Independent Contractor vs. Employee: Why Does Worker Classification Matter?

May 17, 2024 | Workers' Compensation

This article was originally published June 29, 2022

Why is the independent contractor vs. employee distinction important when it comes to workers’ compensation insurance? Worker classification matters because with very few exceptions, employers are required to provide workers’ compensation coverage for their employees. Independent contractors are another story.

If an independent contractor doesn’t have their own workers’ comp policy, the company using their services must provide coverage. But if the contractor has their own workers’ comp coverage, the employer isn’t required to add the person to their policy, although they should obtain proof of coverage from the contractor.

Problems can arise if, for example, an independent contractor has their own workers’ comp insurance and therefore doesn’t need to be covered by yours, but you accidentally classify them as an employee. That classification means you’re supposed to add them to your policy, but you don’t because you know they have coverage.

Most states require businesses to provide workers’ comp insurance coverage for independent contractors and subcontractors who don’t have their own coverage. You can avoid covering contractors by collecting their Certificate of Insurance before doing business with them. If they don’t have workers’ comp insurance, your insurer will charge you for their coverage based on their total pay and the type of work they do.

One way to know whether someone is an employee or an independent contractor is how you report their wages—on form W-2 or 1099. There are federal laws for when a worker should be an employee using form W-2 versus an independent or subcontractor using form 1099.

Typically the rules for using an employee classification are that the business manages the person, controlling and directing their work, the individual keeps a consistent schedule, and the company pays them a set hourly wage or salary. Businesses typically pay independent contractors for a project and don’t control their work. Contractors also tend to work fewer hours. Classifying workers incorrectly could result in fines or investigation from the IRS.

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Beyond Employee vs. Independent Contractor: Workers’ Comp Cost and Employee Classification Codes

In addition to making the employee vs. independent contractor distinction, employers must use a separate set of classification codes to indicate the employee’s type of work. Insurers rely on a standard set of three- or four-digit codes assigned by either a state rating bureau or the National Council on Compensation Insurance (NCCI), depending on the state. These codes reflect the level of risk associated with the type of company and the duties of its employees. biBERK can help you make this determination with a few straightforward questions.

It's vital that you assign the correct classification codes. Using the wrong codes can mean you owe a significant additional premium at the end of the policy period when we perform a mandatory policy audit. And it’s crucial to be aware that intentionally misclassifying workers constitutes fraud and can have serious legal and financial consequences.

Insurance Cost and MODs

What an employer pays for workers’ comp coverage for their employees is based on the company’s gross annual payroll. Other factors also influence workers’ comp insurance premiums. One is called an experience modification or "MOD." Insurers use MODs to determine rate adjustments based on a company’s claims history compared to other businesses of the same size and with the same types of operations.

A business must be in operation for at least three years and have generated sufficient premium in a single year for a MOD to be assigned. A MOD less than 1 is better than average and decreases the premium charged, whereas a MOD greater than 1 is worse than average and increases the premium.

Workers’ Compensation Insurance: Attention to Detail Delivers Important Protection

You must provide your insurer with current and accurate information when purchasing workers’ comp insurance or renewing coverage. However, the result of your attention to detail is vital protection for your employees and business.

Workers’ comp insurance helps pay an employee’s bills resulting from a work-related injury—including medical care and lost wages. It can also protect the business from injury/illness-related costs, as well as certain kinds of lawsuits outside of workers’ comp claims filed by employees. And, of course, having coverage means your state won’t hit you with fines and penalties, which they can levy even if you’ve never had to file a workers’ compensation claim.