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Drawing the line between employees and contractors

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Workers compensation experts say employee misclassification continues to be a problem for insurers, but add there are steps employers can take to make sure they don’t mistakenly misclassify their workers.

Worker misclassification typically happens when employers classify workers as independent contractors rather than as employees who would be eligible for workers comp and other employee benefits.

Employers can avoid purchasing workers comp coverage for those workers by listing them as contractors, thereby falsely reducing their overall workers comp premiums.

“From the carrier side, our concern is making sure we are collecting premium for the risk we are covering,” said Mark Walls, Chicago-based vice president of communications and strategic analysis for Safety National Casualty Corp. “If someone is classified as an independent contractor, we are going to want to see those certificates of insurance proving that they are covered.

We also need to make sure they clearly pass as an independent contractor.” Mr. Walls was speaking at the International Risk Management Institute Inc.’s Construction Risk Conference in Orlando, Florida, last month. Other experts at the conference and in interviews also expressed concern about misclassification.

More than $22 billion in payroll is misclassified each year, said Bret Shroyer, Minneapolis-based vice president of services at Valen Analytics, which provides analytics and predictive modeling for the insurance industry.

Those misclassified wages translate into $1.2 billion in annual workers comp premiums that insurers aren’t collecting, or about 2.5% of overall comp premiums each year, Mr. Shroyer said. He adds that the statistic is based on workers comp policies that have been audited, and that the degree of misclassification on all policies that haven’t been audited in detail is unknown.

For companies that are found to have misclassified workers in a policy audit, insurers “face the risk of policyholders not paying the additional premium due post-audit,” among other risks, Mr. Shroyer said.

Experts say employee misclassification is most prevalent in the construction industry.

According to Mr. Shroyer, construction firms are 20% more likely than other industries to underestimate how much they should be paying in workers comp premiums.

Sonja Guenther, Denver-based vice president and workers compensation specialist at financial services firm IMA Financial Group Inc., said misclassification can happen when its unclear when workers are considered employees and when they are considered independent contractors. She said the distinction usually lies in whether a company has control over how a worker performs their job and “how substantially you have documented that control.” 

“From a litigation standpoint, here is how you get in trouble. You want to maintain control, so you call the person an independent contractor, but then you oversee their work every day,” said James E. Pocius, Moosic, Pennsylvania-based shareholder and workers comp defense attorney at law firm Marshall Dennehey Warner Coleman & Goggin P.C.

“The more control you exert, the better chance there is that the person is not an independent contractor,” Mr. Pocius added.

In addition to employer control over a person’s work, the Fair Labor Standards Act says that other factors can classify a worker as an employee instead of a contractor.

To prevent mistakes in how workers are classified, employers should make sure they understand and follow state laws regarding the issue, Ms. Guenther said. She added that one of the best defenses for employers is requiring independent contractors to carry their own workers comp policies when they sign a contract to perform work.

If a contractor claims to hold workers comp coverage, Mr. Walls said employers should request to see the contractor’s insurance certificate directly from their broker, rather than having it provided by the worker.

“That’s another aspect of the fraud. People will either forge the papers or cancel the policy after they provide you with the certificate. When you get the certificate from the broker, it reduces the opportunities for fraud,” Mr. Walls said.