Most contractors I know seem to recoil in fear or get very angry when anyone mentions the two words “workers’ comp”. While it’s a topic dreaded by many, as a general contractor you need to know the rules around workers’ compensation in order to make sure you’re in compliance with state regulations. Every state is a little different, so for the purposes of this article we've focused on our home state of Vermont. We’ll break it down into the key information you need to know.
What is workers’ compensation?
Workers’ Compensation provides payment for medical treatment necessary to treat a work injury, and provides wage replacement benefits if the injury prevents the worker from working. However, workers' comp is more than just income insurance, because it compensates for lost wages, medical expenses, and provides benefits to dependents of workers killed during employment. Workers’ comp is regulated by the state Department of Labor and Department of Financial Regulation which require that businesses purchase a policy for the benefit of their employees.
Do I really need it?
If you are a sole proprietor, and you do not have any employees or independent contractors performing work that is an integral part of your business, you’ll need to decide whether you want to purchase a policy to cover yourself (and your subs―see below). Typically, if you as a business owner are injured on the jobsite and cannot work, and you have health insurance, then your health insurance will cover any medical costs. Beware, some health insurance companies will not cover work injuries, so be sure to check with your health insurer. However, you’ll still be responsible for the deductible and you will not be covered for lost wages. For that you’ll need a Disability Insurance policy. There are many flavors of DI―short term, long term, and even Business Overhead Expense (BOE) insurance which can help to cover the costs of your business overhead if you are injured.
If you ever have anyone working for you, even on a temporary basis, workers’ compensation coverage is required for ALL employment, and employers are liable for anyone they hire, including independent contractors and subcontractors if they are deemed employees under state law. If you hire a subcontractor or independent contractor and they cannot supply you with proof of workers’ comp insurance, then you are required to cover them via your policy.
If you are often working as a sub to someone else, you can purchase your own WC policy, and exclude yourself. This will allow you to show proof of WC coverage to people who want to hire you. For construction related contractors in Vermont, the average minimum policy is around $1,100, but this can vary widely from state to state. In this scenario, the general contractor that hires you may still be liable if they control the sub (tell you when to arrive and leave, what to do and how to do it).
But I thought they were an independent contractor?
A company that provides workers’ comp coverage to its employees will need to provide the same coverage to anyone that is hired to perform the work of the business. The Vermont Department of Labor calls this the nature of the business test. Under Vermont law anyone hired to perform the work or services that the business provides is an employee by law even if you hire them as an independent contractor . The rules and tests the State uses to determine employee status are clearly outlined on the Vermont Department of Labor website under the workers’ compensation section along with numerous examples. If you hire subcontractors or independent contractors for a job, you need to require that they provide proof of workers’ compensation insurance, otherwise you are legally responsible to provide the coverage and your insurer will charge you for them. If the independent contractors you hire can pass ALL of the State’s tests of not being employees, then you are not responsible for providing workers’ compensation for them.
Getting Certificates of Insurance from your subs
The first step is making sure any sub who will be issued a 1099 at the end of the year has provided you with a Certificate of Insurance. But you can’t just file it away- you need to look at it! Make sure the certificates show workers’ compensation coverage is being provided. You'd be surprised how many small contractors have general liability coverage but no workers’ compensation coverage. Also check the dates―certificates of insurance must cover the period when the subcontractor worked for you, and should be updated annually for people you work with on an ongoing basis. We suggested collecting this paperwork prior to hiring the sub to do the work. If you have a subcontractor agreement, make sure that carrying liability insurance and workers’ comp is a condition to the agreement. If you don’t get certificates of insurance, you will be charged for subcontractors by your insurer as if they were your employees both for liability and workers’ compensation coverages.
Getting started with workers’ comp
Unfortunately, when you go to take out your first workers’ comp policy, since you have no history to show, you may be in an “assigned risk pool” which can mean a higher premium, less choice of insurers who are willing to offer you a policy, and possibly being required to pay the whole year’s premium up front. After a few years with no injury or accident, you can graduate to a carrier who offers you a payment plan and more civilized audit processes.
How can I minimize the cost of workers’ comp insurance?
The #1 factor in determining your workers’ comp rates is how your employees are classified. Different types of work have different levels of risk. For example, an office manager or clerical position might cost around $0.40 per hundred dollars of payroll. But on the higher end, a high-risk category like roofing or ironwork could carry a rate of around $25.00 per hundred dollars of payroll. For general contractors it may be useful to distinguish between carpentry and millwork as these categories carry different rates.
Make sure you have set up your payroll reports so that you can break out hours and dollars paid by classification code. If you use QuickBooks, you can set this up under Payroll Items. If the payroll records do not document the hours spent in each kind of work, all the employee’s payroll will go into the most expensive classification applicable. You’ll also need to be able to break out any Overtime from regular wages. A little extra effort in time tracking and documentation could save you big bucks when it comes time for your audit.
