Workers' Comp: What Small Business Owners Should Know

Workers' compensation (commonly called workers' comp) is an insurance system designed to provide replacement income and pay medical expenses for employees who suffer work-related injuries or illnesses. Let's go over what small business owners need to know about workers' comp.

Workers' comp: A background

Before the first workers' compensation laws were adopted, about 100 years ago, an employee injured on the job had only one recourse: sue the employer in court for negligence. Of course, legal action was a difficult, time-consuming, and expensive process.

The workers' compensation laws changed this by establishing a no-fault system. Although employees can't sue in court, they are entitled to receive compensation without having to prove that the employer caused the injury.

In exchange for paying for workers' compensation insurance, employers are spared from having to defend against lawsuits by injured employees and paying out damages. Workers' compensation benefits are set by state law and are usually modest.

Each state has its own workers' compensation laws and insurance system. No two states' laws are exactly alike. Let's go over the basics about what you need to know.

Who must be covered by workers' comp

You'll need to obtain workers' compensation coverage only if you have employees. You do not have to provide workers' comp coverage to independent contractors you hire to help you in your business. An independent contractor is a person who operates his or her own independent business.

Self-employed sole proprietors, partners in partnerships, and limited liability company members aren't required to purchase workers compensation unless and until they have employees who aren't owners. The same rule holds true in most states for officers of small "closely held" corporations with no employees.

In some states, sole proprietors, partners, LLC members, or corporate officers must file a document (often called a waiver) with their state workers' compensation agency to obtain their exemption from their state's workers' comp requirements.

Also, not all employees must be provided with workers' comp coverage. All states exclude certain types of workers from workers' compensation coverage. The nature and scope of these exclusions vary from state to state.

However, they typically include casual labor (workers who work for a brief time period), and certain types of domestic workers and farm laborers. Several states also exclude employers having fewer than a designated number of employees (anywhere from three to five, depending on the state).

Obtaining coverage

Workers' compensation insurance must be purchased as a separate policy from a workers comp insurer. It can't be purchased as part of a business owner's liability insurance policy.

Each state has its own rules about where employers may buy workers comp insurance. In a few states, all employers must buy their workers comp insurance from a "state fund" that has a monopoly on issuing such insurance in the state. In other states, workers' comp coverage may be purchased from either the state fund or from private insurers.

Some states allow an employer to self-insure‚ a process that typically requires the business to maintain a hefty cash reserve earmarked for workers‚ compensation claims. Usually, this isn't practical for small businesses.

If private insurance is an option in your state, discuss it with an insurance agent or broker who handles the basic insurance for your business. Often, you can save money on premiums by coordinating workers' compensation coverage with property damage and liability insurance. A good agent or broker will be able to explain the mechanics of a state fund if that's an option or is required.

How much does workers' comp cost?

The cost of workers' compensation varies from state to state and depends upon a number of factors, including:

• How generous the state's workers' comp benefits are (each state's benefits differ)
• The size of the employer's payroll
• The nature of the industry
• how many claims have been led in the past by the employer's
• employees

As you might expect, it costs far more to cover employees in hazardous occupations such as construction than it does to provide coverage for those in relatively safe jobs such as clerical work. It might cost $500 to $600 a year to insure a clerical worker and perhaps ten times as much to insure a roofer or lumberjack.

What happens if you don't have workers' compensation coverage?

If you lack workers' comp insurance, an employee who is injured on the job can sue you for damages. Defending these lawsuits would likely cost far more than obtaining workers' compensation coverage would have in the first place.

You'll also be subject to fines imposed by your state workers' compensation agency. Such an agency could even order you to stop doing business in the state until you obtain coverage.

Where to get more information

You should check with your state workers' compensation agency to find out the details of your state's requirements. Links to all 50 state workers' compensation agency websites are at this location.