RESCINDED AND INOPERATIVE

To:           All Insurance Companies Writing Workers Compensation Insurance

From:      Jay Angoff, Director

Re:          Treatment of limited liability (LLCs) for premium collection and audit purposes

Date:       January 23, 1996

BACKGROUND

The Missouri Department of Insurance has been asked by various insurers, agents, and employers to develop some general guidelines on how insurance companies should treat "limited liability companies" for purposes of workers' compensation premium calculations.

The limited liability company (or "LLC") is a new and increasingly popular form of business organization which combines certain advantages of a partnership with those of a corporation. The key characteristics of an LLC are that it has the flexible management and capital structure -- and can possess the tax status -- of a partnership while also possessing the limited liability status -- for its owners -- of a corporation. In Missouri, LLCs were sanctioned under Senate Bills 66 & 20, passed during the 1993 session of the General Assembly and effective December 1, 1993. These provisions where subsequently assigned to Sections 347.010 through 347.187 of Chapter 347 of the Revised Statutes of Missouri.

While these new statutory provisions outline the formation, structure and dissolution of LLCs, they do not address the issue of how the "members" who own and often operate these LLCs should be treated for purposes of workers' compensation insurance. This has led to some confusion in determining the proper payroll basis for the workers' compensation insurance premium to be charged an LLC.

Since the LLC possesses characteristics of both a partnership and a corporation, the problem is whether to treat the "members" of the LLC as partners of a partnership, as executive officers of a corporation, or as some combination of the two. If the members of the LLC are treated like the partners, the members' payroll would not be counted when determining the payroll basis for the premium calculation for the entity (unless the members actively "elect" such coverage under Section 287.035, RSMo). On the other hand, if the members of the LLC are treated like the executive officers of a corporation, their payroll would be counted in the premium calculation of the entity if they were actively employed, thereby adding to the total cost of the LLC's workers' compensation coverage.

THE DEPARTMENT'S RECOMMENDATION

Because Chapter 347 is silent on the matter, and because LLCs possess key characteristics of both partnerships and corporations, insurers could justify treating LLCs as either partnerships or corporations for purposes of establishing an LLC's payroll for workers' compensation premium-calculation purposes. However, while arguments can be made in support of either approach, the Department recommends that insurers treat the members of LLCs in the same manner as corporate executive officers entitled to coverage under the workers' compensation law, with their payrolls limited at the same levels as is currently the case for such executive officers (i.e., at a minimum of $213 for each week employed, capped at a maximum of $500 for each such week). However, in recognition of the fact that many LLCs may legitimately believe and argue that they ought not be required to cover their members in absence of a specific statutory mandate, the Department also recommends that individual members be allowed to opt out of such coverage, but only after amending their LLC's Organizational Agreement to permit such opt outs, and having the members reject coverage individually by signing the Rejection of Coverage Form set forth in Exhibit 1 of this Bulletin.

THE DEPARTMENT'S REASONING

The Department has reached this conclusion for the following reasons. The Department recognizes insurance companies will have legitimate concerns about what would happen if a member of an LLC presents a claim for compensation for a work-related injury or illness. The workers' compensation system will have to decide if the member meets the definition of an "employee" who is eligible for workers' compensation benefits.

It could be argued that an LLC member should not be entitled to benefits on the theory that he is an "owner" of the LLC and therefore an "employer." Certain Missouri cases have distinguished between "employees" who are statutorily entitled to benefits and "employers" who are required to provide these benefits. In the context of partnerships, the courts have concluded that partners are "owners" of the partnership; the partnership is not obligated to purchase workers' compensation insurance to cover them (unless the partners individually "elect" to be covered under Section 287.035, RSMo).

However, the workers' compensation system has a presumption in favor of concluding that an injured worker is an "employee." In the context of corporations, while inactive shareholders are considered to be the "owners" of the corporation, whereby the corporation is not obligated to cover them, shareholders who are active in the corporation and exposed to the hazards of the occupation are considered "employees" entitled to coverage, even in the case of the small, closely-held corporation where the corporation is merely the "alter ego" of the corporate officer.

