policy would not be used if the employers of subcontractor workers lawfully secured their workers compensation obligations.
Based on this language, the policy clearly required T&S to maintain the necessary records to avoid incurring premium charges for its subcontractors, i.e., certificates of insurance from the subcontractors. Because T&S intentionally did not determine whether its subcontractors had employees working T&S’ contract jobs and did not require all of its subcontractors to submit the insurance certificates, Travelers increased the premium based upon T&S’ payroll and compensation records as permitted by the policy.
Therefore, T&S, not Travelers, bore the burden to establish that its subcontractors were adequately insured.
Finally, the appellate court could find no support for T&S’ argument that the premium adjustment is inequitable because no claim was ever filed against the policy. As is clear from the policy language, the final premium for T&S’ workers’ compensation insurance policy is determined by its payroll for these periods and was not affected by the amount of claims for this period.
T&S and Travelers created a valid contract. The resulting insurance policy permitted Travelers to retroactively adjust the premium.
In some states misrepresenting the number and class of employees is a crime known as workers’ compensation premium fraud, a felony. T&S was lucky that it was only required to pay additional premium instead of going to jail for up to five years.
By having no “official” employees T&S attempted to deceive Travelers to insure the “employees” of its subcontractors without paying a premium to Travelers for the risk it was taking or obtain the records that showed its subcontractors maintained such insurance and thereby eliminated T&S and Travelers’ risk if they were injured.

Barry Zalma is an attorney, a CFE (Certified Fraud Examiner), and an expert witness for myriad types of insurance fraud. His website is at



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