How Does Workers’ Compensation Insurance Work?

As an employer, you’re likely required to provide workers’ compensation insurance for your employees. This type of business insurance helps pay for employees’ medical bills and healthcare expenses if they become ill or are injured in the course of working for you.

But calculating workers’ compensation premiums can be confusing, as can knowing if your state requires you to offer workers’ comp or not. If you’ve recently hired your first employee and are new to the world of workers’ comp, keep reading. In this guide, we explain what workers’ comp is, how to calculate premiums and how workers’ comp can benefit businesses and employees alike.

Jump to:

• What is workers’ compensation insurance?
• Who pays workers’ compensation insurance premiums?
• How much does workers’ compensation cost?
• How are workers’ compensation premiums calculated?
• Who is exempt from workers’ compensation?
• Frequently asked questions

What is workers’ compensation insurance?

Workers’ compensation insurance is a type of employer-sponsored business insurance. If one of your employees becomes ill or is injured as a direct result of working for your company, your workers’ compensation insurance will help pay for their medical bills and ongoing healthcare costs.

In exchange for accepting a workers’ compensation insurance settlement, employees waive the right to sue your business for their injury or illness. Ideally, this insurance coverage benefits both you and your workers: Workers receive a fair settlement that helps them recover after a job-related illness or injury, and businesses avoid costly legal fees that could put them in the red.

SEE: How to Do Payroll: A Step-by-Step Guide (TechRepublic)

State governments require most employers in most states to offer workers’ compensation, though each state has slightly different laws about which businesses are exempt. (Texas is the only state where the government doesn’t require employers in any industry to maintain workers’ compensation coverage.)

Who pays workers’ compensation insurance premiums?

Employers are responsible for paying workers’ compensation insurance premiums.

While workers’ compensation coverage is required in most states, there are a few exceptions. (For instance, most businesses in Texas are exempt from mandatory coverage — though opting into coverage is a possibility and, for most companies, a wise choice.)

How are workers’ compensation premiums calculated?

Calculating workers’ compensation premiums is a multi-step process. You can streamline and automate the process with payroll software, but whether you work with a payroll provider or not, it’s a good idea to understand the math behind how premiums are calculated.

Generally speaking, your insurance company will use the following key metrics to calculate your premium.

1. Workers’ compensation classification codes

Workers’ compensation insurance companies use codes defined by the National Council on Compensation Insurance (NCCI) to determine your company’s risk. These codes are usually three to four digits long and represent your employees’ risk of injury or illness based on their job duties and your specific industry.

If your business’s classification code indicates that your employees work in a physically demanding, high-risk industry, you’ll pay a higher premium.

Typically, your business and your employees are assigned the same code — with some exceptions. For instance, if you employ both office workers’ and industrial laborers, each type of employee might be assigned a different code, and your premium will be lower for one group than for the other.

2. State laws

If your state requires workers’ compensation insurance, the state’s workers’ compensation bureau determines the baseline premium rate for businesses in your area.

3. Previous insurance claims

If your business has a history of submitting expensive insurance claims, your workers’ compensation premium will cost more than a business with a completely clean slate.

How much does workers’ compensation cost?

workers’ compensation insurance premiums are based on a variety of factors, which makes it hard to estimate exactly how much your business will pay in premium costs each year. However, The Hartford (one of the most popular business insurance providers in the U.S.) estimates that its small-business customers pay around $70 a month/$840 a year in workers’ comp premiums.1

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Since workers’ comp payments are based on how many workers you employ, you can count on your premium costs going up as your workforce expands. Additionally, your business will pay a higher premium if you work in a more dangerous industry (e.g., construction or welding) with higher physical risks to workers’ safety.

Who is exempt from workers’ compensation?

Texas is the only state in the U.S. that doesn’t require private employers to provide workers’ compensation coverage. (However, Texas-based companies that contract with any government entity are required to have workers’ comp insurance.)

Apart from Texas, though, every state — as well as Washington, D.C. — requires business owners operating in the state to have workers’ compensation insurance.

In other words, as long as you have at least one employee, odds are that you’re required to offer workers’ comp. However, the exact law differs from state to state. For instance, in some states, you aren’t legally obligated to take out a workers’ compensation insurance policy unless you have three or more employees.

In other states, businesses in certain industries aren’t required to have workers’ comp. For example, agricultural businesses in 15 states are exempt from the workers’ compensation requirement. Fourteen other states mandate workers’ comp coverage for all agricultural workers, and a further 21 states mandate coverage for some, but not all, types of agricultural work.

To understand your business’s workers’ compensation obligations, meet with a legal professional who can explain the ins and outs of workers’ comp insurance in your state.

Frequently asked questions

What is workers’ compensation insurance?

Workers’ compensation insurance is a state-mandated insurance program paid for by employers. If an employee is injured or becomes ill as a result of their job, workers’ compensation insurance pays benefits like health care costs and lost wages.

In return for accepting a workers’ compensation insurance payout or settlement, the employee agrees not to sue their place of employment.

What is the most important factor in determining the cost of workers’ compensation premiums?

Workers’ compensation premiums are determined by how big your workforce is. The more employees you have on payroll, the higher your monthly workers’ compensation premiums will be.

Along with workforce size, factors like the type of work your employees perform can impact insurance premium costs. (For instance, if you operate in a high-risk industry like construction, you’ll probably pay a higher premium than a small arts and crafts business located in an office setting.)

Finally, if you’ve submitted claims in the past that have resulted in large payouts (or if you’ve submitted an above-average number of claims), your insurance premiums are likely to increase.

What situations qualify an employee for workers’ compensation coverage?

If an employee is injured while working at a job or experiences an illness directly related to the job they were performing, they might be eligible for workers’ compensation benefits. They must have been an employee at the time the injury or illness occurred, and their employer must have workers’ compensation insurance for the employee to be eligible.

The employee must also apply for workers’ compensation coverage before their state’s application deadline. They’ll likely need to submit documentation demonstrating that the injury or illness was directly related to their work as well as evidence that they attended medical appointments, received official diagnoses and underwent recommended medical treatment.

Are workers’ compensation premiums tax deductible?

Yes, if your state requires workers’ compensation insurance, you can likely write off your workers’ compensation premium costs when filing end-of-year business taxes. Your tax professional can offer specific financial advice about tax write-offs tailored to your unique situation.

Read next: What Payroll Documents Do You Need to Pay Employees? (TechRepublic)

Sources

1. The Hartford, “How Much Does Workers’ Comp Insurance Cost?” Accessed 1 Nov. 2023.

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