The tip of the iceberg emerged on January 11, 2007, in an online article from WorkCompCentral: A New York think tank is preparing to release a critical review of the states workers compensation system at the end of the month. The article goes on to explain that the report focuses on non-compliance by employers with respect to payroll reporting and, in particular, the fragmented collection of payroll data and of enforcement.

The report itself appeared on January 25. Entitled New York State Workers Compensation: How Big is the Coverage Shortfall? and published by the Fiscal Policy Institute (FPI), the report states bluntly, Employer non-compliance with the states workers compensation program is a growing problem in New York.

It is not entirely new news. A May 2006 PIANY white paper on the states workers compensation system suggested that up to 20 percent of employers do not comply with the coverage requirements. And, perhaps preemptively, the New York Compensation Insurance Rating Board (NYCIRB) subcommittee on fraud issued its own report last June: Workers Compensation Fraud in New York and the Insurance Industrys Response.

But FPIs findings and interpretation have certainly enlivened and broadened the discussion about reforming the workers compensation system. (A copy of the full report is available on-line at www.fiscalpolicy.org.)

What Fraud, and Whose?

No one argues that workers compensation is subject to fraud. According to estimates by the National Crime Bureau, workers compensation fraud nationwide costs businesses $5 billion per year. Typically, it is assumed that such fraud is perpetrated largely, if not solely, by claimants and those who abet or take advantage of them " medical providers, vendors, attorneys.

But fraudulent payroll reporting with respect to workers compensation is also a major contributor. According to the FPI report, it is even more significant than the authors anticipated. Quoted in a New York Times article on January 25, James Parrott, FPI chief economist and deputy director acknowledged, We were surprised to find this level of non-compliance.

Such non-compliance most often involves employers inaccurately classifying workers. An employer may classify a worker in a job category for which the workers compensation insurance premium is lower than that for the category of the workers true job " listing a nursing home employee, for instance, as a clerical worker rather than as an aide. In other instances, a worker may be misclassified as an independent contractor, a practice the FPI report notes is widespread and rapidly growing throughout the country.

Dan Corbin, director of research for PIANY, explained that [m]any workers succumb to pressure from employers to label themselves as independent contractors because they are eager for any employment. Of course, he continued, when the injury occurs, they want to be employees, and most likely will be deemed to be employees by the Workers Compensation Board. This results in compensation without offsetting premium.

It is not the fact of payroll fraud that is roiling the workers compensation waters " its the figures. The FPI study suggests that somewhere between $500 million and $1 billion a year in premiums is not being paid. That underpayment, according to the report, represents a 15 to 20 percent loss of premium annually.

Leveling the Data Playing Field

FPI itself, in describing its methodology, noted that inadequate data, and a lack of parallelism in data collection and analysis from different sources, makes absolute accuracy problematic " it is hard to pinpoint the exact amount of cheating, Parrott told The New York Times. FPIs approach, essentially, involved comparing payrolls reported under the workers compensation and unemployment insurance systems, saying that, in theory, the two total payrolls should be similar.

In practice, the report states, it appears there is a substantial discrepancy. It notes, too, that comparable data from the two systems are available only for the period from 2001 through 2003 and focuses attention on the latter year.

In 2003, New York State employers reported a total payroll amount of $389 billion to the labor, and taxation and finance departments when they paid unemployment insurance taxes. In contrast to that single source of data, there is no one entity charged with collecting information concerning workers compensation-related payroll and premium payments. Employers send premiums and payroll data, the report explains, either to the New York State Insurance Fund (NYSIF), or to their private insurers. NYCIRB compiles payroll data for companies purchasing workers compensation insurance from carriers; the Workers Compensation Board compiles data for self-insured businesses.

Further muddying the waters, certain categories of employment are excluded from coverage under the states workers compensation law: independent non-profit school teachers; New York Citys public school teachers; and the citys uniformed police, fire, and sanitation employees. There is also a limit on workers compensation premiums paid for high-wage construction workers.

The FPI report acknowledges that the discrepancies between the basic data for unemployment and workers compensation payroll necessitated estimated adjustments, which actually served to narrow the gap. Nevertheless, FPI arrived at a total payroll for workers compensation of $311 billion, $78 billion less than the unemployment insurance payroll.

Who is Minding the Gap?

The report observes that, as is the case with insurance in general, individual states have sole authority to regulate workers compensation. In New York, the responsibility for administering workers compensation is fragmented, with the result that there is no overall strategic enforcement capability, much less systematic coordination with the Labor Departments unemployment insurance system, which, in contrast to the workers compensation system, operates under federal oversight, according to the report.

FPI is scathing in its indictment of the states government: By not enforcing its own laws, the state of New York has allowed extensive non-compliance and the underground economy to proliferate, states the report.

Robert Detlefsen, NAMIC vice president for public policy, strongly agrees with that conclusion. He said that the report places the blame for this state of affairs squarely where it belongs " on the government of New York State. He noted, too, that the states inattention to its official duty appears to have been facilitated by a regulator mindset that conveniently shifts responsibility for state law enforcement to private entities.

