Your Workers' Comp Insurance Primer

Workers’ compensation insurance is all about managing risk. We face risks every day of our lives. To protect against these risks, we take preventative measures like checking the weather forecast, maintaining our cars, or installing smoke alarms. Many people also purchase insurance policies to prevent risk.

Injury or death at work is also a risk. States began adopting workers' compensation laws in 1911, and by 1963, all 50 states had some form of workers' compensation law in place. Today, employers are generally required to provide workers’ comp coverage for all employees.

What is Workers' Comp Insurance?

Workers' compensation insurance (WCI) programs are primarily implemented and regulated by state governments, and generally provide a “no-fault” program under which employees give up their right to sue employers for work-related injuries, illness, and death. In return, employers provide insurance coverage to employees who suffer work-related injuries, illness, or death. 

Unlike many of the labor laws that employers must comply with, the federal requirements for WCI coverage do not apply to private sector employers. Since workers’ compensation insurance requirements vary from state to state, in this article we discuss WCI only in general terms. Employers should understand and comply with their state’s specific workers’ comp law requirements. The Department of Labor provides a state-by-state guide to help you get started.

Why Does My Company Need Workers' Comp?

The short answer is because most states require you to. Penalties for not having coverage for your employees can be stiff. However, even if it’s not a requirement for your business, other companies may not want to do business with you if you don’t have workers’ compensation coverage. At the end of the day, it’s about taking that step to protect your business from the cost and complexity of potential lawsuits.

What Does Workers' Comp Insurance Cover?

Generally speaking, employers are required to provide WCI coverage to all employees. Since sole proprietors, partners, and members of an LLC are usually not considered employees, they are generally not covered by workers’ comp policies. Additionally, while shareholders who work for an S-Corporation are normally considered employees, in many states, such employee-shareholders may elect to opt out of workers’ comp insurance coverage.

Independent contractors are self-employed and are not considered employees of the customers for whom they provide services. As a general rule, independent contractors are usually not covered by their customer’s workers’ compensation policy.

Does Every Business With Employees Need to Have WCI Coverage?

Generally, yes, but there are exceptions. Whether or not an employer is required to provide workers’ compensation coverage may depend on the number of employees. The majority of states require coverage for all employees, but several states have a minimum requirement of three or more employees.

Again, the rules vary by state. South Carolina has a minimum of four employees (with exceptions), and Missouri and Tennessee only require coverage for five or more employees (with exceptions). Some states exempt coverage for agricultural workers, and a couple of states require coverage only if the annual payroll exceeds a certain limit. For more general information on state workers’ comp laws, check out the National Federation of Independent Businesses chart.

What Benefits Do Employees Receive?

Workers' compensation benefits are provided to employees whose injuries or illnesses arise out of their employment. In addition, an employee's beneficiaries may be eligible for benefits if an employee dies as a result of an on-the-job activity.

There are two categories of benefits: indemnity benefits and medical benefits. If an employee experiences work-related injuries or illness, indemnity benefits provide partial wage replacement for loss of income or earning capacity. Medical benefits are paid to treat the injury or illness, or to relieve the effects of a permanent injury or illness if it is incurable. Unlike health insurance policies, there are no policy limits to reasonable medical benefits under workers’ compensation.

How Do You Calculate Workers' Comp Premiums?

Basic premiums may be determined based on a number of different factors, such as the type of industry, an employer's experience, and administrative costs. But there is one factor that is relevant in all states: total payroll within specific classes of employees.

Each employee is assigned to a class based on the type of work performed and the degree of risk, the estimated payroll for a year in each class is then multiplied by the rate for the class.

For instance, suppose an engineering firm has three classes of employees: engineers, clerical, and outside sales. The employer's base premium could be calculated as follows:

In some states, premiums for officers, key employees, or highly compensated employees may be based on a maximum salary rather than the employee's actual compensation.

Premiums are based on the employer's estimated payroll for the upcoming plan year. Every year, the insurance company will perform an audit of the employer's payroll for the prior plan year. If the actual payroll is greater than the estimated payroll for the plan year, an additional premium will be due. If the actual payroll is less than the estimated payroll, then the employer will receive either a credit or a refund.

Is All Employee Compensation Included in a Company's Payroll for WCI?

With the exception of four states (Pennsylvania, Delaware, Utah, and Nevada) overtime pay (a 50% overtime wage premium) is not included in the calculations for workers’ compensation insurance. How overtime is reported in an audit can be a critical factor in how premiums are calculated, especially if workers are paid different hourly rates or are paid shift differentials.

This is because the “regular rate,” which is used to calculate overtime wages, can be different from the hourly rate. Many insurance companies define overtime pay as the wages paid at one-and-a-half times the employee's hourly rate for overtime hours.

For instance, suppose an employee is paid $10 per hour and works 600 hours of overtime during the year. The workers' compensation insurance company will expect the overtime pay to be reported as $9,000 ($10/hr x 1.5 x 600 hr).

It’s critical that the employer inform the insurance company that the reported overtime pay is the amount that should be excluded from premium calculations.

How Justworks Can Help with Compliance

The above discussion is only a general consideration of some of the factors that affect an employer's workers' compensation insurance. This is one area in which homework is absolutely essential, especially if a business has employees working in more than one state. It’s always advisable to consult with employment counsel on this issue.

Justworks can help companies on our platform comply with the applicable workers’ comp requirements. By grouping all our customers onto our workers’ compensation policy, we make it easy for businesses to obtain and manage their coverage, which makes for one less compliance worry. Get in touch with us today to learn more.