A workers-compensation insurer’s audit reveals that the 10-person clerical business the insurer thought it covered actually is a 100-person window-washing firm, specializing in high-rise buildings. That can be dangerous work, high up on the scaffolding. The employer illegally paid minimal workers-compensation premiums by misclassifying its business and lowballing the number of employees. The owner might have paid tens of thousands of dollars more in premiums a year if he’d told his workers-compensation insurer the truth.
Premium fraud in workers compensation has long bedeviled insurers. The growing willingness of insurers and prosecutors to combat these expensive schemes is something new and welcome. The question is what are an insurer’s remedies? The answer involves traditional approaches along with newer ones — some that are untried though promising.
One of the most-promising yet least-deployed solutions is civil litigation — suing businesses that lie and cheat to avoid paying their full share of premiums. Civil suits may be the best choice if the premiums owed are substantial and/or an insurer is faced with a plethora of claims. Several affirmative civil litigation avenues can help return the money owed, recoup damages, and possibly deter other employers from similar premium schemes.
Insurers deploy civil suits sparingly in workers compensation, and didn’t sue cheaters at all until recently. Sometimes insurers just don’t discover the scams. Other times, the insurer makes a business decision not to sue — often relying on prosecutors to go after cheaters criminally instead. Perhaps at least some insurers have developed a larger appetite to sue fraudsters because the fraud losses have reached an intolerable state, or the insurers want to make a loud deterrent statement to the criminal underworld. Certain auto insurers assertively pursue staged-crash rings and crooked medical providers in civil actions. Some fraudsters deliberately avoid scamming auto insurers known to push back hard. Civil actions also send a public-spirited message that the insurer is protecting premiums.
“Insurers deploy civil suits sparingly in workers compensation, and didn’t sue cheaters at all until recently.”
Let’s outline the full panorama of legal options, civil and criminal, for going after workers-compensation premium scammers.
Possible litigation strategies
Do nothing. Chalking up a premium scam as the cost of business and doing nothing is one option. Unfortunately, this has been the most-popular approach to date. Often there are spirited discussions between insurer underwriting staff (who bring in clients) and claims staff (who pay claims) as to the best “business” approach.
Warnings. Perhaps a stern warning letter to the insured, or a report to claims-reporting agencies and NICB would deter future premium misconduct. This approach may make sense if the premiums owed are relatively low, or there are no injury claims.
Criminal charges. Another option is going the criminal route. Reporting well-packaged evidence to the local district attorney or state insurance department may start the road to premium recovery. This is a relatively easy form of criminal prosecution for workers-compensation insurers.
Law enforcement seems more willing to file charges in cases where premium scams are straightforward and relatively simple to diagnose and prove in court. Prosecutors only need to review policy applications, audits and far less-intricate-financial information. To garner assistance from prosecutors for more-complex premium schemes, insurers may need to do much of the leg work to pull these cases together for prosecutors.
Whether a straightforward premium case or a more-complex one, insurers should ask the prosecutors to demand restitution as part of any plea or sentence.
“Law enforcement seems more willing to file charges in cases where premium scams are straightforward and relatively simple to diagnose.”
The chief advantage of criminal action is cost and efficiency. It costs relatively little to report fraud, and insurers have a legal obligation to report fraud crimes in most states. The drawbacks of relying solely on criminal prosecution include lack of control over whether a case will be filed, and little control over the prosecution itself. Cases also can last years. And insurers have little control over whether restitution is ordered, or over the amount ordered. Overall, the chances of recovering money and certainly the stolen premiums, have long odds.
Civil actions are possibly the most-viable alternative if the goal is to recoup unpaid premiums and/or damages. Insurers have much more control over a civil action — causes of action, remedies and the amount the insurer expends for civil litigation. Unlike criminal actions, many civil premium-fraud cases also can be relatively simple because insurers control the scope of litigation.
Many premium actions are not document-intensive, and avoid protracted discovery. As the plaintiff, you control how deep into a premium fraud scheme you wish to go, including who to sue. Also, the burden of proof is far less than for criminal actions — preponderance of the evidence, versus beyond a reasonable doubt. The question then becomes which civil causes of action to pursue?
