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What is Workers' Compensation and How Does it Work?

Workers' compensation insurance is mandatory for many business owners. You may know that you need it, but do you know what it does and how it works? This article gives you a basic understanding of workers' comp, whether you're exempt, and how to calculate premiums.

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. The answer to the first question is pretty straight forward; it is a type of insurance that is compulsory to have for anybody with employees in every state except Texas.

It 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 in some cases limit the amount of compensation to be claimed, and they can often eliminate the liability of co-workers. This is true of the California's Workers' Compensation Act, for example, which also has a fund to cover the costs when employers illegally fail to take out workers’ compensation insurance.

Exemption from Workers’ Compensation Responsibilities

Some companies may be exempt from purchasing workers’ compensation insurance depending on the state in which they do business, they include;

  • Businesses where only the owner(s) do work
  • Very small businesses
  • Family businesses
  • Businesses that only hire independent contractors (though the definition of this can vary from state to state)

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 in order 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 accepted, all medical related costs that are covered revert to the employer, subject to the policy, type of employment and state laws.

Calculating Workers’ Compensation Premiums

Different types of employment are usually put into ‘classification codes’, all of which have a preset value and policy based on the amount of risk involved in that particular job. When working out the premium for workers’ comp, this amount is then multiplied by the payroll for the given job, which provides a rough estimate for the premium.  Other relevant factors are then taken into consideration such as the employer’s claim history and the types of safety training in place at the workplace. 

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.

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