What is AB 5? From the Insurance Perspective

Much has been written about the infamous AB 5 of CA.

This is the law that clarifies whether a worker is an independent contractor or an employee, starting January 1st, 2020.

Every article I’ve read about the law approaches it from the wage and tax perspective, meaning:

An employer will categorize a worker as an independent contractor rather than an employee, saving the employer from paying the following payroll taxes:

  • Social Security Tax
  • Medicare Tax
  • Federal Income Tax
  • CA Income Tax
  • CA Disability Tax
  • Federal Unemployment Tax (FUTA)
  • CA Unemployment Tax (SUTA)…

… which will deprive the worker from receiving the following rights and protections:

  • Getting paid at least minimum wage (currently $100 per hour… that was a joke to see if you’re paying attention)
  • Getting overtime pay
  • Getting unemployment insurance
  • Being protected under the Fair Labor Standards Act (FLSA)
  • Being protected under the Americans with Disabilities Act (ADA)
  • Being protected under the Civil Rights Act

There is one thing that seems to go unnoticed in much of the discussion, and that is the insurance implications.

I will attempt to bring some clarity to this.

First, there will be many changes to commercial insurance as a result of independent contractors being re-categorized into employees, over many different policy types. But the biggest insurance issue as I see it is workers comp and that’s what I’m going to focus on.

So let’s clarify. Who has to have workers comp?

Answer: anyone with employees:

  • If you do not have employees, you do not have to have workers comp, legally. (Contractually? Maybe on some occasion. But legally? No.)
  • If you do have employees, you do have to have workers comp. (Even short term, part time, or temporary employees)
  • Since independent contractors are not employees, you do not have to cover independent contractors on workers comp.

The problem is that AB 5 redefines who is an employee and who is an independent contractor by the use of a three question test. In this new test, the answers all need to be YES in order for your worker in question to be an independent contractor. If any of the answers are NO, you have an employee. Let’s take a look.

  • 1) Is the worker free from control and direction of the hiring entity in connection with the performance of the work and in fact?  If YES, you have a potential Independent Contractor at this point.  Continue to #2. If NO, you have an employee. No need to go further.
  • 2) Does the worker perform work that is outside the usual course of the hiring entity’s business?  If YES, you still have a potential Independent Contractor at this point. Continue to #3.  If NO, you have an employee. No need to go further.
  • 3) Is the worker is customarily engaged in an independently established trade, occupation, or business of the same nature?  If YES, congratulations! You have an Independent Contractor.  If NO, you made it so far, but as it turns out, you have an employee.

While there can be debate about where a worker stands with each of the three questions, Question #2 is by far the muddiest and will undoubtedly leave us and our lawyers debating for decades, unless/until the law gets rewritten. Because what really constitutes “outside the usual course of the hiring entity’s business”?

  • A general contractor hiring subcontractors for electrical, drywall, or roofing in a new home build?
  • An avocado farmer hiring a farm labor contractor to maintain and harvest its avocado grove?
  • A winery hiring a bottling facility to bottle its wine?

Are these various roles considered inside or outside “the usual course of the hiring entity’s business”? Great question to which I don’t have an answer, just an opinion…. subject to change…. depending on the situation… and who’s claiming what.

So what’s happening is AB 5 will require businesses to have workers comp on workers that they previously thought were independent contractors.

As I see it, there are two categories of businesses that will be affected by this.

The first is the business that only utilizes independent contractors, and thus has never carried workers comp. They are going to run into two problems:

  • 1) As of January 1st, 2020, they are in violation of the law (yes, there are some exceptions to this date, but I’m trying to keep it simple). The ramifications for being caught without workers comp are ugly. I won’t get into the details, but you can read them on the Dept of Industrial Relations website here: Scroll down to “About Being Illegally Uninsured.”
  • 2) Depending on the size of the business and type of operations, this could be a major expense. Businesses that do the type of work where workers actually face risks of injury, such as construction, agriculture, and manufacturing, could have to pay a lot of money. The rates for construction, agriculture and manufacturing worker can easily hang around 10% of gross payroll. Yes, this is added on top of the employer’s payroll taxes!

The second category is businesses that have employees and thus already have workers comp in place:

  • 1) Fortunately, because they have workers comp, they’re not in violation of the law.
  • 2) Unfortunately, because they have workers comp, they are going to have to deal with their auditor on unexpected employee situations. The auditor will want to categorize every worker as an employee unless proven otherwise, per AB 5 guidelines. For example, let’s say the business is a metal pallet rack manufacturer and they outsource the powder coating to Steve the Powder Coating Guy. They will need to be prepared to potentially get stuck paying extra workers comp premium for Steve as he appears to be a “No” for Question #2 above, turning him into an employee.

So there it is: the insurance implications of AB 5.

I realize I haven’t given anyone any good news to this point. I will now try to deliver some, in the form of advice.

Here it is. Two things that you, the California employer, can do to protect yourself against surprise AB 5 insurance expenses.

  • 1) For those workers you consider independent contractors, get a written contract for their services along with an invoice from them. Don’t pay them hourly. Don’t try to control when they show up. Don’t provide them tools or equipment to use. And for the love of God, don’t try to micromanage them. A true independent contractor is his own man. He does the work for a negotiated fee, you approve and pay for it, you get a receipt, and you let him do his work. Don’t try to pretend that an employee is a independent contractor.  It won’t work.  And 1099ing a worker means nothing.
  • 2) Demand that those people that you consider independent contractors get their own insurance – both General Liability and Workers Comp (even if they don’t have any employees of their own). Get a Certificate of Insurance from them. Insurance auditors know that uninsured independent contractors are basically employees whose lawyers are always looking for ways to collect benefits from your workers comp. But if an independent contractor has his own insurance, the auditor knows that the insurer is highly unlikely to have to pay a claim on his behalf and is therefore highly unlikely to take an unfavorable interpretation of AB 5. (It’s another topic, but on the General Liability, it wouldn’t hurt to get Additional Insured endorsement from them too).

Lastly, some businesses are exempt from AB 5. You can read here on the Dept of Industrial Relations website to really get to know the law and find out if your industry is one of them:

Good luck and Godspeed.

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I’m the commercial producer and owner at Gillespie Insurance Services.



Posted on February 25, 2020 By Eli Gillespie

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