A Washington state contractor recently got a painful reminder in workers’ compensation insurance laws. His drywall company, E & E Acoustics LLC, was fined $1 million in workers’ comp premiums and penalties after he allegedly attempted to skirt the laws.

While this case highlights an extreme example of workers’ comp insurance gone wrong, experts say even contractors who try to follow the law often misunderstand their requirements. And they say those misunderstandings can also lead to contractors paying more than they need to for the insurance.

“I’ve come across numerous policies that are structured wrong, and I say, ‘Hey, you’re paying 30 percent more than you need to be and have been for years,’” said Brian Downs, president of Downs & Associates Inc., a former contractor who specializes in remodeling insurance.

Contractors are legally required to carry workers’ compensation coverage for employees, but each state has different laws for when those requirements kick in. Usually, it’s based on the size of the company, and most states use a threshold of three or more employees, including corporate officers, Downs says. Contractors get audited at the end of the year to make sure they paid enough, and if they haven’t, they get a bill, sometimes a hefty one.

But what most contractors don’t realize is that the cost of workers’ comp is dependent on what employees do. Insurance for contractors who only work indoors is typically 30 percent less than those who work outdoors. Salespeople and office workers only cost pennies, while roofers can cost thousands, Downs says.

Knowing how your insurance agent is classifying your employees is the first step in making sure you’re covered correctly — and paying only what you should, says Robert Criner, president of Criner Remodeling. “Workers’ comp is an odd animal,” Criner said. “There’s 50 different categories a carpenter can fall under. Very few people are aware of that.”

That includes insurance agents, Downs says. “In theory, agents should be classifying workers correctly,” he says. “But many of them just don’t know. There’s so much misinformation being disseminated.”

Workers’ comp gets especially confusing when contractors hire sub contractors. Downs says many contractors assume it’s the subs responsibility to have insurance, but when subs get hired they are treated like the contractor’s employees. If subs don’t have their own insurance, it defaults to the contractor.

Criner recommends only hiring subs with insurance. He says the best way to make sure that’s the case is to get a certificate of insurance directly from the carrier the sub is using. That way, if the sub’s insurance gets canceled, the contractor gets notified.

If you are paying for a sub’s insurance, make sure you separate out materials, because rates are based on payroll. For example, a roofer who does a $20,000 job including materials, shouldn’t get paid on that rate. Instead it should be based on what the contractor paid for the labor to do the job. That’s often quite lower, says Criner, also chair of the National Association of Home Builders Remodelers.

Downs adds that contractors can save more money on workers’ comp through discounts based on well-structured safety programs and drug free workplaces, which require drug testing.  

Finally, don’t forget to tell your employees about the benefits you’re providing through workers’ comp coverage, says Karen Cates, professor at the Kellogg School of Management. Additionally, Cates says contractors should explain how costs such as workers’ comp affect labor costs.

Criner recommends that all contractors take the time to educate themselves about workers’ comp through programs from NAHB and other organizations. “Just make sure you’re classifying employees correctly so you’re paying the fair rate for whatever you do,” he says.