What is Workers’ Compensation and How Does It Work?

On-the-job injuries are bad news for everyone. Whether it’s the hurt employee, the concerned employer, or the whole team soldiering on for a while without their injured coworker—a workplace injury or illness hits hard. And that’s exactly when workers’ compensation insurance comes into play.

If you’ve been injured in a workplace accident, we want you to know: This isn’t an ad for a law firm. (Seriously. We hate those sleazy come-ons.) But we do want to help you answer two questions: What is workers’ compensation? And how does it work? That goes for employees and business owners.

And if you’re a business owner, we’ll also give you some guidance on how to protect yourself and your workers with great workers’ compensation insurance—one of the key types of business insurance you’ve got to have.

Workers’ compensation coverage really is a win-win kind of insurance. After all, it protects both employers and employees from possible financial disasters. Here’s how:

• Say you’re an employee. Most states require your employer to have workers’ comp in place. (Texas, for example, is one exception.) That’s reassuring because it means you’ll have medical coverage if you ever get hurt at work.
• Or maybe you own a business with employees. In that case, workers’ comp helps you avoid financial ruin over their injuries.

What Is Workers’ Compensation?

Workers’ compensation—or workers’ comp, for short—is designed to protect both workers and companies when someone’s injured (or suffers a work-caused illness) on the job. The idea is that neither party should have to risk their entire financial future when a workplace injury or work-related illness happens. And they do happen.

With workers’ comp, both sides benefit, and both sides pay a cost. Employers pitch in their premiums for financial protection, and employees who receive workers’ comp payments agree not to sue over the illness or injury. (We’ll talk more about all of that below.)

And about those payments: Workers’ comp covers medical costs and wages for employees who have been injured or gotten sick at work—but only if the incident took place in a line of work covered by the laws of the state where it happened.Let’s look at how those laws work.

What Is Workers’ Compensation Law?

Workers’ compensation law protects employers and employees by ensuring that both sides are treated fairly in the event of a workplace injury. The laws around workers’ compensation define:

• The requirement for employers to buy workers’ comp coverage to help their employees recover from workplace-caused illness or injury
• The employee’s right to get compensation for those illnesses or injuries
• The requirement for employees who have received workers’ comp payments to waive the right to sue their employer over the injury or illness

Almost every state legally requires at least some employers to buy workers’ compensation insurance, though each state has its own specific regulations around it. Here are a few of the factors that come into play for determining who’s required to buy workers’ comp in any given state:

• Certain industries
• Businesses of a certain size
• Whether the employment is salaried or by contract

For example, Texas doesn’t require most businesses to buy workers’ compensation coverage, but private employers who contract with the government must buy coverage for anyone working on those projects.¹ Yeehaw!

We’ll talk more later about who pays for workers’ compensation coverage, but in short, it’s always on employers to take care of this. In fact, it’s illegal to require an employee to help fund workers’ comp coverage in any way.

Workers’ Compensation Insurance Definition

Workers’ compensation insurance works as a kind of disability insurance for workers who sustain an injury or illness, either on the job or as a direct result of their job.

State governments and employers both view workers’ compensation as part of the cost of doing business. If you’re a business owner, workers’ comp is an essential protection to have both for your employees and yourself.

When a worker gets hurt, they’re entitled to at least two kinds of compensation:

1. Cash benefits to replace some (never all) lost wages
2. Health care benefits for treatment of the workplace injury or illness

If it weren’t for workers’ compensation coverage, who knows how much financial damage a workplace injury might inflict on everyone involved? On the other hand, it’s not a type of insurance any business owner should even think about skipping. Everybody needs this protection!

Understanding Workers’ Compensation

Let’s get into more detail on how workers’ comp works.

Recipients Waive the Right to Sue

We’ve already said this, but it can’t be overstated—workers’ comp costs and benefits go both ways for workers and companies.

In the case of injured workers, once they receive workers’ compensation benefits, they legally waive, or give up, their right to sue their employer for the illness or injury that brought about the compensation.

