Lorem ipsum dolor sit amet, consectetur adipiscing elit. Vivamus convallis sem tellus, vitae egestas felis vestibule ut.

Error message details.

Reuse Permissions

Request permission to republish or redistribute SHRM content and materials.

Understanding Workers' Compensation Premium Fraud

Insurers and states are aggressively pursuing underpaid premiums.

February 2014 CoverAmong the many obligations imposed on employers is securing workers’ compensation insurance in case their employees are injured while working. The cost of this insurance is a significant concern for all employers.

The major factors that determine the insurance premiums that carriers charge are the employee’s classification and pay rate, as well as the employer’s claims history. Misrepresenting any of these factors to an insurance company for the purpose of being charged a lower premium is a form of insurance fraud commonly referred to as "premium fraud."

Because misrepresentation of an employee’s pay rate and an employer’s claims history is self-explanatory, this article focuses on the potential repercussions of deliberate misclassification and how to handle disputes in this area.

Workers’ compensation premiums vary depending on the nature of the job. A company in the business of washing the windows of high-rise buildings, for example, will pay higher premiums for its window washers than a movie theater will for employees who sell tickets. In this comparison, the insurance company considers two factors: the risk of injury faced by each employee and the pay rates. High-rise window washing is both more dangerous and higher-paid work than selling tickets.

For contractors in the construction industry, the cost of workers’ compensation insurance is factored into each bid they submit for a job as part of their overhead. Many contractors may bid for the same job. The price of bids is generally the most important consideration for the developer or general contractor in selecting a contractor. Contractors therefore try to trim their costs to keep their bids as low as possible, as well as to maximize their profit margins.

Thus, it can be tempting for an employer to misrepresent an employee’s classification or pay rate to lower workers’ compensation premiums. Many employers do not realize, however, that doing so is a crime. In California, for instance, deliberately making false statements to the State Compensation Insurance Fund (SCIF), the largest provider in the state, is outlawed under Insurance Code Section 11880 and provides for a punishment of up to five years in jail and up to $50,000 or double the value of the fraud, whichever is greater.


In one instance, a couple who owned separate tree-trimming and gardening companies classified their tree trimmers as gardeners to save a significant amount of money. In July 2009, SCIF audited one of the couple’s businesses and found that vast sums of money were being transferred from the tree-trimming company to the gardening company to pay expenses and payroll. In November 2011, the couple pleaded guilty to 29 counts of misrepresenting facts to SCIF and five felony counts of misrepresenting facts to a workers’ compensation insurance company, with sentencing enhancements for a loss of more than $100,000 and a taking involving more than $500,000. They also pleaded guilty to multiple counts of tax evasion, which were uncovered after the SCIF audit. They were given 10 years’ probation and ordered to pay $3.4 million in restitution, plus penalties and interest. The judge ordered that if the couple failed to fulfill the terms of probation, they would both be sentenced to five years in prison.

In addition to criminal penalties, some states take punitive measures. In California, another consequence for an employer convicted of premium fraud is that all of the information about the crime is published on the state Department of Insurance’s website, including the amount of money defrauded, the punishment and sentence, and the amount of the fine.

Protect Yourself

Here are a few steps employers can take to avoid premium fraud and the associated penalties:

Be certain you can justify the classifications of each of your employees. Are they classified as machine operators or millwrights? In determining such distinctions, consider not only job descriptions but also industry standards, such as union or trade association membership. These factors may be used as circumstantial evidence down the road.

Be diligent in reporting to your insurer instances of reclassification, such as when an employee is promoted from a clerical position to a role that requires fieldwork that could expose him or her to additional risk of injury.

Cooperate with the insurance company if it requests an audit. If the auditor finds what he or she perceives to be irregularities, the employer’s cooperation will typically result in a simple reassessment and correction of the premium actually owed.

Aggressive Pursuit

There are incentives for both the insurance industry and state governments to aggressively pursue criminal prosecution of companies they suspect of committing premium fraud. According to Insurer Financial Results: 2010, a study published by Insurance Services Office, an insurance industry information service, the U.S. property/casualty insurance industry’s net income after taxes and return on average net worth fell that year to just over half their prerecession 2007 levels.

This significant drop in income is not surprising considering the recent state of the economy, but the tightening of profit margins could be serving as an incentive for the industry to become more aggressive in pursuing recompense from those it perceives to have committed insurance fraud.

State governments have taken action to support the insurance industry in an effort to crack down on such fraud. In 1991, the California Legislature enacted the Workers’ Compensation Fraud Program, which added an assessment to the cost of workers’ compensation insurance premiums to fund fraud investigations and prosecutions. The total assessment for fiscal year 2010-11 exceeded $50 million—quite a war chest to fight this category of crime.

The California Department of Insurance reports that its efforts resulted in the avoidance of more than $1 billion in potential losses. In fiscal year 2010-11, restitution of more than $58 million was ordered as a result of 666 convictions for workers’ compensation fraud.

Clearly, these are significant incentives motivating the insurance industry as well as state governments to pursue fraudulent claims by way of criminal prosecution rather than civil suit.

Other Possible Penalties

The standard workers’ compensation insurance policy contains a provision allowing the insurer to conduct an audit of the insured’s records at its discretion. Being perceived as dishonest or obstructive in the context of the audit can have serious consequences.

Keep in mind that this is not like a civil fraud situation where the injured party’s main recourse is taking the offending party to civil court. In this circumstance, the insurance industry has the police power of the state at its disposal by way of criminal investigation and prosecution. The insurance company does not necessarily have to sue the insured in civil court, obtain a judgment and then incur further expense in an effort to enforce a judgment against the insured.

Instead, it can simply report the alleged fraud to the state, and the state can coordinate the criminal investigation and prosecution of the insured; the cost of this, at least in California, is paid for by the statewide assessment imposed on all workers’ compensation policies.

Then, upon conviction, the state can impose an order that the insured pay the insurance company restitution, plus penalties and interest.

Our firm recently got a call from a client in the construction industry who told us that the sheriff’s department was at his home searching through his family’s belongings. Only his daughter was home when the sheriffs arrived, so she immediately called her father when she was served with a warrant. The client happened to be on vacation with his wife.

After the client called us, we immediately contacted his daughter, who was quite distraught, and instructed her on how to respond to the investigating officers. Then we contacted the district attorney’s office and were able to determine that our client was being investigated for premium fraud. Since he was a contractor who worked out of his home, the sheriffs confiscated not only his business records but all of the family computers, as well.

The situation upset the entire family, embarrassed the client in the community and disrupted his ability to conduct business. All of this occurred because of a dispute over classification of his employees and the manner in which he handled the dispute. The insurance company considered the client to be uncooperative and eventually chose to take the route of criminal prosecution.

Any employer being prosecuted for insurance premium fraud should retain a criminal attorney who specializes in white-collar crime and has experience in fraud-related cases.

As we have seen, a charge of premium fraud can take a substantial toll on a business, its operations and its people. However, with knowledge of how to avoid such circumstances, and how to handle disputes when they arise, employers can avoid costly consequences.

Kevin M. Cruz is an attorney at Gray Duffy LLP, a California-based business litigation law firm. His practice focuses on insurance law, business litigation, employment law and personal injury.

Web Extras

Newsletter: Workers’ Comp Premium Fraud: Being Alert to Indicators Can Aid Early Detection and Curb Losses (Insurance Services Office)


​An organization run by AI is not a futuristic concept. Such technology is already a part of many workplaces and will continue to shape the labor market and HR. Here's how employers and employees can successfully manage generative AI and other AI-powered systems.