Why Workers Compensation Insurance Companies are Afraid of Independent and Subcontractors –

A perennial thorn in the side of workers compensation insurance carriers is the notion of an employer who uses subcontractors in their business. This paranoia stems from an insurance carriers often misdirected desire to know all risks associated with a new insured. Blurred lines between employees and independent or subcontractors always seem to cause workers comp insurance carriers to gasp for breath. In this post we’ll try and answer the question: “Why are insurance companies afraid of independent and subcontractors?”

We all know the world is full of unknowns. Most of us, being the control freaks we are, find that notion a bit difficult to deal. We’ve been taught that unknowns are dangerous, unpredictable and unwary. Having control and knowing at every step just where we are, where we’re going and what we’re doing is the right thing. That the unknown equates to the unpredictable. Well, insurance companies are no different.

Insurance companies fear the unknown. At every turn, you’ll find they’ve invested great amounts of capital and human resources to the single practice of prediction. Prediction of future accidents to come, the sources and reasons that accidents occur and the requirements and practices required to avoid having those future accidents come true. In other words, insurance companies invest huge amounts of money in predicting the future, identifying risk, identifying the cause of occurrences and developing an understanding of what steps need to be put in place to mitigate that risk.

To understand this obsession a little better you need only to look at the use of predictive modeling that most insurance companies use today in front line underwriting. Not a new concept by any means, however it seems that within the last decade predictive modeling has taken over the insurance industry. Developed as an underwriting tool, predictive modeling provides an in-depth analysis of an insurance carriers risk tolerance points. These statistical tools allow an insurance company to identify areas of success (where they make money) and areas of failure (where they lose money.)

You might say that predictive modeling has become the crystal ball of the insurance industry!

So, when an insurance company looks into their workers compensation crystal ball all they see, when it comes to independent contractors and subcontractors, is trouble with a capital T!

Direct employees provide a certain level of predictability and comfort for the insurance company. From an insurance company stand point they believe the insured or employer has much better control over the activities of a direct employee. So the first thing to keep in mind is that a workers compensation insurance company wants to see all work processes of a business they insure being conducted by direct employees.

Here are a few reasons for this:

  • It’s easier to properly identify direct employees;
  • Supporting payroll records are available from the employer;
  • Payroll tax documents can be used to verify reported payroll for audit purposes;
  • Employees are under the direct control of the employer;
  • Lost wage documentation is readily available if a claim should occur;
  • Direct employees have gone through training;
  • Direct employees follow the employer’s safety procedures;
  • Direct employees are usually assigned to a specific work location;
  • Direct employee work processes are easier to identify;

The use of independent contractors and subcontractors by insured business owners creates a certain level of unpredictability and uncertainty for a workers comp insurance company. Remember it’s unpredictability that gets under the skin of a workers comp insurance company. Actually that could apply to any insurance company!

Here’s a few reasons why:

  • It’s more difficult to properly identify independent and sub-contractors;
  • Verification of remuneration paid to independent and sub-contractors is more difficult to obtain;
  • Insurance carriers maintain a belief that independent and sub-contractors operate outside the control of an employer;
  • Safety training for the independent contractor’s employees is unknown;

Another, possibly more realistic, issue regarding this employee vs. non-employee situation is the fact that an insurance company wants to make sure they receive all premium dollars that they deserve for identified exposures. Here’s how to look at it, when the insurance company has to pay a claim, they are due a premium. Don’t understand?

Ok, let’s go a little deeper.

It’s easy to understand that when an employee sustains a work related injury the employer is responsible, under state workers compensation statutes, to provide benefits to the injured employee. Benefits include paying for medical costs incurred; lost time or lost wages of the employee because they were off from work while healing from the injury and related rehabilitation expenses.

It becomes more difficult to understand when the line between employee and non-employee becomes blurred. That’s what happens when subcontractors are used. From a definition stand point, and the manner in which a worker’s compensation policy responds to an injured employee, you need to know that an uninsured subcontractor will be treated no different than a direct employee when it comes to tendering a workers compensation claim for payment.

What was that? That’s right, as a general rule, you should always consider that an uninsured subcontractor will be treated by a hiring contractors workers compensation insurance company just like a direct employee especially when it comes to their obligation to respond to paying a claim. With this concept in mind you should begin to see one of the big problems that an insurance company faces when one of their insured employer uses subcontractors.

But don’t get carried away! You also have to keep in mind that the use of subcontractors is a normally accepted practice found within the construction industry. Subs and independent contractors play a big part in making things work in the world of construction. And believe it or not, most insurance carriers are quite aware of this normal practice and under certain circumstances can be very accepting. But remember, while they might be aware of it doesn’t mean they like it!

Ok, so let’s dig a little deeper.

When you have a large construction company that has many direct employees on staff who may be spread out over many states it will not be unusual to find that they use subs on a regular basis. You’ll also find that these types of companies will be very well organized in their management of subcontractors. Look deeper and you’ll find detailed contracts between the hiring contractor and sub. You’ll find scope of work details for specific projects and performance expectations along with safety requirements and insurance requirements. You’ll find indemnity and hold harmless agreements within these contracts. Basically, you’ll find that well defined lines exist between the hiring contractor and the sub contractor. This is what an insurance company wants to see!

A big problem exists when the hiring contractor has no direct employees but only uses subcontractors. Within the insurance industry the term “General Contractor” is normally used to describe this specific situation. It will be difficult and perhaps almost impossible to find an insurance carrier that will knowingly provide workers compensation coverage for the employer with no employees and who exclusively uses sub contractors in their business.

So why are insurance companies afraid of independent contractors and subcontractors?

  • They feel the employer or hiring contractor has no direct control;
  • It’s more difficult for the insurance company to identify work being performed by subs;
  • They may be performing unidentified, unacceptable underwriting exposures for the insurance company;
  • It’s more difficult for the insurance company to develop a consistent premium base;
  • The unpredictability of having an uninsured subcontractor exists;
  • Some employers call their workers subcontractors when in fact they are employees;
  • They may not be able to identify subcontractors exist until after the end of the policy and an audit has been completed;

Back to where we started. Insurance carriers love predictability and certainty. Uncontrolled use of independent contractors and subcontractors create an environment of unpredictability and uncertainty. And this plays a big part in the reason that insurance companies don’t like excessive use of independent contractors and subcontractors.

Hope this helps you out!

And thanks for reading!

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