Wait a minute. Does that sound a bit unfair? We can understand what you’re thinking. After all, sometimes when you’ve gotten hurt on the job, the only way to get justice is to sue. But the bigger picture is more complex.

For one thing, employers need some protection too. If businesses had to face lawsuits every single time a worker got hurt on the job, they’d very soon go right out of business. They deserve a fair way to manage the risks of business. On the other hand, the injured worker often receives financial help faster through workers’ comp than through a lawsuit.

Lawsuits are almost always messy, bureaucratic nightmares for both sides! Plus, worker’s comp is guaranteed by insurance. A lawsuit may or may not result in a worker getting more money for their injury.

Workers’ comp isn’t a perfect solution to the risks of workplace injury—no insurance eliminates all physical or financial risk. But it’s a decent compromise for everyone, helping workers and employers hedge against potentially life-altering outcomes.

How Workers’ Compensation Claims Work

Let’s say the unthinkable has happened—either you’ve suffered a workplace injury as an employee, or someone who works for you gets hurt on the job. Here’s what needs to happen next.

The worker who’s been hurt should write out a detailed description of the injury or illness and share it with the employer. (And by the way, if it’s an emergency, the employee should seek medical attention immediately.) Once the immediate needs are met, it’s up to the employer to file a claim with the workers’ comp insurer.

From there, the insurer will either pay the claim or deny it. If you’ve reported a workplace injury to your employer, you’ll want to follow up with them to confirm they’ve filed a claim on it for you. Next, an insurance company adjuster will advise you of your rights and benefits under workers’ compensation.

But as with any insurance, sometimes workers’ comp claims get denied. The reasons for denial can include:

• Insufficient evidence that any illness or injury has occurred
• Questions about the extent of the injury or whether it is severe enough to require medical treatment or time off work
• Doubts about whether the illness or injury was a result of any work done for the employer

If the workers’ comp insurer denies a claim, the worker has the option to appeal. The case will then go to the state’s workers’ compensation board. Again, the board can rule in the worker’s favor, requiring the insurer to pay after all.

If you have a legit claim, but are having trouble getting it approved, you may have to consult a lawyer to help you fight for the benefits you’re due. However, if you’re not really sick or injured and are just trying to score a payday, that’s called fraud. And it could land you in deep trouble. Better to walk away now.

Workers’ Compensation Benefits

We mentioned before that workers’ comp can cover lost wages, health care reimbursement or both (if necessary). It can also include survivor benefits.

Salary Replacement

Typically, a worker will receive their workers’ comp check on the same schedule they already receive their paychecks—weekly, biweekly and so on. And it’s less than the full salary. The portion paid out varies from state to state. But in general, payments top out at two-thirds of gross pay. Some states also have maximum payouts, regardless of your salary.

Health Care Cost Reimbursement and Survivor Benefits

Most workers’ compensation plans include coverage for medical expenses, but only for injuries that are a direct result of job duties. For example, if a waitress slips and breaks her arm on a hard floor during a brutal lunch shift, she can probably expect a cast and a workers’ comp check. But if she breaks the same arm in a car crash speeding to work? Well let’s just say, we hope she has auto coverage and health insurance! She’s not likely to be collecting any workers’ comp.

Sometimes workplace injuries don’t require medical treatment, but do call for time off to recover. In those cases, workers’ comp plans can cover what’s basically sick pay for a medical leave until the worker is cleared to get back on the job. And workers’ comp can also pay the family or dependents if (God forbid!) an employee dies from a work-related incident.

What Does Workers’ Comp Cover?

Workers’ comp covers some of the medical costs and salary loss that are the result of workplace injuries or illnesses. That’s the nutshell answer.

But workers’ comp doesn’t always pay for everything. That especially goes for salary. A lot depends on the state where the injury occurred. Each state sets its own comp rates, and some even have pay-period caps. (Those limits are sometimes tied to the industry the incident happened in—another detail determined by state law.)

