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Worker’s Compensation Insurance – A Basic Understanding

Any business with employees should have worker’s compensation insurance, also referred to as workman’s compensation insurance.  Most states mandate this insurance if the employer reaches a certain number of employees (numerical and not full time equivalents).  The most common cited minimum count is three or more employees (eight states).  However, I strongly urge you to purchase this insurance even if you only employ one worker.

This article describes the insurance and the legal issues involved.  In addition, I’ll explain the various types of policies and how you may wish to approach this issue in your business.

Description

Worker’s Compensation Insurance a.k.a Workman’s Compensation Insurance provides for the medical cost of the sustained injury and for lost wages during recovery.  In addition, if the worker sustains permanent disability, the insurance provides compensation until the Social Security Administration’s Disability Program starts.

This insurance is required in all the states except for Texas.  In Texas, the business owner may elect out of this requirement.  However, if the Texas based employer elects against the insurance, then he opens himself up for a lawsuit for the costs associated with the employee’s injury.

This form of insurance is a legally binding exchange between an employer and an employee.  The employer provides the coverage in exchange for the right of the employee to sue the employer for the cost and future losses associated with the injury.

Legal Issues

As stated above, the employer buys insurance in exchange for the employee giving up his right to sue the employer if injured.  There are several underlying historical justifications for this insurance.

In law there is a concept known as contributory negligence.  Here, if the victim contributed to his own accident in any way, then their ability to obtain relief is greatly diminished in a court of law.  A great example of this is a case from back in 1893 – Martin vWabash Railroad, 142 F. 650 (1905).  Mr. Martin was a conductor on a train.  A part of his job was to inspect the safety of the train including hand rails.  One of the hand rails gave way and he suffered serious injury.

Well, the court sided with the railroad company because Mr. Martin was responsible to inspect the hand rails, the very safety device that gave way causing his injury.  In effect, the courts decided he caused his own injury.

Another historical issue dealt with the concept of the assumption of risk.  In the 1800’s labor was treated more like a commodity.  Large employers had little regard for safety or dealing with the injury after the accident.  Many employers had workers sign statements that they understood the risk of the job thus signing away their right to sue in case of injury.  If you were the laborer needing work to support your family, you were willing to sign in order to earn wages.

The greatest barrier to a laborer when suing the employer were the costs associated with judicial process.  But over time, social injustice forced the hand of the courts and they began to award compensation to the injured.  This in turn added costs to the employer to defend their position.

The federal government was the first to enact this form of insurance back in 1908.   The federal law also required those involved in interstate commerce to have some form of insurance.  Of course the costs of insurance decreases as more members purchase insurance.  With the costs of legal defense and the mandated interstate compliance, many large employers began to push their state legislators for mandated insurance in exchange for judicial relief.  Wisconsin passed the first form of mandated insurance in 1911.  By 1921, 46 states had passed some form of workman’s compensation insurance law.

The fundamental principle used in the law is “NO FAULT”.  Basically the program is designed with the understanding that accidents happen and therefore, the employee cannot sue his employer in exchange for financial relief for the cost of injury and lost wages.

Types of Policies

Each state is different in their respective requirements for insurance.  Your insurance representative should understand your state’s requirements.  All states mandate that the policy provide the following benefits:

  • Medical
  • Disability Income
  • Rehabilitation
  • Financial Support to Family in Case of Death

The minimum levels of insurance will vary some from state to state.  However, an employer may increase the levels at an additional cost.

I do not know of any state requiring a deductible to the employer for an injury.  However, many policies do have a waiting period (three to seven days) related to lost wages payments.  Many policies provide for vocational rehabilitation (training for a new job), costs to maintain a home during the rehabilitation period and a payment to modify a vehicle to accommodate the physical disability.

Policy costs are related to several factors.  In general, employers paid an average of $1.23 per $100 of wages in 2010.  This is down from a high of $2.17 per $100 back in 1993.  The highest weighted factor in calculating the premium is the type of work.  Those individuals involved in low risk positions such as clerical or office administration have lower premiums (less than $.25 per $100 of wages).  Whereas those in high risk environments such has high rise building metal fabricators have high risk premiums (greater than $20 per $100 of wages).  Some fields are off the charts in terms of risk and the potential for critical injury.  These include firemen, positions with exposure to radiation, and those handling dangerous chemicals.  Often commercial insurers do not cover these types of jobs and the employer must seek out insurance through a state pool of insurance or self-insure via state guidelines (large employers such as hospital systems, shipyards and energy companies self-insure).

Best Practices

As a small business employer we often forget why we are in business.  Our primary goal is to generate a profit.  Our secondary goal is to provide for the long term security of our employees.  After all, they are the ones that do all the hard work.  Our job is to protect them and their families.  So with this in mind, let’s talk about best practices.

There are three steps you need to take to create a sound protection program for your employees.  First you must educate yourself, secondly, review your work environment, and finally decide on a program that you are comfortable with that protects you and your employees.  The following describe these three steps:

 Step 1 – Education

Gain an understanding of your state’s requirements for insurance.  Many states have a Worker’s Compensation Board and they have a website describing what they do.  Your job is to spend an hour reviewing the site and educating yourself with what is required of you and how the state runs the program.  Seriously, you are the owner of your business, spending one to two hours reading the material for such an expensive cost for your business is worthwhile.

Step 2 – Work Environment

Review your work environment, read Gain an Understanding of the Work Environment to understand more about this fundamental business principle.

The article explains how the owner should identify the industry; list the customer, employee and vendor types, and finally characterize the work environment.  Do you have an environment where the employees are pure labor driven with low education requirements?  Or are you at the other end of the spectrum where employees are highly skilled and it takes a lot of resources to find the employees and then train them?

What does it take to be successful in your business?  What are the best employee traits to have?  Once you know and understand this, you can design a worker’s compensation program.

Step 3 – Design a Program

Remember, you own your business.  Talk to your agent about costs and ways to reduce costs.  Methods of price reduction include paying deductibles, using third party safety education, workplace safety inspections and so on.  Your agent should know of ways to help you.  If he can’t, get a new agent!

Make a few decisions, if you have employees that are young and you will funnel them through the work details because of the nature of your industry – food service, cleaning and landscaping etc. and you will not have a long term relationship with these workers, consider only minimum coverage.  However, if you are at the other extreme and have highly educated or skilled workers that will be with you for many years, consider an expanded insurance coverage.

Expanded coverage includes family benefits, higher disability payments during extended periods of absence due to injury.  You can and should discuss these issues with your agent.  In addition, pull a committee of employees together and educate them about insurance.  Let them decide what is important and you’ll be surprised at the result.  They may be willing to give up wage increases in exchange for more protection (security).

Summary

It is important for the small business owner to understand worker’s compensation insurance.   It is a significant cost factor in the day to day operations of your business.   This insurance is mandated in every state and the requirements are state specific.  So you need to visit your state’s Worker’s Compensation Board or insurance compliance department.  Read up on your state’s rules and then decide how you want to approach addressing the amounts and additions to the policy.

This insurance is a ‘NO FAULT’ insurance agreement.  The employee will have his medical costs and loss of wages covered in exchange for the right to sue his employer for his injury.  Act on Knowledge.

If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org.  I would love to hear from you.   If interested in my help as an accountant or consultant, contact me through the ‘My Services’ page in the footer.   

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About David J Hoare (389 Articles)
I spent 12 Years as a Certified Public Accountant, Over 20 Years of Practice in Accounting and Consulting, Controller in Management of Closely Held Operations, Masters of Science in Accounting, Prepared over 1,000 Business Tax Returns and Hundreds of Individual Returns

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