Workers' Compensation Insurance

Injured worker
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Workers' compensation insurance pay benefits to employees for injuries incurred on the job. It is a mandatory coverage in a majority of states. Thus, most businesses that employ workers are obligated by law to purchase workers' compensation coverage.

Origin of Workers' Compensation Laws

Before workers' compensation laws were enacted, U.S. workers faced a multitude of employment-related hazards. Many toiled in dirty factories, dusty mines or fire-prone offices.

Numerous workers suffered serious injuries or were killed on the job.

Injured workers (or their survivors) who wanted compensation for their injuries had only one option: suing their employer. Few employees took this step. For one thing, lawsuits were expensive and most employees lacked the needed funds. Secondly, employers could defeat most employee lawsuits by using one of the three defenses listed below. These defenses are often called the "unholy trinity" because they were so difficult for injured workers to overcome:

  • Contributory Negligence: The employee's own negligence contributed to the injury.
  • Assumption of Risk: The worker assumed the risks of the job when he or she agreed to employment.
  • Fellow Employee Negligence: The worker's injury was caused by the negligence of a fellow employee

By the early 20th century, the American public had become sympathetic to the injured workers' plight and demanded reforms.

In 1911, Wisconsin passed the first workers' compensation law in the U.S. Other states quickly followed, and by 1920 a majority of states had passed a workers' compensation law. The last state was Mississippi, which passed its law in 1948.

The Grand Bargain

Workers' compensation laws are often referred to as the Grand Bargain between workers and employers.

The laws obligate employers to provide benefits, via their workers' compensation insurer, to workers injured on the job. If employers fulfill this duty, they are (mostly) protected from lawsuits by injured workers.

In virtually all states, workers' compensation insurance is intended to be the sole remedy for employees injured on the job. Thus, the laws generally prohibit employees from suing their employers for work-related injuries if the workers are covered by workers' compensation insurance.

Laws Cover Most Workers

Although workers' compensation laws cover a majority of workers, they do have some exceptions. These vary somewhat from state to state. Virtually all states exclude individuals, such as maritime workers, who are insured under a federal workers' compensation program. Most states exclude independent contractors, domestic workers, and agricultural employees. Some states exclude workers in specific occupations, such as ordained priests, real estate agents, and professional athletes. If you are unsure how the law applies in your state, consult your insurance agent or attorney.

A hallmark of workers' compensation laws is that they pay benefits regardless of fault. Workers receive compensation for job-related injuries even if their own negligence or that of a fellow worker contributed to their injuries.

Benefits Provided

State laws determine the benefits that are afforded to injured workers. States are fairly consistent in the types of benefits they provide. These generally include:

  • Medical Coverage: Includes medical expenses for doctor, hospital and nursing care; medications; diagnostic tests; physical therapy; and medical equipment
  • Disability: Provides partial reimbursement of wages lost during a temporary or permanent disability. The disability may be total or partial.
  • Rehabilitation: Provides vocational training for workers who must change occupations due to their injury 
  • Death: Pays death benefits to the surviving spouse and minor children of workers killed on the job

While most states afford similar types of benefits, the amounts they provide can vary considerably. For instance, one state may provide up to 500 weeks of benefits for a temporary total disability.

Another state may pay benefits for only 104 weeks.

Workers' Compensation Policy

Unless they do business in a monopolistic state, employers can purchase workers' compensation insurance from any private insurer that offers this coverage. Most workers' compensation insurers issue policies on a standard form developed by the National Council on Compensation Insurance (NCCI). This form includes two parts. Part One provides workers' compensation coverage. Part Two covers employers liability.

Part One of a workers' compensation policy pays benefits to employees injured on the job. Employees receive benefits prescribed by the workers' compensation law of the state where the employer's workplace is located. This law is incorporated into the policy by reference. If an employer has workplaces in multiple states, then the laws of all of those states become part of the policy.

Part Two of the policy provides employers liability coverage. It covers lawsuits by injured workers against the employer. As noted above, workers' compensation laws don't cover all workers. Moreover, the laws may exclude certain types of illnesses or injuries. Examples are heart attacks or strokes that occur on the job but are not considered occupational. Employers liability insurance protect employers against lawsuits based on injuries that aren't covered by workers' compensation insurance.

Workers' Compensation Classifications

The pricing of workers' compensation insurance is based on a classification system. Employers are categorized into classifications that describe their specific business. The idea is that workers employed by similar types of businesses face a similar risk of on-the-job injuries. Each classification represents a type of occupation, such as landscape gardening or electrical wiring. Employers in similar occupations are assigned the same classification.

The most widely-used classification system was developed by the NCCI. Most states use this system or one similar to it. The NCCI system includes hundreds of classifications, each of which is identified by a description and a four-digit code. An example is Clerical Office Workers, code 8810. Each classification is assigned a rate. The rate that applies to a specific classification varies from state to state. In some states, workers' compensation rating is administered by the NCCI. In others, it is administered by a state rating bureau.

Premium Calculation

Workers' compensation premiums are calculated based on two main factors: rates and payroll. Payroll means salaries, wages, bonuses etc. paid to workers annually as remuneration. Payroll is divided into the appropriate class codes. For each applicable class code, the payroll is divided by 100 and then multiplied by the rate.

For example, Harry owns Happy Hardware, a retail hardware store. Harry employs 25 workers. One employee works in a back office as a part-time bookkeeper. The remaining 24 employees work in the store. On an annual basis, the payroll for Harry's 24 store workers amounts to $500,000. The payroll for his bookkeeper is $25,000. Harry's store employees are classified as Store-Hardware, Code 8010. His bookkeeper is classified as Clerical Office Employees, Code 8810. The rate assigned to class code 8010 in Harry's state is $2.50, while the rate for code 8810 is $.40. Harry's premium is calculated as follows:

Store workers: ($500,000 / 100) X $2.50 = $12,500

Bookkeeper: ($25,000 / 100) X $.40 = $100

$12,500 + $100 = $12,600 premium

Experience Rating

Most employers that purchase workers' compensation insurance are subject to experience rating. When experience rating applies, an employer's loss history affects the premium the employer pays for workers' compensation insurance. The employer's loss experience is compared to the average experience of other employers in the same industry group. If the employer's history is better than average, it will receive a credit on its workers' compensation premium. If its experience is worse than average, it will receive a debit.

Depending on your state, the experience rating system may be administered by the NCCI or a state insurance bureau. Your workers' compensation insurer reports your premium and loss data to the administrator. The administrator then uses that data to calculate your experience modifier. Your modifier is typically based on three years of data and is updated annually. It may be less than one (a credit), equal to one (unity), or greater than one (a debit). Your modifier is shown on an experience rating worksheet produced by the NCCI or your state bureau.

The following example demonstrates how your experience modifier can affect your premium. Suppose that Happy Hardware has had a better loss history than most hardware stores in his state. Happy Hardware's experience modifier is .90. Happy's good loss experience has earned the company a 10 percent discount on its workers' compensation premium: $12,600 X .90 = $11,430

Now suppose that Happy Hardware's loss experience has been worse than the group average, resulting on a modifier of 1.15. Happy's premium is now 15 percent higher than average. Happy's premium will be $12,600 X 1.15 = $14,490.