CLASSIFYING RISK–CONTRACTORS

(April 2019)

INTRODUCTION

Contractors come in many sizes, from one-person operations that specialize in restoring wood scrollwork all the way up to large general contractors capable of handling massive construction projects. However, most contracting businesses are specialists so that even a small job may involve several different types of contractors.

Example: A sudden burst of wind tore the metal porch from Marty’s house and lifted it skyward. Its violence and intensity drove parts of the porch into Linda’s house and damaged the roof, back wall, and a window. The insurance paid $5,000 in a loss that involved contractors that specialized in roofing, siding, windows, floor refinishing, and painting.

In most cases, contractors are hard-working, efficient, and conscientious about completing their projects on time. They need to be in order to be successful and remain in business. They are also concerned about their expenses, one of which is the cost of insurance. How then can they best be served in getting the best coverage at the most equitable cost? The first step is for their agent to understand how their general liability exposures are classified and the cost basis used to develop their premium.

While many contractors are eligible for specialized Businessowners Coverage Forms and policies, this analysis uses the standard Insurance Services Office (ISO) CG 00 01–Commercial General Liability Coverage Form. This is a neutral starting point for understanding the risk. Using ISO definitions for payroll and receipts is important because the more accurate they are, the easier it is to understand the differences in rating plans and to guide the insured contractor to the best coverage and rating arrangement for its circumstances.

PAYROLL LIMITATIONS

The contractors' category is extremely broad and includes many different classifications. However, some elements are constants and apply to all of them. Most contractors' codes are based on payroll. As a result, it is important to understand what and who is included and excluded. To begin, based on General Liability Manual Rule 24, payroll for clerical personnel, salespersons, collectors, and messengers who work away from the insured's premises, drivers, and their helpers is excluded.

Sole proprietors, partners, executive officers, and managers of limited liability companies are subject to payroll limitations. Contractors can receive a significant premium reduction and benefits from a payroll limitation. As an example, if the sole proprietor pays himself $50,000 but the state exception limits his payroll to $24,000, the premium is significantly reduced. Rule 24 permits this payroll limitation because sole proprietors, officers, and managers are compensated differently than most other employees because he or she may spend time in supervisory activities and in clerical and accounting activities. Another savings occurs because ISO recognizes that many contractors do not operate year-round. It developed a formula for seasonal or part-time businesses where the annual limitation may be reduced by 2% for each full calendar week over 12 weeks that the business does not operate.

Example: A sole proprietor receives $30,000 in remuneration but the state exception limits payroll for sole proprietors to $24,000. However, if the insured works only four months, the actual limitation is determined as follows:
Total weeks in a year	52
Less total weeks worked	-16
Less total weeks before the ISO exception begins	-12
Equals total weeks not subject to reduction	28
Total weeks in a year	52
Less weeks not subject to reduction	-28
Remaining weeks subject to reduction	24
Weekly reduction percentage	x .02
Reduction factor	= .48
Annual payroll subject to premium reduction	X $24,000
Payroll reported for audit purposes	$11,520
The insured reports $11,520 in payroll instead of the annual limitation of $24,000 because of the rule for seasonal or part-time businesses.

PAYROLL INCLUSIONS

Some contractors include a tool purchase plan for employees just starting out in the contracting business. They require that employees have certain tools of their own and help them purchase the tools over the course of their employment. In addition, some employees own mobile equipment that their employers use. In these cases, the contractor pays the employee for the cost of the equipment in addition to the regular wage. The use cost of such tools and equipment must be added into the total payroll.

Contractors usually travel from one job to another. While many projects are such that employees can stay in one place, others require travel. At times, the cost to stay at a distant location is less than the cost to travel back and forth. In those cases, the cost to rent a home or other lodging is added to the employee's payroll. If the insured owns the home or lodging where the employee stays and provides it to the employee without charge, the fair rental value of the lodging provided is included as payroll.

These employees may also receive additional incentives to make their lives more pleasant and they are treated as part of their remuneration. They include, but are not limited to, food, store certificates, and a variety of merchandise.

