Workers’ Compensation: What It Is, How It Works, and Who Pays

Workers' compensation, also known as "workers' comp," is a government-mandated program that pays benefits to employees who are injured or become ill on the job or as a result of their job. It is essentially a workers' disability insurance policy that provides monetary compensation, healthcare benefits, or both to workers who are injured or ill as a direct result of their jobs.

Workers' compensation is generally administered by different states in the United States. The perks that are required vary substantially by state.

Texas is the only state where employers are not required to have workers' compensation insurance.

Understanding Workers’ Compensation

Workers' compensation benefits may include partial wage replacement for the time the employee is unable to work. Benefits may also include healthcare and occupational therapy reimbursement.

The majority of workers' compensation schemes are funded by private insurers through premiums paid by individual businesses. Each state has a Workers' Compensation Board, which regulates the program and mediates disputes.

Federal personnel, longshore and harbor workers, and energy employees are all covered by workers' compensation systems. The Black Lung Program is another government program that handles death and disability payouts for coal miners and their dependents.

Workers’ Compensation Benefits

Workers' compensation requirements vary by state, and some states do not cover all employees. Some states, for example, exclude small enterprises from the coverage mandate. Others have specific needs for specific industries. The National Federation of Independent Business (NFIB) has a list of each state's worker compensation laws.

Salary Replacement

In most cases, the salary replacement paid to an employee under workers' compensation is less than the person's entire pay. The most generous programs pay approximately two-thirds of the individual's gross earnings.

Workers' compensation awards are typically not taxable at the state or federal level, compensating for a significant portion of lost income. Taxes may be owed to beneficiaries who receive benefits from the Social Security Disability or Supplemental Security Income programs.

Healthcare Cost Reimbursement and Survivor Benefits

Most workers' compensation programs cover only medical expenditures incurred as a direct result of employment. A construction worker, for example, could seek compensation for an injury sustained in a fall from scaffolding but not for an injury sustained while driving to the working site. 

In some cases, workers may be paid the equivalent of sick leave while on medical leave. Workers' compensation pays out to an employee's dependents if he or she dies as a result of a work-related incident. 

Recipients Waive the Right to Sue

Workers who accept workers' compensation waive their ability to sue their employer for carelessness.

This compensation agreement is designed to safeguard both employees and employers. Workers forego additional redress in exchange for guaranteed pay, and employers accept some liability while avoiding the possibly higher expense of a negligence action.

Special Considerations

An employer may contest a workers' compensation claim. In that instance, the Workers' Compensation Board can be called in to settle the disagreement.

Disputes may arise as to whether the employer is genuinely responsible for an injury or illness.

Insurance fraud might potentially affect workers' compensation benefits. An employee may falsely report an injury on the job, misrepresent the severity of an ailment, or fabricate an injury.

Indeed, the National Insurance Crime Board argues that there are "organized criminal conspiracies of crooked physicians, attorneys, and patients" who file bogus claims for workers' compensation and other benefits with medical insurance companies.

Independent Contractor Exception

Only regular employees are eligible for workers' compensation in most states; independent contractors are not. That was one of the primary grounds of dispute in the fight over a California ballot initiative that aimed to extend employment benefits to drivers for ride-sharing apps such as Uber and Lyft.

The issue of workers' compensation and other benefits for contract employees, like the so-called gig economy, isn't going away. In 2020, around 17 million Americans worked full-time as contractors, with over 34 million working part-time or occasionally as contractors.

Types of Workers’ Compensation

Workers' compensation policies are handled by separate states in the United States. The Office of Workers' Compensation Programs is housed inside the United States Department of Labor, but it is only responsible for federal employees, longshoremen and harbor workers, energy personnel, and coal miners.

Due to the lack of federal rules for workers' compensation, policies for the same types of injuries vary greatly from state to state.

Depending on where a worker lives, the same injuries can result in vastly different types of compensation. According to an Occupational Safety and Health Administration (OSHA) study, workers' compensation is a "broken system," with individuals bearing 50% of the expenses of job injury and illness. Low-wage and immigrant workers frequently do not seek benefits.

Workers’ Compensation: Coverage A vs. Coverage B

Workers' compensation insurance comes in two varieties: Coverage A and Coverage B.

• Coverage A includes all of the state-mandated benefits to which an injured or ill employee is entitled under the employer's insurance policy. It pays for salary replacement as well as medical care, rehabilitation, and death benefits as needed. Except for Texas, all states provide similar benefits, albeit they vary greatly from state to state and many states prohibit some employees from participation.
• Coverage B provides benefits in excess of what Coverage A requires. They are normally only paid if the employee wins a lawsuit against the company for carelessness or other misbehavior.

Workers who receive workers' compensation typically forgo their right to sue their employers, so entering into a no-fault contract. State legislation and court judgements in a number of states, however, have restored employees' right to sue in a variety of carefully restricted conditions. As a result, an employer may choose to buy coverage that combines Coverage A and Coverage B.

Who pays workers’ compensation insurance premiums?

The employer pays the premiums for workers' compensation insurance.

As with Social Security benefits, there is no payroll deduction. The employer is compelled by law to pay workers' compensation benefits in accordance with state rules.

How much does workers’ compensation cost?

The cost of workers' compensation insurance varies by state, as do the benefits that are required. There are also variable charges based on whether the personnel insured work in low-risk or high-risk environments.

The insurance fees are calculated using the company's payroll figures. As an example:

• Workers' compensation in California costs an average of 40 cents per $100 in payroll for low-risk employment and $33.57 for high-risk jobs.
• In Florida, the average wage for low-risk jobs is 26 cents per $100, while high-risk jobs pay $19.40.
• In New York, low-risk employment pays an average of 7 cents every $100, while high-risk jobs pay an average of $29.93 per $100.

How do you apply for workers’ compensation?

The procedures for filing a claim for workers' compensation differ by state. In general, a worker who has been injured or unwell on the job should:

• Make a detailed record of the accident or illness, including photos and the names of any witnesses.
• Inform your employer about the injuries or illness. The employer should handle everything else, including filing your claim with the insurer.

You can check with the employer's insurance carrier to see if a claim was filed.

If your claim is refused, you have the right to file an appeal with your state's Workers' Compensation Board.

Who is exempt from workers’ compensation?

Contractors and freelancers are often not eligible for workers' compensation; only salaried employees are.

Aside from that, each state has its own rules. Arkansas, for example, expressly prohibits farm laborers and real estate agents from eligibility. Domestic workers are not permitted in Idaho. Musicians and crop-dusting plane crews are not permitted in Louisiana.

The Bottom Line

Except for Texas, every state requires companies to provide workers' compensation insurance to at least part of their employees. Because the rules are written by the states, there are numerous exceptions and exclusions. Contractors and freelancers are rarely covered, and many states exclude particular occupations from the mandate or limit the scope of the benefits in various ways.

Most states have websites that can assist you in determining whether you are protected by workers' compensation insurance. For example, the Division of Workers' Compensation in Florida includes information on its program, access to required documents, and a database that may tell you whether your company has coverage.