What Is Pay-As-You-Go Workers’ Compensation?

Learn about this pay-as-you-go model, and its advantages and disadvantages for small businesses.


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This type of workers’ comp bases premiums on real-time payroll runs

As a small employer, you’re always on the lookout for new ways to reduce costs — and “pay-as-you-go workers’ comp” may be just what you need. Pay-as-you-go workers’ comp alleviates the inaccuracies and cash flow burdens that often accompany traditional workers’ comp payments.

Before we get into the pay-as-you-go model, let’s examine the basics of workers’ compensation and the traditional payment approach.

What is workers’ compensation?

Workers’ compensation is an employer-paid insurance that covers lost wages and medical costs owed to employees who suffer a work-related injury or illness.

Also called “workers’ comp,” workers’ compensation is an employer-paid insurance that covers lost wages and medical costs owed to employees who suffer a work-related injury or illness. In addition, workers’ comp covers disability benefits, rehabilitation, and retraining costs, and death benefits for employees who died because of a work-related injury or illness.

Since workers’ comp is a state-mandated insurance, employer requirements are determined by individual states — including which employers must carry coverage, what constitutes a work-related injury or illness, and the premium and claims processes.

Although a few states exclude employers with 5 or fewer employees from workers’ compensation requirements, most states mandate all employers (regardless of size) to carry coverage. And while most states permit employers to purchase workers’ comp from private insurers, a few states mandate employers to buy workers’ comp directly from the state.

How do employers traditionally pay for workers’ comp?

Traditionally, employers must make a lump-sum down payment to the insurance carrier. Typically, the down payment is 25% of the employer’s estimated gross payroll/wages for the policy year. The employer then pays the remaining amount/premiums, usually on a monthly or quarterly basis. Note that the key word here is “estimated,” meaning premium calculations are based on guesstimates rather than actual payrolls.

Most states require insurers to audit their workers’ comp policies, and the insurer in turn puts the audit conditions in their workers’ compensation contracts. These audits seek to determine whether the employer paid the right amount of premiums for the right level of coverage.

During the audits — which are normally done at the end of the policy year — the insurer examines the employer’s actual gross payroll versus what they paid based on their initial estimation. If the employer overpaid, the insurer reimburses them accordingly or rolls over the overpayments into the employer’s workers’ comp expenses for the next policy year. If the employer underpaid, the insurer bills them for the difference.

Downsides of traditional workers’ comp payments

On the downside, traditional workers’ comp payments may cause:

  • Cash flow issues. Coming up with the lump-sum down payment may be financially daunting, especially if you’re on a tight budget.
  • Overpayment. If your payroll shrinks during the policy year (such as because you let someone go), you’ll end up paying too much for the policy year — because your policy amount is based on your estimated annual payroll, which did not include reductions.
  • Underpayment. If your payroll increases during the policy year (such as because you hired more people), you’ll get hit with an additional bill because your estimate did not factor in the payroll growth.
  • In-depth audits. Your premiums are based on estimations rather than conclusive amounts; therefore, audit adjustments may be necessary.

You can alleviate these issues with pay-as-you-go workers’ compensation insurance.

What is pay-as-you-go workers’ comp?

Pay-as-you-go workers’ comp bases your premiums on real-time payroll runs. For example, if you pay your employees biweekly, you would calculate your workers’ comp premiums for each biweekly payroll at the time you run payroll. This enables you to pay the exact amount due for the biweekly pay period in question. If you hire or terminate employees during the policy year, pay-as-you-go workers’ comp takes those additions or reductions into account.

Although some down payment is usually required upfront, it is normally much smaller than the traditional payment model’s amount. Often, insurers require 10% down for pay-as-you-go workers’ comp. The remaining payments are spread out in installments over the policy year.

Pay-as-you-go workers’ comp does not replace the traditional payment model. It is simply an alternative payment option.

Although some down payment is usually required upfront, it is normally much smaller than the traditional payment model’s amount. Often, insurers require 10% down for pay-as-you-go workers’ comp.

How pay-as-you-go workers’ comp benefits small businesses

  • Little money down, putting less strain on your cash flow. It also improves your cash reserves so you can better handle unexpected business expenses that crop up.
  • Predictability, since calculations are made according to actual payrolls. This decreases the chance of surprise bills throwing off your cash flow at the end of the policy year.
  • Smaller installment payments throughout the policy year — which lets you hold on to your money longer. For instance, you can make weekly, biweekly, or semi-monthly payments, depending on how frequently you run payroll.
  • Audits are simpler. Audit adjustments are likely fewer, because premium calculations are based on actual payrolls instead of estimations.
  • Lowers the risk of penalties. Since your premiums are more likely to be correct, you do not have to worry about penalties for underpayments or late payments.
  • Integrated with payroll. Many payroll service providers and payroll technology vendors include pay-as-you-go workers’ comp in their service offerings. This enables you to make automated workers’ comp payments each time you run payroll.

What are the disadvantages of pay-as-you-go workers’ comp?

While the pros of pay-as-you-go workers’ comp generally outweigh the cons, it’s important to know the potential downsides of this payment model. Next are a few considerations.

  • Although pay-as-you-go is becoming increasingly popular, especially among small businesses, not all insurers offer this payment option. Further, employers are not eligible for pay-as-you-go workers’ comp if they are located in a state that requires them to purchase the insurance directly from the state. These states — which are called “monopolistic states” — include Ohio, North Dakota, Washington, and Wyoming.
  • If your payroll service provider uses only one insurer, your choices are limited to that carrier. Your payroll provider may also bundle workers’ comp into their payroll services, making it difficult for you to know your true workers’ compensation costs.
  • Employers might misconstrue pay-as-you-go to mean no audits. In reality, audits are still required; they just tend to be less intensive than audits for traditional workers ‘comp payments. Keep in mind that workers’ comp audits aren’t only about verifying gross payroll/wages but also determining whether jobs are properly classified and workers are appropriately covered during the policy period. Even with the pay-as-you-go option, insurers still need to confirm whether the payments you made are accurate.

How to obtain pay-as-you-go workers’ comp

As stated, many payroll service providers offer pay-as-you-go workers comp in their service packages. So, if you outsource your payroll duties to a provider, check to see if they provide this payment option. If you do not outsource payroll, you may go through a third-party pay-as-you-go vendor, or you can utilize payroll technology that facilitates this payment model.

Check out our People Ops Podcast episode “Compensation planning; where do I start?”


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