What is Workers’ Compensation: A Guide to the Basics

Worker’s Compensation: Introduction

Workers’ compensation is one way businesses can protect employees and themselves in case of a workplace accident, injury, or illness. Here we’ll walk you through important perspectives and details on how it works, who benefits and how, and executing it properly in your business. This guide covers:

What is workers’ compensation?

Workers’ compensation is a system that provides specific benefits for employees who are injured or become ill due to their job. In terms of types of employee compensation that companies offer, it’s not always top of mind in compensation conversations. But those who end up needing it understand the value.

Generally, employers are required by state laws to carry workers’ compensation insurance. It pays for various expenses, but primarily medical expenses and partial wage replacement for employees affected. Employers are responsible for workers’ comp premium payments and cannot deduct them from employees’ paychecks.

Work comp covers injuries or illnesses directly sustained by an employee while on the job. These can include:

• Acute injuries, such as machinery accidents and injuries while moving heavy items.
• Chronic injuries, such as repetitive motion injury and lower-back injury due to posture.
• Acute illnesses, e.g., disease contraction from blood exposure.

Chronic illnesses, e.g., from toxic chemical exposure.

What does worker’s compensation pay for?

Workers’ compensation benefits cover an injured or ill employee, as applicable and eligible, for payment of:

Medical and healthcare expenses

A primary function of workers’ compensation insurance is to pay medical costs incurred by a work-related incident or illness. Therefore, medical coverage for an injured or ill employee will only apply to injuries acquired at work, on the clock, or as a direct result of the job.

The medical care coverage of workman’s comp does not have a maximum benefit limit per individual injured. It generally applies to:

• Payments to doctors, nurses, specialty care centers, and other healthcare providers for medical treatment.
• Medical equipment, such as walkers, wheelchairs, canes, and oxygen.
• Payments for at-home care provided by a nurse.
• Medical bills pertaining to hospital treatment, stays, and surgeries.
• Other medical expenses related to the workplace injury or illness.

Lost wages and disability benefits

Workers’ compensation insurance may also pay an employee for missed or lost wages while they’re out of work due to their injury or illness. This also extends to cases of temporary and permanent disability. The lost wages payments are calculated according to the employee’s average weekly wage (AWW) for a period preceding the incident.

The lost wages payment is also affected by the worker’s disability status. This means that the compensation insurance company evaluates how disabled the employee is according to doctors’ notes.

The length of time a person receives these workers’ comp benefits depends on their injury, recovery time, disability status, and the state where they live. There is also a brief waiting period before the injured employee receives benefits.

Rehabilitation costs

Workers’ compensation pays for the vocational rehabilitation of injured employees getting ready to return to work. This can include physical therapy and job retraining. It might also include mental health services. The goal is to help the injured or ill employee cope with their situation and any lasting effects. It also aims to help them return to their previous job or one that better suits their current abilities.

Funeral expenses and survivor benefits

Unfortunately, sometimes an employee dies due to work-related injuries or incidents. In these cases, a calculation is made to determine the surviving family members’ death benefits. While medical payments do not have a minimum or maximum, the death benefit does.

Survivors, typically spouse and children, will receive at least a minimum amount, and the calculation can also max out. The surviving family members can use this money for related expenses not otherwise covered by the workers’ compensation policy. Note that some workers’ comp policies do cover funeral expenses.

The workers’ compensation claim process

In the event of a workplace injury or illness, employers and workers may wonder how workers’ compensation works. Both the employer and injured/ill employee undertake some of the workers’ comp claim effort. The claims process for workers’ comp works as follows:

Employee reports

The employee is responsible for reporting the injury or illness to the employer. This typically requires filling out a form with the employer, although small businesses might have a less formal process. Even minor injuries should be reported.

If immediate medical care is required, the employee should seek treatment first, alert their employer, and make the official report later.

Employer reports

If the injury/illness will or may require a workers’ compensation claim, the employer is responsible for reporting the injury. This usually requires filling out a workers’ compensation claim form with the appropriate insurance provider (the employer’s TPA if self-insured). The insurer can provide the form upon request and guide an employer through its particular reporting process.