It could be argued that the "corporate officer" analogy is inappropriate because Section 287.020, RSMo, was amended in 1967 to specifically include executive officers of corporations within the statute's definition of the term "employee." The same cannot be said for the statutes regarding the members of LLCs. Without clear statutory guidance, it could be argued that underwriters and regulators should therefore proceed in a traditional case-by-case approach, using such legal doctrines as the "controllable services test" or the "relative nature of the work test" to decide whether individual LLC members constitute "employees" for purposes of The Workers' Compensation Law. The courts have analyzed any number of different factors associated with work relationships in applying these tests, such as the right to control the manner and means of the worker's services, the duration of the work relationship, the method of payment, the right to fire the worker, and so forth.

Because of the number of potential factors to be analyzed, the Department believes that an insurance company underwriter would have a very difficult task in determining whether individual LLC members should be treated as employees for premium calculation purposes. And, even after looking at all the possible factors, the underwriter would still only be making an educated guess as to how an administrative law judge or a court would ultimately rule given those same factors should a claim be filed by an LLC member. In addition, such an underwriting process would produce inconsistencies from one underwriter to another.

Rather than encouraging insurers to proceed on a case-by-case basis, the Department feels the best way to handle this is to presume that active LLC members are "employees" and to count their payroll for premium calculation purposes in the same manner as is done for executive officers of corporations, while at the same time suggesting to insurers that they make available the option of allowing individual members to opt out of such an "employee" status (for workers' compensation purposes), if it can be shown that the LLC's Operating Agreement allows such "opt outs" and the individual members choosing to opt out document such a decision on a standardized form (Exhibit I) after being fully informed about the consequences of option.

RECOMMENDED PROCEDURES FOR CALCULATING THE PAYROLL OF LLC MEMBERS

The Department recommends that the payroll level for each LLC member be determined under the same rules as are used for corporate executive officers under the Rules V and IX of the NCCI's Basic Manual. Payroll shall be based on the Manual's definition of "remuneration," which lists a number of types of pay or its equivalents to be included or excluded. (Of particular note in the context of LLCs is the inclusion of " payment to employees on any basis other than time worked, such as piecework, profit sharing, or incentive plans.") In addition, the payroll limitation for executive officers should also be applied.

It could be argued that the Department's recommendation to presume members should be counted for premium calculation purposes is appropriate only for "active" members who are subject to the hazards of the employer's occupation or industry, as the courts have concluded is the rule for executive officers of a corporation. While the Department agrees with this conclusion, we recommend that "inactive" members be added to the Rejection of Coverage Form attached as Exhibit I, and be designated on them as "inactive" in the space provided, at least until a definitive treatment of such members is established by statute or case law. Such a designation on the rejection form clearly documents the understandings of the LLC and any inactive members to their insurer. Insurers should apply the same standards of the Basic Manual's Underwriting Guide for the treatment of executive officers to LLC members as well, to determine which members are so inactive that their payroll should not counted. (See current page G34 of the Basic Manual. The same standards will be located at Rule V.F.4. of the revised Basic Manual to become effective April 1, 1996.)

THE DEPARTMENT'S RECOMMENDED "OPT OUT" PROCEDURE

The Department recommends that two separate forms be used to document the decision of individual LLC members to opt themselves out of coverage under The Workers' Compensation Law. A "Rejection of Coverage Form" such as that contained in Exhibit 1 should be filled out by the LLC members wishing to opt out of coverage in those LLCs which have authorized such opt outs in their Operating Agreements. Once completed, the Rejection of Coverage Form should be transmitted to the insurer (as well as a copy of the Operating Agreement, if requested), which should retain the form in its files and which should use the form to execute a "Missouri LLC Member Rejection Endorsement" as set forth in Exhibit II. Ideally, an LLC should deliver a completed Rejection of Coverage Form to the insurer prior to the issuance of an original policy or the renewal of an existing policy. Individual insurers may permit a longer period (e.g. up until 30 days of the policy effective date) at their own discretion. Decisions by members subsequently added to the LLC should be communicated to the insurer as soon as possible. Insurers should issue an amended endorsement documenting any such deletions within 60 days, unless otherwise agreed to by the insurer and the employer, as per regulation 20 CSR 500-6.500. The Department also recommends that the Rejection of Coverage Form and the endorsement set forth in Exhibits I and II be re-executed annually, prior to or soon after the commencement of each new policy period.

