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What is Workers' Compensation and How Does it Work?

  • Human Resources
  • Article
  • 6 min. Read
  • Last Updated: 12/31/2018

Two co-workers looking at a computer
Workers' compensation is an insurance that covers any worker who has an injury or suffers an illness while executing duties at work. Regulations vary from state to state, but it is recommended that employers with one or more employees carry the insurance to mitigate risk.

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At some point in time, many new business owners find themselves asking the question, “What is workers’ compensation?” Due to its sometimes-confusing nature, even owners of well-established companies often find themselves asking how it works. Workers’ compensation is a type of insurance that is mandatory in most states, although rules vary from state to state as to how many people a business can employ before it is required.

It is strongly recommended that employers carry workers’ compensation if there is an employee or employees on staff. The insurance covers any worker who has an injury or suffers an illness while executing duties at work, and includes coverage for medical bills, rehabilitation costs, and any loss of earnings while the employee is away from work. It can also pay dependents of a worker who dies because of a work-related illness or accident to help cover loss of earnings and other post-mortem costs they may incur.

However, the laws are not only there to protect the employee; they can often eliminate the liability of co-workers and shield an employer from a lawsuit if an employee collects workers’ compensation benefits. Most states even maintain a fund to protect an injured worker in case the employer does not have coverage.

Some companies might be exempt from obtaining workers' compensation insurance depending on their individual state requirements. For example, Texas is the only state in which it is mostly optional, except for a few industries where it is required.

How does workers’ compensation work?

The answer to the question, “how does workers’ compensation work?” can vary from state to state, though there are general steps that need to be taken to make a claim. First, a supervisor must be notified of the injury or illness, preferably on the day it happens. They are then responsible for immediately documenting the problem and passing it on for review. Once the claim is reported to the workers’ compensation carrier, then the carrier is responsible for that bill. If the injured employee gets billed, then it is the employee’s responsibility to work with the claims adjuster to get that bill paid. All medical-related costs that are covered are subject to the policy, type of employment, and state laws.

Calculating workers’ compensation premiums

Workers’ compensation premiums are calculated on employee classification, based on job duties and the rate assigned to that classification (this is based on industry). There are additional factors that could affect the rate such as the size of an employer’s payroll and the company’s claims experience. Also, depending on the state, potential discounts are available as well as the possibility of add-ons such as state fees and charges. 

If you are currently a Paychex payroll client, our workers’ compensation payment service integrates with payroll to calculate your premiums using actual wages instead of estimates, which can improve business cash flow by eliminating large deposits as well as reduce your risk of an audit.

Workers' compensation insurance is mandatory in most states

Set up and manage the right policy with Paychex Insurance Agency to help you comply with regulations and stabilize your cash flow.


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* This content is for educational purposes only, is not intended to provide specific legal advice, and should not be used as a substitute for the legal advice of a qualified attorney or other professional. The information may not reflect the most current legal developments, may be changed without notice and is not guaranteed to be complete, correct, or up-to-date.

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