Safety is the #2 factor in determining your insurance rates. If you have fewer claims, your rates will be materially lower than if you do have claims. The insurance rate depends upon the employer’s payroll, experience rating and the type of work performed. A work injury can affect an employer’s safety record and experience rating for a 3-year period. Too many claims, and your options for coverage may be limited to the assigned risk pool.
Every year your insurance company will do what’s often called a “premium” or “payroll audit” to review your total payroll after the policy term ends. This can be either in the form of a voluntary audit (a form to fill out and send back in that will adjust your rates for the policy year just ended), or an in-person audit where someone from the insurer shows up at your office to go through all your records. If you are paying more than $10,000 a year for your policy, you can expect to get an in-person visit each year. At that point, you’ll need certificates of insurance documenting that any 1099 subcontractors have their own workers' compensation insurance. If you can’t provide those certificates then you will be liable. This will mean a hefty retroactive payment to the insurance company and higher rates for the coming year.
Another useful tip to prevent surprises at the end of the year is to review your WC policy quarterly against your actual payroll. Then your insurance agent can adjust your payments along the way if you’ve had significant changes in the number of employees on your crew. You don’t want to overpay if you have lost employees, and if you hired a bunch of new positions halfway through the year, you don’t want to be surprised by a big bill after the audit. Some insurers offer a pay as you go system where you pay workers comp premiums each payroll according to actual wages paid.
When you purchase a new policy, make sure you understand up front what their audit requirements will be so you can be sure your bookkeeping systems are tracking all the critical information they will need at the end of the year.
Working in multiple states
If you work in multiple states, workers’ comp can get pretty complicated pretty fast. Each state has its own regulations, and if you are in the assigned risk pool you may need separate policies for each state you work in. And you’ll need to be able to split out your payroll records by hours worked and wages earned in each state.
What about Unemployment Insurance?
So far, we’ve been talking exclusively about workers’ compensation insurance, which is mainly an issue between you, your insurance agent, and your insurance company. But the Vermont Department of Labor is also responsible for tracking down cases where businesses have not been complying with state law regarding workers’ compensation and unemployment insurance (UI). The issue is around who is considered an employee vs. who is considered an independent contractor. The guidelines are different both at the federal and at the state level, and the criteria are different for WC and UI. In short, it’s confusing. (For details, see the Vermont Department of Labor website.) The VT Legislature is currently considering a couple of bills which would help clarify the criteria, so stay tuned for more details on that.
What’s the risk of non-compliance?
A labor department auditor or investigator could show up unannounced on one of your job sites, and a DOL audit could take months to complete, possibly resulting in thousands of dollars of penalties or assessments of past due contributions. An Unemployment Insurance (UI) audit may take considerable time, but a workers’ comp investigation is usually completed in a matter of weeks or months. The workers’ comp penalties are higher than the UI penalties, and are in addition to having to purchase workers’ comp insurance. Why do so many companies take the risk? Businesses can save up to 30 percent on labor expenses by classifying workers as independent contractors rather than employees. The construction industry is under the microscope due to a long history of not correctly classifying employees. The chances are you will have to deal with this at some point, so bite the bullet, make sure all your employees are on payroll, check that all your subs are carrying workers’ comp, and you can be confident you’re in compliance. The other risk is that if no workers’ compensation benefits are received, there’s no limitation on the injured worker’s ability to sue your business for whatever damages the court will award as well as your being responsible to pay all the benefits the worker would have been entitled to under workers’ comp. You might be trading immediate savings on your workers' compensation premium for exposure to legal damages which could easily exceed the normal general liability policy limit of $1,000,000. And if an employer has no workers’ comp and a worker is injured, the employer is personally liable to the employee for medical benefits, wage replacement, and any permanent disability caused by the injury.
But my workers want to be considered subs
Often employers will say that their workers are unwilling to go on payroll as employees. They prefer the higher hourly wage they can get as a subcontractor. We will often use our Labor Burden Calculator to show employees that their total income is often higher as employees since they do not have to pay self-employment taxes and insurance, and as employees they are often eligible for paid vacation, sick time or other benefits. If they still insist on being considered a sub, make sure you’re calculating your cost to cover them under your workers’ comp (if they don’t have their own policy). In addition, make sure that you have a contract for each job, that they submit invoices for work completed (not hourly time sheets), and that you can prove that they also work for other contractors, that they are highly skilled and not supervised by you, make their own hours and use their own tools. Contracting only with subcontractors who have formed a business entity such as an LLC or corporation is a good way to protect yourself against an assessment for unemployment insurance taxes as the result of an audit.
At the end of the day
Navigating the world of workers’ comp is complex and can be aggravating and expensive. But once you understand the rules of the road, you can set up a system that protects your employees and your business. As more businesses in the construction industry come into compliance, it will mean a more level playing field for all of us.
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This blog post is based on research and interviews with a variety of insurance providers, general contractors, and state of Vermont department representatives. HELM cannot be held responsible for the legality or accuracy of this information, as it changes over time and varies from state to state. For detailed information relevant to your state, please contact an insurance agent or legal professional.