Understanding Workers Compensation Insurance

Image courtesy of [Doug Ross] / Getty Images. Image courtesy of [Doug Ross] / Getty Images

Workers compensation insurance is mandatory in most states. If your company employs workers, you are likely obligated to purchase this coverage. Here is an overview of workers compensation laws and the coverages they afford to injured workers.

History of Workers Compensation

Before the advent of workers compensation laws, employees who wanted restitution for on-the-job injuries had only one option. They could sue their employer for bodily injury.

Winning a lawsuit against an employer was very difficult. For one thing, few workers had the funds to pay the legal costs associated a lawsuit. Secondly, employers had three defenses, often called the "unholy trinity," which were difficult for workers to overcome. An employer could defeat an employee's suit by proving any of the following:

  • Contributory Negligence The employee was negligent and contributed to his or her injury.
  • Assumption of Risk The worker assumed the risks associated with the work when he or she took the job.
  • Fellow Employee Negligence  Negligence committed by a co-employee contributed to the worker's injury.

By the early twentieth century, the public had become sympathetic to workers' plight and demanded change. In 1911 Wisconsin became the first state in the United States to enact a workers compensation law. Other states quickly followed suit. By 1950, virtually all states had passed such laws.

No-Fault Coverage

Workers compensation laws provide benefits to injured workers on a no-fault basis. Workers forgo the right to sue their employers for negligence in exchange for benefits, like medical care and disability income. To guarantee that these benefits will be available, states require employers to purchase workers compensation insurance.



Most employees are covered by workers compensation laws. If they are injured on the job, their employer is obligated to provide benefits. Yet, some workers are exempt from workers compensation laws. The types of workers that are excluded vary from state to state, but many states exclude the following:  

  • Sole Proprietor or Partners Most states do not require sole proprietors or partners to be insured under a workers compensation policy.
  • Employee Threshold  Some states allow businesses to opt out of coverage if they employ fewer than a specified number of workers.
  • Agricultural and Domestic Workers Some states do not require employers of farm or domestic workers to purchase workers compensation insurance.
  • Independent Contractors Because independent contractors are not employees, they are not generally eligible for workers compensation benefits. Note that you cannot misclassify your employees as contractors to avoid purchasing workers compensation coverage. Such action constitutes insurance fraud. If you aren't sure how your state distinguishes between employees and independent contractors, ask your agent or broker or your attorney for assistance.

Premium Calculation

Most states use a classification system for rating workers compensation insurance.

Employers that have similar operations are grouped into the same classification. Each classification is assigned a rate. The premium for each employer is calculated by multiplying the rate times the employer's payroll, and then dividing the result by 100.

Most employers are subject to experience rating. This means that the premium they pay for workers compensation coverage is adjusted up or down to reflect their loss history. Experience rating plans reward employers with a better-than-average loss history by applying a credit to their premium. The reverse is also true. Employers that have a worse-than-average loss history pay more for workers compensation insurance.

What is Covered? 

The types of benefits afforded by workers compensation laws are fairly consistent from state to state. Most laws provide medical coverage, disability income, and rehabilitation.

If an injured worker dies, death benefits are paid to the employee's spouse and minor children.

Workers compensation insurance covers injuries sustained by workers in the course of their employment. Workers are covered while traveling for their employer on business, including while on short-term foreign travel. They are also covered for injuries they sustain due to workplace violence and natural disasters that occur while they are on the job. Employees are generally not covered for injuries they sustain while commuting to and from work.

While workers compensation laws generally afford the same types of benefits, the amount provided can vary widely from one state to another. For example, State A provides up to 500 weeks of benefits for a permanent partial disability. State B provides benefits for only 260 weeks. The amount of benefits paid in your state can affect the rate you pay for workers compensation insurance.

Policy Form 

Most workers compensation policies are based on the standard NCCI form. This form provides two types of coverage: workers compensation and employers liability.

Part One of the policy provides workers compensation coverage. This section provides benefits to injured workers as required by law. The policy incorporates the workers compensation law of the state in which the employer operates. The policy does not specify a limit under Part One. This is because state law dictates the amount and types of benefits that are provided. 

Part Two of the policy provides employers liability coverage. It protects employers from suits by injured workers who aren't covered by workers compensation laws. In most states Part Two is subject to limits. Separate limits apply to bodily injury caused by an accident and bodily injury caused by an occupation disease.

Edited by Marianne Bonner