The payroll of mobile equipment operators and their helpers is included. If operators and helpers are provided with the equipment hired under contract and the actual payroll is not known, one-third of the total amount the insured paid to hire the equipment is treated as payroll.

Some contractors occasionally find that leasing employees is better than hiring them, especially with seasonal operations. The insured has two payroll options when it does this. In one, the leased employees are shown as regular employees. The other uses 100% of the total cost of the contract for the leased employees. However, if the contract shows the specific payroll for an individual employee, that payroll is used.

Note: Any employer that uses leasing companies to lease employees must report and include the employee fee as payroll or remuneration.

GENERAL CONTRACTORS

Let’s return to the example that involved Linda’s home damaged by flying debris. Different contracting skills were needed to make the repairs because of the nature of the damages. Linda had to decide whether to hire a general contractor to bring all the work together or act as her own general contractor. Few contractors were willing to take it on because it was relatively small. Because her schedule was flexible and she could be at home when the subcontractors arrived, she decided to act as her own general contractor. A general contractor would have been the only logical choice if she did not have the flexibility of being home to direct and oversee the work.

There are two types of general contractors. One is sometimes referred to as a paper contractor because he or she does not actually supply any physical labor. The general works with the customer to determine the work to be done and then arrange for various subcontractors to complete the project to the customer's satisfaction. The price a paper contractor charges includes the cost of the subcontractors plus a general contractor’s service fee. The other type of general contractor is present on the work site and does part or sometimes all the work.

Both types of general contractors bring knowledge of the abilities of local subcontractors and know how to coordinate projects so that jobs can be finished on time and on budget.

Class Code 91580: Contractors–Executive Supervisors or Executive Superintendents applies to both types of general contractors. The notes explain that this code does not apply to employees who provide day-to-day or on-the-job-site supervision. Another note states that payrolls of employees in this classification cannot be divided and partly used in another classification. For example, if an employee eligible for this classification also performs carpentry on the job site, the entire payroll for that employee must be assigned to the carpentry code. Code 91580 is used only for the payroll of individuals who provide project supervision. They cannot do any physical labor or provide daily supervision at a jobsite.

SUBCONTRACTORS

General contractors also pay a premium based on the cost of subcontracted work. Nine classifications from class codes 91581 through 91589 are available. Each begins with the words "Contractors–subcontracted work," followed by a description of the type of work the subcontractor performs for the general contractor. The premiums charged for these classifications are comparatively low relative to the exposures and operations, in large part because the general contractor's coverage contemplates that the independent contractors have insurance coverage for their operations and that they can show proof of insurance by providing valid certificates of insurance.

In a perfect world, the independent contractor is truly independent and has its own insurance. Unfortunately, some general contractors wind up being full contractors because the subcontractors used are actually employees in disguise. These situations must be discovered, revealed, and classifications assigned correctly before the policy is issued, a claim occurs, or the premium audit is conducted.

Numerous court decisions involve determining when a person is a contractor versus an employee but confusion over the distinction between the two remains. Unfortunately, the confusion does not manifest itself until someone falls off a roof or causes an explosion. At that point, that independent contractor suddenly remembers that he or she is actually an employee. Depending on the circumstances that surround a loss, even the insured can have a change of heart. Some questions to ask that might clarify the issue are:

Who determines the job's starting and ending times?

The employer dictates the times and locations of employment. The independent contractor sets his or her work hours.

Who determines the working conditions?

The employer oversees the work environment and establishes policies on what is and is not permitted. The independent contractor establishes the working conditions.

Who determines the work clothing?

The employer determines the appropriate work apparel and provides uniforms in some cases. The independent contractor wears any clothing he or she chooses.

Who supplies the worker's tools?

The employer usually supplies tools to its employees. Independent contractors supply their own tools.

