An Introduction to Workers' Compensation

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Image courtesy of [Monty Rakusen] / Getty Images.

If your business employs workers, you are probably required by law to purchase workers’ compensation insurance. As its name suggests, this coverage is designed to compensate workers for injuries sustained on the job. It ensures that injured employees receive the workers compensation benefits that are prescribed by state law.

History of Workers Compensation

Before workers compensation laws were enacted, injured workers and their employers were governed by common law.

The law largely favored employers. Workers could seek compensation for on-the-job injuries by suing their employer, but they were rarely successful. Most employee suits could be defeated based on one of the following arguments: 

  • 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 for employees to overcome, so few obtained any compensation for workplace injuries. The situation began to change in the early twentieth century as the public became more sympathetic to employees' plight. The first workers compensation law in the United States was enacted in 1911 by the Wisconsin legislation. Other states quickly followed suit.

By the early 1920s, most states had implemented a workers compensation system. The last state to enact a workers compensation statute was Hawaii. Its law was passed in 1949.

Mandatory Coverage

In all but two states (Oklahoma and Texas), workers compensation coverage is mandatory. This means that employers are obligated by law to purchase a workers compensation policy on their employees' behalf.

Employers that fulfill this obligation are protected from lawsuits by injured employees. Workers who accept benefits for an injury under a workers compensation policy are barred from suing their employer for that injury.

Workers compensation laws do not apply to every worker. The laws have some exceptions, which vary from state to state. Many laws exclude domestic and agricultural workers, independent contractors, and sole proprietors

Rates Reflect Expected Losses

Workers compensation insurers and rating agencies (like the NCCI) collect vast amounts of data on workers compensation claims. They tabulate the data by industry group and classification code. For each classification, they calculate the number and size 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. When you buy workers compensation insurance for the first time, the rate you pay will reflect the average claims experience of the class codes listed on your policy.

Agriculture, mining and construction are hazardous occupations. Workers employed in these industries are prone to serious injuries. Thus, their employers pay relatively high rates for workers compensation coverage.

Employers that operate businesses in less hazardous industries pay lower rates.

Experience Rating

Once your business has been operating for a few years, it will likely be subject to experience rating. This term refers to a method of rating in which your premium is adjusted up or down to reflect your company's loss history. Depending on your claims experience, you may pay more or less for workers compensation insurance than 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 in order to minimize on-the-job injuries. If you need help setting up a program, ask your insurer for assistance.

Many insurers offer risk control services to help their policyholders reduce losses.

Another 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 third 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.

Article edited by Marianne Bonner