Workers' Compensation

Are You CoveredWhat is workers' compensation insurance?

Mandatory state-based social insurance program

Workers' compensation is an insurance program that provides workers with insurance protection against disability or death that occurs during work. This could include a workplace injury or occupational disease. Employees who are injured or disabled on the job receive a fixed monetary award that generally eliminates the need for litigation. Many states allow qualified businesses to self-insure for part or all of the claims. Some states allow smaller companies to form groups to self-insure, that is, pool their risk and liabilities with other companies. Federal employees and interstate commerce workers are protected under federal workers' compensation statutes.

Each state has its own workers' compensation system, so it is important to work with an advisor who is experienced in the state(s) in which your business operates.

Two-pronged coverage protects both the worker and the company

Workers' compensation provides your employees with benefits for medical expenses, lost earnings, disability, and death under the statutory liability coverage. Under the employer liability coverage, your business and your employees are protected from liabilities such as lawsuits filed by an injured employee's relatives (e.g., loss of marital consortium) or from third parties (e.g., an equipment manufacturer being sued by the injured employee).

In most states, the workers' compensation laws require businesses to accept the laws' provisions and provide the specified benefits. However, in some states, employers can opt out of the state workers' compensation system, but in so doing, they lose the benefit of certain liability limitations.

If your business has workers who travel to several states, you may be interested in a third level of protection called "other states insurance," which will provide the business with coverage for requirements in another state (such as a higher benefit limit).

Who must be covered?

All employees generally must be covered under state workers' compensation systems. State workers' compensation acts generally classify workers as employees based on factors derived from the common law. Among the factors considered are whether the employer has the right to control the actions of the worker, and whether the work performed by the worker is part of the regular business of the employer. Independent contractors are not included in the definition of employee, and are not covered under workers' compensation statutes. In addition to independent contractors, most states exclude agricultural employees, domestic employees, and casual employees from the requirement. For more information on the different types of employees, please see the discussion on Worker Classification.


Your business may be required by the laws in your state to post a notice in the workplace that provides the name of the workers' compensation insurance carrier.


Failure to carry workers' compensation coverage may be punishable by fines, civil penalties, criminal penalties, exclusion from public contracts, and/or cease and desist orders. The laws vary by state.

State adopts funding arrangement

There are three funding arrangements available. The state funding arrangement determines the extent to which the state bears some or all of the risk of workers' compensation insurance. The following table shows the various funding arrangements and characteristics:

Monopolistic states (state assumes all risk)

In the monopolistic states, the state assumes the risk and pays claims from the state fund. Workers' compensation insurance is generally more stable in states with their own funding arrangements because employers need not worry about the possibility that their insurer will opt out of providing insurance in a given state in a given year. An insurer's decision not to offer insurance in a given state could result in a big headache for those companies with policies written by the withdrawing company.

Competitive fund states (state assumes some risk)

The competitive fund states may offer your business the best opportunity to shop around for coverage. You have the choice between the state fund or a private insurance carrier. While it may seem like more work to compare your choices, you could benefit in the long run.

Insurance company fund states (state assumes no risk)

The third funding arrangement occurs when the state assumes no risk for the workers' compensation insurance. In these states, the funding is handled through insurance companies.

Insurance company premiums based on three factors

Payroll costs

The size of your company's payroll is just one factor used by an insurance company to determine workers' compensation insurance premiums. Payroll costs are generally based on gross wages (straight-time only, not including any overtime premium for hourly workers). Some states cap the compensation amounts for executive management positions in the calculations.

Check the insurance company audit figures to verify that the payroll data don't include overtime premiums that will inflate the payroll amount.

Payroll classification rate

Employee payroll costs are divided into specified categories based on the type of work performed. For instance, clerical employees are grouped and assigned a rating, as are warehouse employees, machine operators, salespeople, etc. Each payroll classification is assigned a rate that is applied to the gross wages for the employee group. The various categories are added to derive a total amount.

Experience-rating modifier

The premium is adjusted by an experience-rating modifier based on your business's claims history. The experience-rating modifier is calculated by a rating bureau, generally once a year, and based on three years' claim experience and excluding the current and previous years. A modifier above 1.0 indicates higher than average claims experience, while a modifier below 1.0 indicates better than average claims experience. The experience-rating modifier serves as an incentive to promote workplace safety by lowering the premium for companies with fewer than average claims.

Ways your company can control workers' compensation premium costs

Don't wait until your premium notice arrives or a workplace incident occurs to assess your workers' compensation policy. There are certain measures you can take to control your company's workers' compensation costs. Some may seem to be time-consuming and a lot of work for you, the company, or your financial advisor, but could be worth it in the end when an employee is injured on the job or the premium payment comes due.

Prevention through education

The best way to prevent or reduce workplace injury and illness is through safety, health education, and training. Education and training in the areas of recognition, avoidance, and prevention of unsafe or unhealthy working conditions in the workplace can help reduce injury and illness and may even increase productivity. A workplace safety committee made up of members from management and labor can be instrumental in identifying and correcting workplace health and safety concerns.

Check with the appropriate labor department and rating bureau in your state. Many offer advice and help in preventing occupational illness, injury, or death in the workplace and may also assist with safety training programs. Many insurance companies now offer workplace safety training programs also. Check with your representative.

Check your company's experience modifier rating

You or your financial advisor may be able to check your company's experience modifier at least once a year. Obtain a copy of the worksheet from the rating bureau or the insurance carrier and check for errors (which unfortunately are not uncommon).

Review insurance company claims data

You or your advisor should review the insurance company's claims data and compare the number of claims to your own records. Also check the claims information for actual claims payments and the estimated future claims reserve.

Be involved in claims settlement

You may find it worthwhile to be involved in the claims settlement process. For example, your business may be able to participate in discussions of proposed claim settlements and review loss reports with the insurance company. This can be a sensitive area because the workers' compensation contract transfers responsibility for handling and settling claims to the insurance company, but check with your agent anyway. Many insurance companies respect and appreciate the attempts of businesses to control costs.

Review employee classification codes

Verify the employee classifications and headcount within each category being used for your policy, and read the classification descriptions carefully. Classifications being used may not accurately describe the work performed by your employees or groups. In addition, you may have certain employees who perform multiple functions across different categories, so you may be able to reclassify employees or groups of employees to other less expensive classification codes.

Monitor claims frequency

Watch the number of claims being filed, not just the amounts. The experience rating factor is based largely on the frequency of claims, so a lot of smaller claims could increase the experience rating even if the total dollar amount of the claims is relatively small. Check with your insurance company; some insurers allow businesses to self-insure for minor claims. While such an arrangement could affect cash flow in the short term, the long-term benefit of reduced future premiums could be achieved.

Check the risk of different business lines (if a multi-line operation)

Generally, the rate modifiers are based on the riskiest line of business. Corporations with subsidiaries may consider moving a high-risk subsidiary to another state (especially if it represents a small percentage of overall operations) or carving out the riskier business line. State law may not require the modifier of a minority interest subsidiary or venture to be applied to the consolidated operations. Your financial or legal advisor can help you here.


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