A law recently enacted in California puts new restrictions on the ability of employers to classify workers as independent contractors, rather than employees. Those restrictions will likely change the way independent insurance agencies do business.
The new law expands on a 2018 decision by the California Supreme Court. That decision established an “ABC test” for wage orders in the state. The new law now applies the test under the state labor code and the unemployment insurance code. It takes effect January 1, 2020 but applies retroactively to existing claims and actions to the maximum extent permitted by law.
In order to classify an individual as an independent contractor, the employer must be able to answer “yes” to these questions:
A: Is the worker free from the hiring entity’s control and direction in the performance of the work, both under the work contract and in fact?
B: Does the worker perform work that is outside the usual course of the hiring entity’s business?
C: Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?
If the answer to any of these is “no,” then the employer must classify that individual as an employee. This entitles the individual to employees’ benefits and legal protections Penalties for misclassifying workers start at $5,000 per violation and may be greater.
Certain types of workers are exempt from the law, including physicians, attorneys, dentists, architects, engineers, and others. However, insurance producers and support staff are not exempt. The California Chamber of Commerce has announced plans to seek additional exemptions.
Independent insurance agencies often hire producers as independent contractors. By definition, however, an insurance producer performs work that is within the usual course of an insurance agency’s business. That means the answer to question B is no and the individual is therefore an employee. Unless a change in the law exempts insurance agencies, it will no longer be permissible to hire most producers as independent contractors.
Penalties assessed by state governments are not the only cost. If a producer has been misclassified for three years, the agency will have to pay to revise three years of payroll records, adjust the withholding, pay unemployment and workers’ compensation insurance premiums, and possibly face penalties for underpaying payroll taxes.
Most states use a list of criteria to judge an individual’s status. No single factor determines the status; courts look at all factors and balance them against each other. That could change as lawsuits are brought in more states seeking adoption of the ABC test. That test is already the law in Massachusetts and New Jersey.
The Internal Revenue Service takes the traditional approach. It looks at who controls what the work is and how the individual does it; how the worker is paid, is provided with tools and equipment, and is reimbursed for expenses; and whether the work relationship is temporary or ongoing, whether there is a written contract, and how important the work is to the business. The IRS says, “(N)o one factor stands alone in making this determination.”
Insurance agencies doing business in California, Massachusetts and New Jersey should interpret the ABC test strictly, particularly part B. If a property-casualty agency takes on a P&C producer, the proper classification for that person will almost certainly be employee. This has been the case in Massachusetts and New Jersey for some time; agencies should start complying with the laws there, if they have not done so already.
The classification could change if the producer is licensed for products the agency does not currently offer, such as benefits or annuities, and if the producer works with multiple agencies. Agencies should consult with an attorney qualified to handle labor issues or with the labor departments in those states. Regardless, it will cost the agency less to comply with the law than it will to recalculate payrolls and pay back taxes.
The impact on all affected businesses, insurance agencies included, will likely be significant. Agencies will have to balance the certain new costs of hiring producers against the hoped-for revenue increases. Unless they become exempt, however, agencies will have to adjust to this new reality.