Labor Department Has New Test For Independent Contractors

The U.S. Department of Labor has issued a new test for determining whether a worker is an employee or an independent contractor. The six part test focuses on these criteria:

Is the Work an Integral Part of the Employer’s Business?
Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?
How Does the Worker’s Relative Investment Compare to the Employer’s Investment
Does the Work Performed Require Special Skill and Initiative?
Is the Relationship between the Worker and the Employer Permanent or Indefinite?
What is the Nature and Degree of the Employer’s Control?

The entire Department of Labor memo can be found here.

A more detailed examination of this test can also be found at the Insurance Journal.

This issue can have great importance to employers and their Workers Compensation insurance premiums, as often employers think that paying a worker via a 1099 rather than a W-2 basis means they don't have to pay Workers Compensation insurance premiums for that worker. In most states, this is wrong, and can lead to very unpleasant surprises when the audit is done at the conclusion of a policy. In fact, this is one of the common causes of what we call "Shock Audits", where the audit bill is unexpectedly much greater than the employer anticipated.

Of course, not all employers are acting out of ignorance when they try to change workers to independent contractors. A story in the Wall Street Journal on June 30 described how some companies try to reduce costs by trying to turn employees into independent contractors.

For those who can't get through the WSJ paywall, here's an excerpt from the article by Laura Weber:

"Employers have long shifted work from employees to independent contractors, often relabeling the workers and slightly altering the conditions of their work, court documents and settlements indicate. Now, businesses are turning to other kinds of employment relationships, such as setting up workers as franchisees or owners of limited liability companies, which helps to shield businesses from tax and labor statutes.

In response, some state and federal agencies are aggressively clamping down on such arrangements, passing local legislation, filing briefs in workers’ own lawsuits, and closely tracking the spread of what they see as questionable employment models.

All this is happening against the backdrop of a broader shifting of risk from employers to workers, who shoulder an increasing share of responsibility for everything from health-insurance premiums to retirement income to job security. Alleged misclassification of workers has been one of the primary battlegrounds of this shift, leading to high-profile lawsuits against Uber Technologies Inc. and FedEx Corp., among others. Both have recently lost or settled big cases. Uber is appealing one decision, and FedEx settled in California for $228 million but is continuing to challenge classification lawsuits in other states."

Competitive Pricing for Workers Compensation Insurance Needs Effective Regulatory Oversight

Recently, a former director of the Illinois Department of Insurance has written that proposed modest regulation of Workers Compensation insurance rates would produce undesirable results for the business community. With all due respect, I think the director is wrong. Here's why.

The theory of price competition is that the marketplace will enable consumers (in this case, employers who have to buy Workers Comp insurance) to see which insurer has the best price, and therefore make a ration decision and in the process exert control over insurance pricing (the more expensive insurers will lose business and be incentivized to reduce rates).

Couple of problems with that. One, the rules that govern computation of Workers Comp insurance premiums are dauntingly complex, and are largely written by the insurance industry itself. So there are ample opportunities for insurance underwriters and agents to "low ball" insurance proposals, making it seem that one insurer's cost is lower when it ultimately will not be.

The other problem is that the ultimate cost of Workers Comp insurance isn't known at the time the buying decision is made. When it starts, the premium is just an estimate. The real cost of the policy won't be known until after the policy ends, usually a year later. That's when the insurer does an audit, and determines what the insurance actually costs. And sometimes those audits can be much, much higher than the original estimate.

That's why effective insurance rate and premium regulation is so important for the business community. Left completely to their own devices, insurance company underwriters and auditors have a natural bias for higher premium charges. Sometimes they're right about that. But sometimes those higher premiums are based on, shall we say, somewhat self-serving interpretations of the rules.

In Illinois, our Department of Insurance has seen an exodus of personnel who were experienced and knowledgeable about Workers Compensation insurance pricing. And there has been a huge reduction in staff at the department over the course of the last decade as well, so the remaining staff are generally overworked and stressed. And the people who knew about Workers Comp premium issues are pretty much all gone, anyway. That's not to say that those who remain cannot help employers with disputes over Workers Comp premiums, but it does mean that the agency is having a harder time providing knowledgeable and effective oversight in this area.

Illinois is far from alone in this regard. In many states, the ability of insurance regulators to provide genuine an effective assistance in disputes over Workers Comp insurance premiums is limited, at best.

Competitive pricing of Workers Comp insurance does likely provide benefits to employers. But without genuinely effective regulatory oversight, those benefits can often be illusory.