The Dynamex Decision Takeaway: Why Hiring Independent Contractors Is Now an Increasingly Risky Business

The definitions of ‘employee’ versus ‘independent contractor’ are up for debate, leaving employers to classify workers properly and remain compliant within state laws.

By: Susannah Levine | January 29, 2019

Given the “more nuanced” definition of “employee” and “independent contractor” in California’s Dynamex Operations West Inc. v. Superior Court, employers, brokers and carriers should carefully audit their payrolls to make sure they do not misclassify workers as independent contractors under Dynamex’s new wage order standard, said John McGowan, Jr., partner, BakerHostetler.

Misclassification can introduce a host of risks, he said, including lawsuits, back taxes, wage payment liability, penalties and fines — and nasty surprises when insurance policies don’t respond as expected.

With the Dynamex decision, California joins Massachusetts and New Jersey in adopting the ABC test, which slashes the number of workers eligible for independent contractor status. Under the test, a worker is considered an independent contractor only if A, B and C are satisfied:

A) The worker must be free from the control and direction of the payor in connection with the performance of the work, both under the contract and in fact.

B) The worker must perform work that is outside the usual course of the payor’s business.

C) The worker must be customarily engaged in an independently established trade, occupation or business of the same nature as the work performed by the worker for the payor.

Dynamex Operations West’s delivery drivers claimed they should be classified as employees, not independent contractors. The superior court agreed, and it ruled against Dynamex in April 2018.

According to the Economic Policy Institute, 10 to 20 percent of employers misclassify at least one employee because of ambiguous laws, prompting greater adoption of the ABC test in other states.

Why Dynamex Matters to Insurance

The Dynamex decision changes the way carriers view independent contractor exposure, said Aileen Smith, vice president, Bermuda professional liability, Allied World, and prompts questions from the underwriting side.

Matt Zender, senior vice president, WC product manager, AmTrust Financial Services

“For employers with a large independent contractor base, we want to know that they have a good understanding of their worker base and that they’re conducting audits around worker classification” to stay compliant, Smith said.

Brokers should know how much their clients use independent contractors so they can properly point out risk exposure and advocate for risk solutions with carriers, said Michaelene Cody, vice president and policyholder counsel, HUB International. “It’s our job to explain why our client is different, how they’re reducing exposure and why the exposure isn’t as big as people feared.”

Wage-and-hour claims are typically excluded from standalone EPLI and casualty insurance policies, said Smith, although some London- and Bermuda-based markets have offered wage-and-hour risk transfer products since 2012.

Although the Dynamex decision is narrowly confined to wage orders, which address working conditions and wage entitlement, different tribunals treat the employee-or-independent contractor question very differently, said Linda Pierce, vice president, Gallagher, and the issue is far from resolved.

For example, she said, employment status is an issue in determining unemployment benefits and workers’ compensation in state tribunals. It’s an issue in determining eligibility for participation in ERISA plans in federal tribunals, and it comes up in vicarious liability cases involving third-party claims where a worker caused an injury.

In California, independent contractors have standing to sue an employer for unlawful harassment, and they may allege to be employees for purposes of claiming they have been discriminated against, Pierce said, “so you want a definition of who can bring a claim to be as broad as possible.”

California’s court of appeals has heard several related cases since the Dynamex decision, including one involving a claim of joint employment status, which the court rejected. Although it’s a narrow decision, said Cody, confined for now to wage orders, “that doesn’t mean at some point it won’t be broader.” She expects future litigation around the scope of the Dynamex decision.

Cody recommends retaining outside counsel familiar with the kinds of issues that can arise from worker misclassification and taking “a proactive approach”— auditing the worker base and ensuring “solid, well-drafted contracts” — to determine and preempt risk exposure early on. “It will help on the back end,” she said.

If Assembly Bill 5, introduced by a democrat, is codified by the democratic-leaning state, “it will apply to worker classification, and therefore workers’ compensation.” — Matt Zender, senior vice president, WC product manager, AmTrust Financial Services

If Dynamex becomes the standard, added Matt Zender, senior vice president, WC product manager, AmTrust Financial Services, the population of “employees” will inevitably expand, resulting in more covered employees and expanded premiums. Losses will scale to the larger covered population, but the expense load from premiums will increase business costs, which employers will pass along to their customers.

“Will this increase the cost of goods and services?” he asked. “It will have to.”

As California Goes, So Goes the Nation?

Although Dynamex applies only to California and solely for work order purposes — not workers’ compensation, employee benefits, tax treatment or ERISA — the insurance community, including carriers that offer wage-and-hour coverage, should take notice, said Smith, because “a lot of state legislatures follow the lead of California.”

To companies in Iowa, for example, she said, “pay attention. Even if you’re not using independent contractors today, you may in 16 or 18 months.”

Because the standard of worker protection is so high in California, she said, “a lot of our insureds who operate in California and other jurisdictions typically roll California’s standards across the other jurisdictions.” That way, “if a large claim were ever brought against them, they’ll have defenses in place.”

John McGowan, Jr., partner, BakerHostetler

Other states currently use the ABC test for determining unemployment compensation. Depending on how California’s state assembly votes on two current bills, said Zender, it may yet apply to workers’ compensation. If Assembly Bill 5, introduced by a democrat, is codified by the democratic-leaning state, “it will apply to worker classification, and therefore workers’ compensation.”

So far, Zender said, no federal standard exists to define who is an employee and who is an independent contractor, although the National Labor Review Board determined last year in Velox that employers violate federal labor law when they misclassify employees as independent contractors. That case involved a former driver’s unfair labor practice claim against a medical courier service. Twelve state attorneys general joined an amicus brief supporting the decision.

So Who Is an Employee?

Identifying who is an employee and who is an independent contractor is easy at the extremes, as when the employer exercises direct supervision and exerts a lot of control over the worker’s hours and processes, but “it gets complicated when you dabble in the middle,” said McGowan.

Read More: The Definition of ‘Employee’ Was Changed by the New Economy; Here’s How That Impacts Insurance

For example, said Zender, take Isha, a software engineer hired as a full-time independent contractor to perform a specific task at a software company — her only employer. If she’s performing software work on its phone network software or some part of the company that is not core to its operation, then maybe she is an independent contractor under the ABC test, said Zender.

But if she’s a server maintenance engineer for WeMaintainServers.com, then she’s an employee under the B part of the ABC test.

And consider Doug, a rideshare driver who picks up commuters from the airport every weekday morning and spends his afternoons running his own mobile phone repair business, his primary source of income.

The nature of the company that sends him rides determines if he’s an employee. The fact that his primary income derives from his mobile phone repair business isn’t a factor, said Zender. “If it’s Airport Shuttles R Us, he’s probably an employee.”

But if it’s Uber, which has successfully argued so far that its core business is technology and not transportation, then no, he’s not an employee under the B part of the test, said Zender.

“You particularly want to understand your client’s workforce as society moves more into the gig economy,” said Pierce, “The generation of people in their twenties like flexibility. These are interesting times.” &

Susannah Levine writes about health care, education and technology. She can be reached at [email protected].

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.