The report, in fact, does explain that [t]he NYCIRB is not a New York State government agency; it is essentially an association of private workers compensation insurers that is designated, under [state] law, to compile data on the workers compensation system, and to recommend changes in premium levels and the rate structure. However, the state implicitly, if not literally, ceded enforcement responsibilities to the carriers, giving them enhanced enforcement tools in the 1996 workers compensation reform legislation.

Last July, then-Superintendent Howard Mills made it plain that he did not believe insurance companies were using those tools to good effect. In denying the NYCIRB request for a workers compensation rate increase, he stated that the insurers efforts to fight fraud " both claimant and employer fraud " can be said to be anemic, at best.

With respect to various anti-fraud measures, NYCIRB and its members conclude that there has been no discernible impact on the severity costs to date, although their report acknowledges that the 1996 reforms have helped deter fraudulent acts. It remains the case, the report states, that workers compensation fraud still represents a serious drain to the current system.

It is noteworthy that the NYCIRB report confines itself almost exclusively to claimant fraud. While it does list claimants, employers, medical providers, vendors, and attorneys all as perpetrators, only 1 of 11 categories refers to payroll fraud explicitly. It includes, among the 1996 reforms, increased criminal penalties from a misdemeanor to a felony.

However, the FPI report explains that while it is a felony to submit a fraudulent workers compensation claim, it is only a misdemeanor for a business not to carry legally required workers compensation insurance. Employer non-compliance, for a first offense, is cheap: a fine of $500 to $2,500, or imprisonment of up to one year.

But enforcement is not a simple matter, especially when it rises to the level of criminal proceedings. Mills pointed out that district attorneys, who bear the responsibility for bringing a case of fraud to trial, are often short on resources, especially in smaller counties. It is difficult to persuade them to give workers compensation fraud priority, he said, especially when they may be faced with having to decide whether to prosecute an employer or claimant as opposed to a child sex offender. Enforcement, he acknowledged, is inconsistent, and the issue is widespread.

Avoiding the Real Issue

There are some who see the FPI report and its focus on employer payroll fraud as a red herring, at best " at worst, as sensationalism. Speaking for the American Insurance Association (AIA), Michael Moran said that he is skeptical about the level of non-compliance. The study comes from a labor-funded group that seems to want to avoid the real cost drivers in the workers compensation system, he said. Those drivers include lifetime payments on partial disabilities, the lack of objective guidelines to quickly and efficiently determine levels of impairment, Social Security and pension offsets, and the high level of lawyer involvement. These are the issues that drive up New Yorks workers compensation costs, Moran explained.

Larry Gilroy, chairman of NYCAN, and IIABNY member, essentially concurred, suggesting that people who are resistingreal reform are trying to cloud the issue[s]: PPDs, procedural reform, and standardizing medical costs. There is fraud in any system, he agreed, and [employer payroll fraud] should continue to be looked at. But in terms of the overall impact of workers compensation costs on the states business environment, he believes that we can get New York on a level playing field with other states by addressing those three issues.

Based on my own experience, there are a lot of improper practices in the workers compensation system, said Warren Heck, chairman and CEO, Greater New York Mutual Insurance Company. Moreover, he noted, It is a constant struggle for our premium auditors to get some policyholders to provide the correct payroll exposures and agree to pay the premium based on the correct rating classifications for their employees.

But he has reservations about the FPI reports conclusion that 20 percent of premium is lost to fraudulent underreporting. I believe that is exaggerated, he said. Heck questioned the studys methodology, and pointed out that it is virtually impossible to quantify accurately the amount of premium lost by classifying employees as independent contractors, though I know it goes on, he said.

Though others do not take a position explicitly on the reports calculations, they believe that it paints an accurate picture of a system in disarray, and highlights genuine and serious problems. There is a general lack of confidence in the system, according to David Dickson, president of PIANY. The report clearly notes that, at present, the system is not fair, that little has been done to correct it, and that even today significant interests are denying that [the problem] exists. He added that no one can dispute the simple fact that reducing fraud reduces cost.

In the end, addressing payroll fraud can only benefit the system. The answer may be statutory changes that give state officials the tools they need to work with the industry to fight premium avoidance fraud, as Paul Tetrault, state affairs manager for NAMICs northeast region, proposed. It may be incentivizing the carriers to seek out fraud, as Mills suggested, so that the costs no longer outweigh the benefits. But when it comes to reform, Mills said that nothing should be off the table.

That is Dicksons point as well. The best what next? is to expand the current argument on reforming workers compensation beyond capping benefits, he said. The issues [relating to] fixing the system are much more complex and entail changes in a lot of areas, many of which are still not being brought into the discussion. Like many others, he expressed exasperation with the tug-of-war: [A]s long as the argument is about who wins or loses on what reform should be, the system will not be fixed.