Claims administrator reviews

The insurance provider reviews the claim. This could be a private insurance company, state agency, or TPA. Assuming the insurance carrier approves, they’ll distribute appropriate lost wages to the employee and cover related medical treatment. If the claim is questioned or denied, it can be reviewed by a workers’ compensation board. This is usually a state-run board that is objective and qualified to make a final determination.

Employee documents

The insurance provider will likely request documentation for the initial claim and ongoing costs. This often includes medical records and bills related to the claim. Employees often can have medical providers send over the information; they might also have to provide some details themselves.

Benefits paid

Benefits will continue to be paid for the duration of the claim, except in the event of a fatality. In that case, beneficiaries may receive a lump sum payment.

Can employees sue for workplace injuries?

Technically speaking, yes, employees can sue employers due to workplace injuries and illness. This can occur if the employer was negligent in providing a safe working environment. It can also occur if the employer was aware of potential hazards but failed to take action to protect employees. In addition, employees may sue for damages. This is usually the case if they were not provided with adequate safety equipment or training and were injured on the job.

The fact that an employer carries workers’ comp insurance doesn’t mean the employee won’t choose to sue instead. However, most often, once a workers’ comp claim is filed the affected worker cannot sue their employer. Typically employees forgo the right to sue when they file a claim, and that choice stands even if the claim is eventually denied. The majority of employees choose workers’ comp coverage from the start; it’s often the most timely, efficient, and predictable route.

Do I need workers’ compensation insurance?

The short answer is: most likely. Most states require businesses with employees to carry workers’ compensation coverage. This requirement typically applies regardless of the number of employees, hours worked, or whether employees are full-time or part-time. There are very few exceptions to these laws. So if your business has 1 or more employees, plan to purchase workers’ compensation insurance. Check the specific requirements of all states where your business has employees, as they will apply to you.

Whether or not workers’ compensation coverage is legally required, it’s still broadly recommended for small and midsize businesses. Few businesses could afford to pay a claim themselves without incurring significant financial stress or hardship. In the end, paying for coverage tends to be much less expensive than paying for claims.

Policies may be purchased at any time during the calendar year. Consider consulting the insurance company that provides your other business insurance products to begin inquiring about availability, pricing, and details.

Who may not need workers’ comp insurance?

In some cases, your state and business structure may impact whether coverage is required. Here are some situations and factors that might affect whether you need workers’ compensation:

Businesses with independent contractors

If a business hires independent contractors and subcontractors, the compensation coverage requirements become more complex. Requirements for independent contractors vary by state and sometimes unique circumstances. It’s wise to talk with a knowledgeable insurance agent about this type of situation.

Sole proprietors and LLCs without employees

A sole proprietor or limited liability company (LLC) without employees usually won’t be subject to a workers’ comp coverage requirement. An example of this may include real estate agents.

They may not be protected against work-related injuries without coverage, though, as standard health insurance benefits sometimes exclude work-related incidents.   

Sole proprietors and small business owners seeking workers’ comp for themselves might be able to acquire it through a particular state program or private insurance.

Special situations

Certain circumstances may shift considerations when determining whether workers’ compensation is needed. For example:

• Corporate officers of closely held corporations may be able to exclude themselves from coverage. Many states allow this if they have at least a 20% to 25% stake in the company.
• Domestic workers might be classified as either employees or independent contractors. Coverage is almost certainly required if they’re an employee and could be if they’re an independent contractor.
• Seasonal employees typically require coverage while they’re employed. Requirements apply regardless of the number of employees, full- vs. part-time status, or their employment duration. The primary consideration here is that businesses should adjust their coverage at the start and end of every busy season.
• Out-of-state employers (employers with workers in other states) must abide by the laws where their workers are located. This may necessitate obtaining different or additional coverage than would otherwise be purchased.
• Family members likely need to be covered if they’re paid employees. Family members may be considered employees in some states even if they’re not paid salary or wages.

In all of these situations, it’s wise to seek the expertise of an experienced workers’ compensation insurance agent.

Workers’ compensation as protection for employers

In addition to being the right way to treat employees, providing workers’ compensation affords employers important legal and financial protections.   

