Beware: On-Demand Company Workers Compensation Costs
COO & Co-Founder
COO & Co-Founder
Update: We’ve released a new whitepaper examining the Sharing Economy industry. We dive into the insurance landscape, legal climate and how to approach risk management for companies in this sector. You can download the report here!
It’s no secret that independent contractors (or “1099s”) are a great tool when a company needs a flexible workforce to match demand. Businesses have been using this secret weapon forever! In the modern era, there are tons of benefits to using independent contractors:
Sounds great, right? Traditionally it works really well, but the rise of the on-demand economy threw everyone for a loop. Things got complicated because of the shift in the arrangement companies have with independent contractors.
Companies have to pay taxes and insurance premiums on employees because it’s understood that as an employer, the company is responsible for both the actions and well-being of that employee.
The relationship with an independent contractor is different. Traditionally, using an independent contractor meant working with an individual or company that had it’s own operation. Traditionally, a contractor came in to do a specific project, and when finished, their job was complete. The logical assumption that arises from this type of relationship is that contractors carry their own insurance to project their independently operating business, and that’s where the challenge of the on-demand economy lies.
If you’re a founder of an on-demand company, you know the modern arrangement isn’t quite the same. Tech-enabled consumer services companies (think Juno, Cleanly, Trustify, Shipt…) now use armies of contractors coordinated by incredible tech to provide superior customer experience at a fraction of the labor cost. With the new model, companies like this can leverage mass quantities of labor at their convenience to match customer demand.
If you think it’s too good to be true, you’re [potentially] right. In theory it’s a perfect solution to scaling a services company, but there are some pitfalls in the cost model. These pitfalls arise predominantly from the legal distinction of “employee” vs “independent contractor.”
The problem is that there’s no one legal definition that makes the distinction black and white. Rather, it comes down to a factor test to determine whether or not the independent contractor is truly that. The factor tests focus around the level of control the company has over the contractor/employee for the reasons discussed above. California’s test is probably one of the most helpful for understanding what’s needed to create the distinction, and New York’s test is pretty robust as well. The determination usually comes down to:
Given the way that many on-demand companies operate, creating this distinction can get very, very messy. There are conflicting forces pulling at the seams of these companies, balancing branding, customer experience, and cost models with legal compliance and general corporate responsibility. Add the fact that the treatment of 1099 economy independent contractors is a hot button issue right now, and it can be quite a headache for on-demand companies. State regulators have already stepped in (the Uber independent contractor lawsuit, for example), and there’s uncertainty about how things will unfold moving forward.
Now to tie it all into on-demand company insurance pricing, specifically workers compensation insurance:
So there’s the problem: if you’re not careful, you can be on the hook for a HUGE audit bill. It’s not uncommon for successful on-demand companies to have massive paystubs associated with independent contractors on their platform, so this becomes a very big issue very quickly.
Unfortunately this is, by definition, a very grey area given legal background. Different tests in different states make it impossible to nail down a bulletproof solution, but here are some things we’ve seen give clients an edge in this difficult legal landscape.
When you’re using independent contractors, review the applicable statutes & regulations in your state, chat with a good lawyer, and make sure you’re doing everything you can to make it clear that it is an independent contractor relationship. The more you can stand on the right side of the compliance regime, the less likelihood of a state regulator coming in and giving you a D&O claim headache.
This isn’t always a feasible option because of the way the model works, but it’s worth analyzing whether or not converting to W2s will actually save you money in the long run and potentially boost morale, even leading to better recruitment and retention. We can help calculate from the insurance side, but again it is a good idea to engage a labor law expert (and probably a tax accountant) to understand the full costs of withholding and employment taxes.
This is probably the most useful and least obvious one. We’ve seen a lot of success when companies separate their workforce: the parent entity houses employees that you’d think are those traditionally employees by a tech company: engineers, designers, executives, salespersons, and other “office” employees. The company then forms a separate wholly-owned subsidiary to either pay the contractors or employ the “field” W2s (depending on the choice of option #1 or #2 above).
Either way, there’s an advantage in separating the liability. Let’s use the example of on-demand food & booze delivery.
If you’re using W2s, you’d employ the delivery personnel via the subsidiary you’ve formed. Beyond just adding an extra layer of liability protection (it’s literally a separate company), you can now actually have a separate handbook for delivery employees where they have to complete TIPS training or take safe driving classes. This will likely lower your insurance premiums and create a safer workforce.
If this on-demand company used independent contractors and use best practices for hiring 1099s as outlined by state law, this extra separation simply adds to their case should a) a state regulator sue, the state workers compensation board attempts to issue fines, or b) an insurance company attempts to audit for extra premium.
Whether using W2s or 1099s, this structure will help the parent company avoid a big audit bill and allow the company to get a cheaper policy for the office employees. Insurance companies are more willing to cover the plain vanilla office exposure when the high risk employees (or uninsured contractors) are out of the underwriting picture. You’ll still have to go to specialty markets for the high risk employees, but under this regime, at least the office employees won’t be subjected to those more expensive rates.
Independent contractors have been used by companies forever, but the massive growth of the 1099 economy turned things into the wild west. While there’s no perfect fix here, we think these are some tips to start down the right path. Talk to your lawyer for more tips to make sure you’re on the right side of employment law, and talk to us for any help on the insurance side. We can be found at email@example.com or (646)-854-1058.
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**This post is for informational purposes and should not be considered legal advice. Be sure to consult an attorney!**
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