Common-law fraud. Any action should start with common-law fraud. The required elements of proof are similar throughout the U.S.: Intentional misrepresenting or concealing of an important fact upon which the victim insurer meant to rely, and does rely, to the insurer’s harm.1
The window-washing firm’s intentional misrepresenting led to payment of lower premiums, and perhaps the insurer’s payment of large and unexpected injury claims. By alleging common-law fraud, insurers can recoup the stolen premiums, and obtain other damages such as the full amount paid for claims. Punitive damages also may be available because misclassifying is an intentional tort. This can dramatically increase the potential recovery.
“By alleging common-law fraud, insurers can recoup the stolen premiums, and obtain other damages ...”
When pursuing other forms of insurance fraud such as work-injury cons, the issue of so called “detrimental reliance” as a fraud element can become a reason not to pursue a fraud cause of action. Insurers must prove — and the defense will try to disprove — that the plaintiff reasonably relied on the misrepresentation to its detriment. In some cases, that can disrupt an organization with aggressive discovery, placing the insurer on its heels. Given the nature of premium fraud, the chances of disruptive or intrusive discovery are minimized.
Unfair business practices. Nearly all states have an unfair business practices statute. It could be another potential cause of action to combat premium fraudsters.2 In California, for example, an unfair business practice action requires an insurer to show one of three elements.3 First, the action was “fraudulent” — intentionally designed to deceive. Alternatively, insurers must show that the action was “illegal” — that it violated a code or ordinance. Here, the violation would be of California Penal Code section 550(b)(3) — concealing information about the right to insurance.4
Alternatively, an insurer can show that the action was “unfair.” This prong is a bit amorphous. It has been defined to mean “offends an established public policy or when the practice is immoral, unethical, oppressive, unscrupulous or substantially injurious to consumers.” 5
Insurers often include this cause of action as a backup due to the easier burden of proof. Still, insurers are limited to restitution and injunctive relief, however, under most business-practices statutes. Insurers thus cannot get monetary damages in the form of restitution and injunctive relief. Another consideration is that insurance companies are sued under this cause of action more often than they sue others. So there is a danger in developing this area of the law, because it can be used against insurance companies.
Breach of contract. Nearly all premium-fraud cases include a breach-of- contract cause of action. In our window-washer case, the action would allege that the window washer breached its duty of honesty in the initial insurance application or policy renewal. The insurer is entitled to all damages flowing from that breach. The damages would include the difference in premiums, and possibly consequential damages. That could include payment of claims the insurer did not and could not anticipate.
There also is a risk in suing for back premiums, no matter what cause of action. If the plaintiff wins and collects those premiums, there is a good argument that the insurer now covers the risks presented — even though it never originally intended to. Thus the insurer could be on the hook to pay all future claims while the policy was in effect.
In workers compensation, public policy strongly favors protecting injured workers and better ensuring they have coverage. The window washer’s employees are innocent “victims” of the fraud by their employer. So, public policy may lead a trier of fact to find an insurer liable for all claims. High-rise window washing claims likely will be much larger than the clerical claims misrepresented in the policy application.
“In workers compensation, public policy strongly favors protecting injured workers and better ensuring they have coverage.”
Account stated. A popular civil cause of action, available in all jurisdictions, is “Account Stated.” This is a common count that is akin to breach of contract. The essential elements are: a) previous transactions between the parties establishing the relationship of debtor and creditor; b) agreement between the parties, express or implied, on the amount due from the debtor to the creditor; and 3) promise by the debtor, express or implied, to pay the amount due.”6
This represents another way to collect owed premiums, with the same risks for being on the hook for future claims. This would be a viable option when there are no claims, few claims or low-exposure ones — and recovering premiums owed is the key driver behind the lawsuit.
Rescind policy. Any suit should include a way to part company with the insured that has materially misrepresented information on its application. This usually is an action for rescission or declaratory relief.
Misstatements or concealment of any material facts in an application for insurance, even if unintentional, entitles the insurer to rescind the insurance policy. Rutter Group, Insurance Litigation, ¶ 5:161 et seq.
The materiality of a representation is determined by the probable and reasonable influence that a truthful answer would have had on the insurer. Rutter ¶ 5:203. Information is material if it would have caused the insurer to reject the application or charge a higher premium. Id. If an insurer properly exercises its right to rescind a policy, the insured’s rights are extinguished as if the policy had never existed. The insurer may thus avoid liability for benefits under the policy, even for pending claims.