Generally, you can expect workers’ comp to cover all the medical costs from the illness or injury, but this can also depend on a few factors like:

• The kind of illness or injury
• The industry the worker was working in
• Whether the injury is expected to disable them from working, either briefly or permanently

Whether you’re the injured worker or you’re helping your employee through a workers’ comp case, you’ll want to look up your state’s laws to know what’s covered, and how much workers can receive in workers’ comp payments.

Exceptions to Workers’ Comp

With the already noted exception of Texas, every state mandates employer-funded workers’ comp coverage for at least some of its private-sector workers.

Each state has its own rules. So it’s no surprise that many have their own exceptions about who doesn’t have to buy workers’ comp.

Here are a few exceptions you might find in your own state:

• Freelancers and contractors
• Certain professions or industries
• Private employers (which are exempt in Texas)

So, does your state require your business (or your employer) to have workers’ comp coverage? You can probably find out through your state’s specific workers’ comp site online.

Independent Contractor Exception

States also get the say-so over whether to require workers’ comp coverage for independent contractors, and almost all states choose not to require it. So, most of the time, if you’re making a living with contract work, you’re not going to be covered by workers’ comp. Sorry, Doordashers and Shipt-drivers!

But here’s a Texas-sized exception to the exception that might surprise you: Those rebels down in Texas do require workers’ compensation benefits for contractors—so long as they’re working on government projects!

Types of Workers’ Compensation

The types of workers’ comp are as varied as the state legislatures that design them! And no two states handle this kind of coverage identically. There are two rules of thumb when asking, Which type of workers’ comp applies to my situation?

• Each state has its own rules, so look yours up.
• Federal employees fall under their own coverage by the U.S. Department of Labor’s workers’ comp program.

Workers’ Compensation: Coverage A vs. Coverage B

Another way to think about workers’ comp types is as Coverage A and Coverage B. State governments use those terms to distinguish ordinary cases without disputes (Coverage A) from cases where there has been a lawsuit brought by the worker against the employer (Coverage B).

If the insurer accepts a claim and pays out according to the state law as usual, Coverage A applies. It’ll include any state-mandated payments for salary replacement, medical care, rehabilitation and death benefits, if applicable.

In the case of lawsuits won by a worker, benefits to be paid often exceed the defined limits of Coverage A laws. At that point, Coverage B kicks in and covers whatever the court has determined the worker deserves.

How Much Does Workers’ Compensation Cost?

Remember all those workers’ comp features that vary by state? Here’s another: the cost of workers’ compensation insurance! Considering how many different rules exist across the country, it would make sense that workers’ comp rates would vary quite a bit as well.

Another factor influencing your workers’ comp premiums is the industry you do business in. You can expect to pay more if your employees are doing higher-risk work like construction, roofing and steel working.

Workers’ Compensation Rates

Would it surprise you if we said the compensation rate varies from state to state, and is determined by each state’s government? Well, here’s a shocker: Each state decides the rate for its own workers.

How Is Workers’ Compensation Calculated?

There’s no federal rule, but workers’ compensation payments tend to be around two-thirds of your normal salary. Keep in mind, some states also set a weekly (or biweekly) maximum on the payments. Those caps are sometimes calculated using the statewide average weekly wage the year that the injury or illness incurred. But again, each state sets its own rules. Contact your state’s workers’ comp board to learn more.

Is Workers’ Compensation Taxable?

In general, workers’ comp payments will not be taxable. One exception can be if an injured worker also receives income from Social Security, resulting in a tax event from that combination of income streams.

Who Pays Workers’ Compensation Insurance Premiums?

All premiums are covered by the employer alone, as required by law in every state.

The Best Way to Get Workers’ Compensation Coverage

You and your employees need workers’ comp coverage. It’s an essential part of your total business insurance package!

Now that we’ve answered, What is workers’ compensation?, you may be thinking, I need to get me some of that—or at least explore my options! If that’s on your mind, we have a few next steps you can take right now to finish educating yourself before you buy.