When considering these questions, think about the paper contractor that only arranges and coordinates jobs. While it may actually determine a starting time, it does so only because one job must be finished before another begins. In many states, paper contractors are also responsible for maintaining safe working conditions on the job site. Because numerous independent contractors may work on the same job site at the same time, the paper contractor may also be responsible for dictating safety rules that apply to all workers. The paper contractor may even impose a dress code or establish clothing requirements for security purposes for certain jobs at certain job sites.

A general contractor's best safety net is a solid certificate of insurance program. An independent contractor that works on a job but does not provide the necessary certificate is treated as an employee of the general contractor. This is important if the uninsured independent contractor causes a loss, the general contractor is responsible for it, and is likely unable to subrogate against the independent contractor. Maintaining and monitoring certificates of insurance is a vital part of the general contractor's activities. Independent contractors should not be permitted on a job site unless and until they first provide a current and valid certificate of insurance to the general contractor.

When general contractors use certain independent contractors on a regular basis, a good contract between them solves many problems. The written contract should clearly outline the relationship between the parties and establish the insurance requirements. This includes requiring that the general contractor be named as an additional insured on the independent contractor's policy. The contract should also specify the type of insurance and the limits required. If the independent contractor has high limits, there is less chance of the general contractor's policy being called on to respond to a loss the independent contractor caused.

SINGLE JOBSITES WITH MULTIPLE CONTRACTOR CLASSIFICATIONS

Let’s return one last time to the example that involved Linda's home. The parties called on to repair the damage all had one thing in common. Each was a contractor and provided a service instead of selling a product. They were there to repair the damage done to the house. Each chose the building materials to be used, without consulting Linda. As the customer, Linda trusted their judgment and expertise in making those choices and really paid more for their accumulated knowledge, experience, and ability than for the cost of the materials.

The hole in the roof required a roofer’s services. The ISO Commercial Lines Manual (CLM) classifies roofers as either Class Code 98678: Roofing–Residential–Three Stories and Under or Class Code 98677: Roofing–Residential Over Three Stories and/or Commercial. Both codes are based on payroll. In this case, Linda hired a residential roofer and its premium should have been developed using class code 98678.

Linda chose a contractor advertised as a "disaster expert" that specialized in emergency work and was able to do both interior and exterior repairs. It qualified for several classifications. The roofing classification included carpentry work done in conjunction with the roof repairs. If other carpentry work had been needed, one of four carpentry classifications might have applied but only Class Code 91342: Carpentry applied to this situation.

The electrical system had to be checked because water entered through the hole in the roof and shorted out an overhead electrical light fixture. This work fell under Class Code 92478: Electrical Work–Within Buildings.

The water that entered through the roof reached the dining room walls and damaged the wallboard. The damage had to be repaired and that work was classified as Class Code 92338: Dry Wall or Wallboard Installation.

The interior wall painting work was classified as Class Code 98305: Painting–Interior–Buildings or Structures.

Since Linda had new windows and siding installed about a year earlier, she called the firm that did that work to repair the damage to the windows and siding. The primary classification for the siding work was Class Code 98967: Siding Installation. The classification for the window work was Class Code 91746: Door, Window, or Assembled Millwork–Installation–Metal. However, if the windows were wood instead of metal, Class Code 91341: Carpentry–Interior would have applied.

The work done last involved the floor. The dining room had been carpeted, so the first thought was to purchase and install new carpet. Had Linda exercised this option, she would have purchased carpet at a floor-coverings store and let them install it. Carpet installation is classified as Class Code 94569: Floor Covering Installation–Not Ceramic Tile, or Stone.

However, she had a second choice. Because a beautiful hardwood floor was under the damaged carpeting, Linda decided to refinish it instead of carpeting over it. This was classified as Class Code 91341–Carpentry–Interior.

SUMMARY

Properly classifying a contractor requires research about what the contractor actually does and research in the way ISO classifies the work. Insufficient research can result in an inappropriate premium that could be embarrassing when a company auditor evaluates the exposure. Just as a contractor evaluates a job before selecting the right materials and tools for it, the insurance agent should carefully evaluate the contractor’s operations and then select the proper classification and the correct payroll in order to arrive at the correct premium.