Legal penalties for insufficient coverage can be immediate and severe. Having coverage that meets state requirements can help businesses avoid the following:

• Stop work order. States enforce their requirements by issuing stop work orders (SWOs) when required coverage isn’t in place. These prohibit a business from continuing to operate until they are covered.
• Fines. States have steep fines for not carrying workers’ comp. Penalties may begin accumulating on day 1 of no coverage or an SWO. For example, Massachusetts fines businesses at least $100 per day (not business day) from the day an SWO was issued.
• Jail time. In severe cases, not having workers’ compensation can result in criminal charges. Some states have laws allowing up to 1 year in jail.

Additional financial hardship can stem from lawsuits filed by injured workers. The recently reported average workers’ comp claim hovers around $41,000 (and nearly double for auto accidents). These don’t include attorney and court fees incurred during a lawsuit. Employees rarely sue when workers’ compensation covers claims.

The cost of workers’ compensation insurance

Nationwide, employer costs for workers’ compensation insurance vary widely. In 2020, state averages spanned lowest to highest from $0.46 (Texas) to $1.78 (Wyoming) per $100 of covered wages, according to the National Academy of Social Insurance’s 2022 Workers’ Compensation Report.

There’s a simple formula for estimating base workers’ comp insurance costs:

(Your annual total employee payroll divided by 100) multiplied by (Your business’s class code rate).

This will give you an estimate of your company’s base workers’ comp premiums per year. To estimate per employee, divide the employee’s annual payroll by 100. Multiply that total by the class code rate for that employee’s job. This will give you the estimated base workers’ comp rate for that specific employee.

Workers’ comp insurance cost factors

While workers’ compensation benefits are fairly straightforward, every policy is written specifically for the individual business needing it. This is because different businesses have different circumstances. The primary factors that play into workers’ compensation rates for employers include:

• The business location.
• The industry and types of work performed at the business.
• Amount of the company’s annual payroll.
• The number of employees.
• Claims history, based on how many workers’ compensation claims the company has filed.
• How or where the workers’ comp insurance is purchased.

Job type class code rate tables. Insurance companies have classification codes for job types. Each one is assigned an “experience rating.” This correlates to the risk of an employee becoming injured or sick due to performing that job.

How can you keep workers’ comp insurance and related costs down?

To help keep the costs surrounding workers’ compensation more manageable, employers can take the following steps:

Be proactive about claims history factors

With claims history as a factor in premium costs, it’s wise to manage your known and potential risks going forward. 

Reduce workplace hazards

This could include implementing safety protocols and conducting regular safety inspections. Another way to reduce workplace hazards is to use ergonomic furniture and equipment. This helps to reduce the risk of musculoskeletal injuries and ensure that employees are comfortable and productive. Additionally, keep the workplace well-lit and free from tripping hazards. Take steps to ensure that hazardous materials are correctly stored and labeled.

Be sure employees are adequately educated on safety and trained for their positions

Education should include providing safety information, training, and resources to help employees understand workplace safety protocols and procedures.

Additionally, make sure they receive training specific to their job roles. This may involve extensive instruction on the use of certain machinery or adhering to safety protocols in specific environments.

Supervisors should also ensure that employees are aware of any changes to those protocols and procedures. Provide refresher training as needed.

Finally, employees should have access to the proper safety and protective equipment and supplies to do their job safely.

Be proactive at the time of incident

Immediately provide injured workers with proper medical care and attention at the time of injury. This reduces the risk of them suffering a long-term disability or worse. It can also help keep medical expenses down and lower your chances of being hit with a costly lawsuit.

Some workers’ comp insurances also use an outcomes-based network (OBN). This is in place of or in addition to the traditional preferred provider list. OBN physicians may be able to provide better health outcomes for injured employees and get them back to work faster.

Develop a return-to-work program

A successful return-to-work program is designed to get injured employees back to work as safely and quickly as possible. This may involve returning employees to light duty or part-time shifts until they recover fully. Implementing such a program can help reduce the costs associated with hiring and training replacement employees. It can also help employers avoid overtime pay to employees picking up slack.

