The insurance industry loses more than $100 million per year in premiums when misclassified workers are added onto workers’ compensation policies. This RIMS 2016 session discussed the issues related to employee misclassification, including state and federal action on this matter and the impact on employer and insurer costs and risk.
– Stephanie Watts, Resolution Manager, Gallagher Bassett
– John Zeigler, Attorney at Law, Marshall, Dennehey, Warner, Coleman & Goggin
The government has determined that many employers are misclassifying workers as independent contractors in an effort to avoid obligations to pay minimum wages and overtime, as well as unemployment, payroll, workers’ compensation and Social Security taxes. It is estimated that, out of 10 million independent contractors, 30% are misclassified.
Employee misclassification creates an uneven playing field for employers who properly classify their workers, uneven protections and benefits for workers in otherwise similar work environments (i.e. workers’ compensation), and uncertain risks and exposure for insurers in regards to accidents and injuries.
The U.S. Department of Labor Economic Realities Test
This test asks a series of questions to define whether a worker is an employee or independent contractor under the FLSA.
1. The extent to which the work performed is an integral part of the employer’s business. It is more likely that the worker is economically dependent on the employer and less likely that the worker is in business for himself or herself.
2. Whether the worker’s managerial skills affect his or her opportunity for profit and loss. Managerial skill may be indicated by the hiring and supervision of workers or by investment in equipment.
3. The relative investments in facilities and equipment by the worker and the employer. If a worker’s business investment compares favorably enough to the employer’s that they appear to be sharing risk of loss, this factor indicates that the worker may be an independent contractor.
4. The worker’s skill and initiative. To indicate possible independent contractor status, the worker’s skills should demonstrate that he or she exercises independent business judgment. In addition, the fact that a worker is in open market competition with others would suggest independent contractor status.
5. The permanency of the worker’s relationship with the employer. Permanency suggests that the worker is an employee, however, a worker’s lack of a permanent relationship with the employer does not always necessarily suggest independent contractor status because the impermanent relationship may be due to industry-specific factors or that an employer routinely uses staffing agencies.
6. The nature and degree of control by the employer. Analysis of this factor includes who sets pay amounts and work hours and who determines how the work is performed, as well as whether the worker is free to work for others and hire helpers. An independent contractor generally works free from control by the employer (or anyone else, including the employer’s clients). This is a complex factor that warrants careful review.
Risks of Employee Misclassification
There are significant risks to both the employer and insurance carrier.
Employer risks include:
- Payment of back wages.
- Civil penalties.
- Criminal prosecution.
- Stop work orders.
Insurer risks include:
- Uncertain workers’ compensation distributions relative to premiums collected.
- Differences in policies relative to state standards/regulation.
- Possible unintended liability exposure and risk.
- Unrealized revenue from employers impacted from misclassification enforcement.
Ways to minimize risk:
- Avoid contracting with former employees.
- Limited contractor access to employer facilities.
- Avoid use of uniforms, business cards.
- Contractors working off site of under their own on-site management.
- Contractors self trained or trained elsewhere.
- Project specific work with limited duration.
- Use of staffing agency.
- Clear and concise independent contractor agreements.
- Periodic self audits.