Rescission is achieved by giving the insurers a notice of rescission and tendering repayment of all premiums received. This can be done unilaterally, without a lawsuit. But there is often a risk that the insured will respond with a bad-faith complaint. In many jurisdictions, the more-prudent course is to sue for rescission or pursue a lawsuit seeking declaratory relief that the policy can be rescinded. This reduces the bad-faith exposure. The key advantage of rescission is that the insurer will not be on the hook for claims presented, past or future.
“In many jurisdictions, the more-prudent course is to sue for rescission or pursue a lawsuit seeking declaratory relief ...”
Qui tam actions
California’s popular and potent anti-fraud statute is a bellwether for other states to consider. While New York and Illinois have passed versions of California's law, neither have evolved and they both remain underused (Insurance Code section 1871.7). Part of California’s larger Insurance Fraud Prevention Act, this section allows insurers to sue someone who uses a recruiter, or who is involved with submitting a fraudulent insurance claim (California Penal Code sections 549, 550 or 551).
The problem is that 1871.7 is designed to deter and punish the submitting of false claims. So what about the window washer’s premium fraud? Penal Code section 550 includes a section geared for premium fraud:
“(b) It is unlawful to do, or to knowingly assist or conspire with any person to do, any of the following: (3) Conceal, or knowingly fail to disclose the occurrence of, an event that affects any person’s initial or continued right or entitlement to any insurance benefit or payment, or the amount of any benefit or payment to which the person is entitled.”
The question becomes whether an employer’s misrepresenting the work performed in order to save premiums would affect its ability to obtain coverage, or whether the falsehood would just affect the amount of premium. Assuming the insurer plaintiff has stated a sound case and liability thus attaches, the question then moves to the amount of “damages” obtainable. Insurers are entitled to an assessment of up to three times each claim for compensation, and a penalty of $5,000-$10,000 for each code violation under 1871.7.
Since the assessment attaches to false claims, there is an argument that insurers are not entitled to treble assessment. This would entitle the plaintiff only to the single $5,000-$10,000 penalty.
Yet insurers have a potential safety valve. What if a window washer falls and suffers a severe spinal injury? The insurer did not assume this risk when underwriting a supposed clerical operation. Insurers might argue that deliberately misidentifying the work the window washer performs to pay lower premiums gave way to the severe injury claim, and thus amounts to a false insurance claim. There is no authority in this area; it is an undeveloped area of legal precedent.
An argument can be made that any claim should be considered a false claim when a business lies on the insurance application. While the claim itself is not false and the injured employee is not accused of a false claim, the employer has made the claim false by submitting by purchasing the policy under false pretenses. If this argument succeeds, the insurer would be entitled to three times each claim, plus the penalty.
These are uncharted legal waters. To date, a premium fraud case has yet to be pursued under section 1871.7. This case likely would be decided by the appellate courts, interpreting the legislative intent.
Premium schemes remain one of the most-rampant areas of workers-compensation fraud in the U.S. Many such scams are straightforward opportunistic fraud by employers trying to game the system and save on their premiums. Affirmative litigation can be straightforward and less-intensive than when pursuing bogus injury claims.
Yet the law is still largely undeveloped in civil litigation against premium schemes around the U.S. Workers-compensation insurers pursue few lawsuits. The insurers may not have considered suits closely enough as a strategic option. Some insurers also may be concerned about jeopardizing a lucrative account by suing its own client.
Any civil action should include at least some of the above causes of action. This opens up the possibility of awarding penalties, assessments, restitution, contract damages, and/or punitive damages.
Most important, rescission and/or declaratory relief will allow a workers-compensation insurer to be relieved of the risk. The insurer will not have to pay for unexpected and sometimes catastrophic claims for which it never contracted. This allows proper allocation of resources to fairly compensate injured workers, yet avoid unjustly paying money for insurance scams. In forging a relationship between insured and insurer, that is what both sides expect.
About the author: Dennis B. Kass is a founding partner at Manning & Kass. He leads the firm’s Complex Litigation Team. It focuses on affirmative litigation involving insurance fraud, first- and third-party special investigation defense, high exposure and catastrophic personal-injury matters, mass torts and other actions. Kass assists in prosecuting complex and sophisticated fraud rings. He regularly lectures across the U.S., and trains professionals about insurance-fraud defense, affirmative litigation, and insurance coverage issues.