California AB5's Impact on Workers' Compensation Insurance

California Assembly Bill 5 (also known as CA AB 5), which went into effect January 1, 2020, will apply to all workers’ compensation policies as of July 1, 2020. It implements a new test to determine whether a worker qualifies as an employee or an independent contractor under the California Labor Code. The law applies to all workers in California, regardless of where the employer is based. It does not apply to workers outside of the state who work for a California-based employer. It is important that employers review the new standards to determine if any workers should be reclassified as an “employee,” which would have a corresponding impact under the employer’s workers’ compensation policy.

After passage, the CA Labor & Workforce Development Agency created the “ABC Test” to help employers work through the process of identifying “employees.” Under the ABC Test, a worker is defaulted to employee status, unless the hiring entity demonstrates that all three of the following conditions are satisfied:

1. The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact
   (e.g., paid by the job vs. by the hour; provides own tools and equipment; works for a brief time; distinct occupation).
2. The person performs work that is outside the usual course of the hiring entity’s business (e.g., car dealership hires a plumber for a plumbing leak).
3. The person is customarily engaged in an independently established trade, occupation or business of the same nature as that involved in the work performed (e.g., separate office location; employs assistants; carries own liability insurance; possesses own business licenses).

All three prongs of the ABC test must be satisfied for workers to be classified as independent contractors. Some occupations are exempt from the new classification (see the labor.ca.gov AB5 FAQs #4). Those industries exempt from the ABC Test will continue to use the existing Borello test for determining whether or not the worker must be included under their workers’ compensation policy.

The new legislation applies to all employers with workers’ compensation policies in-force on or after July 1, 2020. This means that a worker could be classified as an independent contractor before July 1, 2020, and as an employee after July 1, 2020. It also means that effective July 1, 2020, all payments to workers reclassified from independent contractor to employee are considered payroll and are included in your workers’ compensation premium. To avoid a possible civil penalty of up to $25,000 per violation and to avoid unexpected premiums adjustments following a final audit, employers must act immediately to bring themselves into compliance with CA AB 5.

The ABC test is also applicable for minimum wage, overtime pay, breaks, paid sick days, family leave, business expense reimbursement, state disability, unemployment and other wage-related matters.

What about employee benefits?

Employee benefit eligibility is governed by different tests than the ABC test for CA AB5 compliance. For example, a test emanating from a U.S. Supreme Court case, Nationwide Mutual Insurance Co. v. Darden (commonly referred to as the Darden test), is relevant for ERISA matters. Both employer group health plans and 401(k)s are governed by ERISA and thus courts would turn to the Darden Test to determine an individual’s classification. A similar test, the IRS “right to control” test, is relevant for those matters under their purview, such as cafeteria plans. Both tests are less rigid than the ABC test in that there is no presumption the worker is an employee and no one factor must be met to determine employee status. While some employers may wish to use one test for administration simplification, there are possible implications for covering individuals under a group health plan or 401(k) who do not qualify as an employee under the Darden test. In fact, the employer may unwittingly create a MEWA by including such independent contractors in the employer’s group health plan. Because worker classification creates complex and significant legal issues, we recommend working with your legal counsel to properly classify any California worker.

For questions related to your workers’ compensation policy, please reach out to your NFP advisor.