Choose the right policy

Employers can work with their insurance providers to identify areas where they might reduce premiums and other costs. But let’s assume you’ve done all you can and find that your workers’ comp costs are still too high. In that case, it could be time to find new workers’ compensation insurance. It’s wise to review your policy selection every few years or when you experience an unprecedented rate increase.

Talk with your insurance provider to find the most efficient and cost-effective workers’ compensation policy for your business. Ask them to look at adjusting your deductibles. You may also want to look at other available premium credits and recalculate premium rates based on your losses.

How to purchase workers’ compensation insurance

Employers paying for workers’ compensation may procure the policies in a few different ways. What options are available depends on the state where a business has employees.

State-run agency

Many states have state-funded workers’ compensation programs. When businesses buy workers’ comp coverage through a state agency, they make payments directly to the state. The state’s workers’ compensation board will adjudicate any claims filed, determining eligibility and distributing any workers’ compensation payouts.   

In states that have their own programs, purchasing workers’ compensation coverage through them might be mandatory or optional.

Mandatory state programs: Currently, North Dakota, Ohio, Washington, and Wyoming have monopolistic state funds in which the state-run program is the only option. Employers must purchase workers’ compensation coverage from the state program in states with monopolistic programs. This includes employers located in other states but employing workers in a monopolistic state.

Optional state programs: Arizona, California, Colorado, Hawaii, Idaho, Kentucky, Louisiana, Maine, Maryland, Minnesota, Missouri, Montana, New Mexico, New York, Oklahoma, Oregon, Pennsylvania, Rhode Island, Texas, and Utah all currently have “competitive” state programs. State programs provide standard coverage, have standard terms, and meet their respective workers’ compensation laws. Businesses can compare these to what insurance companies offer and choose which best suits them.

Private insurer

Most states allow businesses to buy coverage from private insurance companies. Private insurers offer workers’ compensation policies as standard business insurance.   

When coverage is purchased through a private insurer, premiums are paid to the insurance company. The insurer then pays benefits for work-related illnesses and workplace injuries without charging any additional fee beyond a policy’s premiums.   

Any policies that insurers offer should meet the state’s coverage requirements where they’re underwritten. Businesses employing individuals in other states should ensure that their policy meets those states’ requirements.   

Self-insurance

Larger businesses may be able to choose self-insurance, taking full responsibility for workers’ compensation claims. When self-funded, a business must be able to pay any injured workers’ claim expenses that arise. Those can include lost wages, medical expenses, rehabilitation, retraining (for permanent disability), funeral costs, and/or death benefits.   

Businesses that self-insure may hire a third-party administrator (TPA) to handle the paperwork and processing of claims. Still, the business pays for claims and the TPA fee. Several third-party services specialize in health administration and workers’ compensation.   

Self-insuring should be reserved for large organizations. Small businesses often don’t have the resources to administer their own policies and would struggle financially to honor a claim.

Companies normally only consider this option once they have so many employees that a private policy becomes particularly expensive. Before taking this step, companies should be sure that:

• They can afford multiple potential claims.
• They have enough claims that the administrative expenses of hiring a TPA are worthwhile. 

Businesses that employ people in high-risk jobs might look into self-insuring slightly sooner than other businesses would. Workers’ comp for high-risk jobs can cost significantly more to purchase.

Pay-as-you-go workers’ comp

Pay-as-you-go workers’ comp is an alternative way to pay for workers’ compensation insurance. Instead of requiring a large lump sum upfront, the down payment is typically lower. The remaining payments are spread out in installments over the policy year. Workers’ comp premiums are based on real-time payroll runs. This allows employers to pay for what they need when they need it, eliminating overpayments and extraneous constraints. Businesses gain greater flexibility and can manage their cash flow and budget more effectively.

Find the right worker’s compensation for your business

Workers’ compensation is an important form of insurance that employers and employees should understand and value. It’s a crucial part of a healthy, safe, thriving business. As part of an attractive compensation package, it can help employers maintain positive relationships with their employees by demonstrating care and concern for their well-being.

For help developing or reassessing your company’s employee compensation program, see our guide to creating a compensation plan.

For more tips, tools, and resources for HR and business management, visit Workest by Zenefits daily.