Carve-Out Policies: Are You Really Protected?

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The removal or “carve out” of workers’ compensation exposure under the PEO client service agreement is a common practice in our industry. This is simply a re-allocation or assignment of risk to a worksite employer of the exposure for work-related injuries.  Unfortunately, many misunderstand carve-out policies and how to best mitigate liability associated with allowing a client to maintain a policy without proper endorsements. 

First, let’s define what our industry refers to as a workers’ compensation “carve -out” policy. There are various ways a PEO can partner with a client under a co-employment model as it relates to workers’ compensation responsibility. The common ways are under a master policy, multiple coordinated policy, or carve-out (client based policy). Today, we will focus on carve outs. 

There are times when it may be in the best interest of the worksite employer or PEO to contract under a co-employment agreement while allowing the client to maintain a workers’ compensation policy as the principal insured. In this case, the work-site employees are co-employed (under the PEO’s FEIN#), while the client is the named insured under a workers’ compensation policy (client FEIN#).

As a PEO, it’s imperative that you protect your interests by clearly defining whose responsibility it is to obtain workers’ compensation for the co-employees through verbiage in your client service agreement (CSA) or an addendum to your CSA. In addition, it is highly recommended you require to be endorsed as an Alternate Employer (AEE) under the clients’ policy. Too often, we find carve out policies where the PEO is not listed as an alternate employer – and this can create confusion if a claim were to occur.  

The International Risk Management Institute (IRMI) defines an Alternate Employer Endorsement as:

“An endorsement added to a workers’ compensation policy that provides an entity scheduled as an alternate employer with primary workers compensation and employer’s liability coverage as if it were an insured under the policy.”

Please keep in mind that workers’ compensation regulations vary by state.  Therefore, it is imperative you verify that the state your client and/or WSE’s are domiciled will allow co-employed carve-out coverage. It is also imperative that the applicable endorsements including alternate employer be approved in that state as well.  All but four states (non-monopolistic) have approved usage of the AEE.  Contact us for a full list of states and approved endorsements.

There can be challenges with obtaining an AEE on a client-based policy, as most carriers will not underwrite a client-based policy knowing the employees are co-employed.  In fact, we’ve had to educate many carriers on the purpose and reasoning behind the usage of the AEE.

Naturally, the alternative to a carve-out is to not co-employ and offer an Administrative Service (ASO) solution where the WSE’s wages are filed under the client’s FEIN#. In this scenario, an AEE is not necessary as a co-employment relationship does not exist.  

There is much more that can be discussed on this subject and other PEO-related endorsements. As always, feel free to reach out to your Stonehenge team if you have additional questions related to this subject or other PEO-centric topics.