The Basics of Workers Compensation Insurance

All States Had Passed a Workers Compensation Law by 1950

Businessman in an office chair falls backwards

If your business employs workers, you are probably obligated by law to purchase workers compensation insurance. This coverage compensates employees for injuries sustained on the job. States require employers to buy this coverage to ensure that injured workers can obtain the benefits afforded to them by law.

History of Workers Compensation

States began passing workers compensation laws in the early twentieth century. Before that time, workers seeking restitution for on-the-job injuries had to rely on common law. While the law permitted injured workers to file a tort claim against their employer, such claims were rarely successful. The law largely favored employers as it allowed them to use any of the following defenses against employee suits: 

  • Assumption of Risk. The employee assumed the risks associated with the work when he or she took the job.
  • Contributory Negligence. The employee's own negligence contributed to the injury, so the employer was not at fault.
  • Fellow Employee Negligence. The worker's injury was caused by the negligence of a fellow employee.

These defenses were difficult to overcome so few employees obtained compensation through the court system. By the early 1900s, the public began demanding legal reforms to aid injured workers. In 1911, Wisconsin enacted the first workers compensation law in the United States. Other states quickly followed and by the early 1920s, most had implemented a workers compensation system. The last state to enact a workers compensation statute was Mississippi, which passed its law in 1948.

Mandatory Coverage

Workers compensation coverage is mandatory in every state except Texas. Employers that comply with the laws are largely protected from lawsuits by injured employees. In most states, workers who accept workers compensation benefits for an occupational injury are barred from suing their employer for the same injury.

Workers compensation laws have exceptions, which vary from state to state. Most laws exclude domestic and farm employees, independent contractors, and sole proprietors

Rates and Premiums

The rates you pay for workers compensation insurance depend on the classifications assigned to your policy. Depending on the state in which your business operates, the rates may be calculated by a rating agency (like the NCCI) or your insurer. Insurers and rating agencies collect vast amounts of data from workers compensation claims. They tabulate the data by industry group and class code. For each classification, they calculate the number and magnitude of claims that have occurred in each of the last few years. They utilize this data to predict the frequency and severity of future claims.

The rate you pay for workers comp insurance is based on the premiums and losses of all employers assigned the same classification as your business.

Workers employed in hazardous occupations like agriculture, mining, and construction are highly prone to accidents. Thus, their employers pay relatively high rates for workers compensation coverage. Employers that operate businesses in less hazardous industries pay lower rates.

Once your business has been operating for a few years, it will likely be subject to experience rating. This means your premium will be adjusted to reflect your company's loss history compared to other employers in your industry. If your loss experience is better than average, a credit may be applied to your workers compensation premium. The reverse is also true.

Premium Reduction Strategies

Employers have a number of options for reducing their workers compensation premiums. One is to institute a risk management program to minimize on-the-job injuries. Many workers compensation insurers have a risk control unit that will help their policyholders establish a loss reduction program. Another option is to create a return-to-work (RTW) program. Such a program can help reduce your workers compensation costs by expediting injured employees' reintegration into the workplace.

Ask your workers comp insurer for suggestions on steps you can take to reduce your premium.

A third option for reducing your premiums is to enroll in a dividend plan. Dividend plans reward employers that have a good loss record. There are several types of plans. Some plans calculate dividends based on premium only. Others also consider your loss experience. Dividend plans vary by state, and from one insurer to another.

A fourth way to lower the cost of workers compensation coverage is through self-insurance. When you self-insure, you assume a portion of the risk of workers compensation losses. Two types of self-insurance that are available to small businesses are a small deductible plan and group insurance. A self-insured group is a collection of businesses that pool their premiums and losses. Group self-insurance is not available in all states.