CONCLUSION

The Department feels this approach has the following advantages:

• It is consistent with the statutory and case law presumptions in favor of finding that benefits are available to injured workers.
• It advances the public policy of spreading the losses associated with economic behavior by encouraging a wider extent of coverage.
• It protects the assets of LLCs from the potential of major out-of-pocket claim costs by assuring the existence of workers' compensation insurance prior to any claims.
• It avoids discouraging the formation of LLCs due to the cost of worker's compensation coverage by permitting LLCs to allow their individual members to opt out, assuming the insurer is willing to agree, and by capping the payroll of members in the sane manner as it is capped for corporate executives.
• It allows insurers to collect a level of premiums to cover potential future claims by LLC members.
• It provides a uniform manner for members to opt out of coverage through the use of a standardized endorsement form.
• It reduces the potential that agents will be sued under their Errors and Omissions policies for failure to inform LLCs and their members of the lack of coverage for members under alternative approaches.
• It provides a compromise methodology until a clear statutory provision is enacted.

The main "unknown" about such an approach is that no one can know how administrative law judges and the courts will treat this issue. Our assumption is that the conclusion will be that active LLC members are entitled to coverage, which is why we believe insurers should be allowed to collect premiums for such members.

How the judges deal with this entitlement issue for those members who have gone through the recommended opt-out procedure is more problematic, and insurers who decide to allow opt-outs should proceed with caution. As such, this Bulletin is "advisory" in nature only. This Bulletin represents the Department's best advice on a consistent approach for the insurance companies to use at this point in time to protect themselves should they decide to permit LLCs to opt out. Should ALJ or court decisions (or a clarification of the statutes) necessitate a different approach, this Bulletin will be amended. For now, however, underwriting judgment should be exercised by the insurer regarding potential candidates for the opt-out procedure. (Underwriting discretion regarding the issue is specifically authorized for the Contract Carrier under the Department's Alternative Residual Market Plan.)

The Department has been in contact with representatives of the Missouri Bar Association on this issue. The Bar Association was a prime proponent of the passage of Senate Bills 66 and 20 on LLCs, and is currently working on amendatory language for future legislation. Insurers wishing to comment on this matter should call Mark Doerner of the Department's P&C Section, (314) 751-3365. Insurers may wish to use this Bulletin to help explain their premium calculation methodologies to a particular LLC.

ADDENDUM TO BULLETIN 96-02

January 25, 1996

Before the Department could complete its mass mailing of Bulletin 96-02 to Missouri's Workers' Compensation insurers, several questions were raised which the staff felt deserved comment:

• Although this Bulletin is only "advisory" in nature, it should still be treated as applying "prospectively." Insurers who have previously underwritten LLCs without collecting premium on the LLC's members are not being encouraged to do so after the effective date of the policy, such as at audit. Attempts at such collections will doubtless generate complaints from LLCs which have not budgeted for such premiums; retrospective underwriting is seldom appreciated, especially by those insureds against whom no claims have been filed during the policy period.
• Those insurers deciding to charge premium for LLC members on a prospective basis should communicate the Bulletin's "opt out" option to the LLC at renewal.
• While the staff feels encouraging specific "opt out" language in an LLC's Operating Agreement is an important safeguard for insurers, documentation of that portion of the Operating Agreement should be sufficient; requiring the text of the entire agreement could be burdensome to both the LLC and the insurer attempting to keep it on file.
• Should an insurer decide to allow members of an LLC with an oral operating agreement to opt out, the Rejection of Coverage Form (For Oral Operating Agreements), attached as Exhibit III, can be used.
• Finally, it should be pointed out that the Department's suggestion that the Operating Agreement be amended is merely one method by which an LLC could document that it has informed its members of their status and options. In the alternative, for example, a statement on LLC letterhead, signed by an "authorized person" (see Chapter 347), indicating that "Each member of the LLC has been informed of the contents of Bulletin 96-02; those opting out are listed below:", followed by a list of the opting members' names, signatures and dates, similar to Exhibit I, would also be acceptable.

EXHIBITS