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Research and Briefings

Employee or Contractor? What California’s AB5 Means for Workers and Businesses


On September 18, California Governor Gavin Newsom signed into law Assembly Bill 5, which establishes a three-part test that a business must prove to maintain that a worker is an independent contractor for employment purposes in the state. Some professions — including doctors, insurance agents, and artists — are exempt from AB5, which takes effect January 1, 2020. But transportation network company drivers and potentially other marketplace contractors are not.

The law establishes stricter criteria, known as the ABC test, to maintain a worker as an independent contractor. Specifically, a business must prove that:

  1. The worker is free from the company’s control.
  2. The duties performed by the worker are not central to the company’s core business.
  3. The worker is customarily engaged in an independently established business, trade, or industry.

Workers that do not satisfy all three criteria will be reclassified as employees, which could allow them to start earning a minimum wage and qualify for overtime pay and paid leave, among other benefits.

New Costs and Liabilities

For employers, AB5 could represent a costly change and expansion of risk profiles. Among other effects, AB5 will affect:

  • Workers’ compensation programs. Beyond the fact that more individuals will now be eligible for statutory workers’ compensation benefits in the event of work-related injuries, the reclassification of independent contractors will almost certainly increase insurance purchasing costs for many employers. If premiums increase to an extent that businesses will no longer be able to absorb their costs and instead pass them on to customers, revenues could be adversely affected.
  • Employment practices liability and wage and hour risks. Misclassification of workers who are eligible for overtime could result in significant legal exposure in a state that was already at the forefront of costly wage and hour litigation and well known for the broad protections provided to its workers. California’s expansive civil rights laws will also now apply to a much larger population of workers, providing protections for oft-filed claims of harassment, discrimination, and retaliation. Any company with operations in California that uses independent contractors can expect to face more frequent wage and hour and employment litigation to unemployment insurance for these newly reclassified workers.

Take Action Now

There is still debate on the effect the new legislation will have on workers themselves, and not all have endorsed it amidst fear that new regulations will lead to the companies they work for restricting their working hours or, worse, cut them off completely. Some workers for app-based businesses worry that the new law will take away their flexibility.

Although AB5 is expected to face legal challenges and there remain some unanswered questions, including whether Dynamex applies retroactively, businesses should begin preparations to adapt to the new law. Employers should take steps now to carefully review the classification of any independent contractors in California, ideally in concert with counsel to ensure the results are protected by the attorney-client privilege. They should also consider how the reclassification of workers — including the potential for employee status to be awarded retroactively — could affect:

  • Insurance programs, including workers’ compensation, employment practices liability and wage and hour liability.
  • Human resources.
  • Payroll.
  • Benefits.

While AB5 is restricted to California, the Golden State is known as a workplace protections trailblazer, and lawmakers in other states have expressed interest in passing similar legislation, as have labor groups. That means even businesses not directly affected by the new law should keep an eye on its progress and consider how similar legislation elsewhere could affect their organizations.