Do I Need Workers' Compensation Insurance? A Guide for Small Business Owners

For most small business owners, having workers’ comp coverage is a necessity. In nearly every state, you must carry workers’ compensation insurance if you have one or more employees. This applies whether your employees are full-time, part-time, or temporary.

While this general rule is a safe guide, the exact requirements can vary. Some states set the threshold at a different number of employees or have specific rules for certain industries. Because laws are state-specific, check the requirements in the states where your business operates.

For a detailed breakdown, see our guide to Workers’ Compensation Laws by State.

Workers’ Compensation: What’s Covered

Workers’ compensation insurance is a “no-fault” insurance coverage that protects both you and your workers. It provides your employees with immediate care for work-related illness or injury and protects you from expensive lawsuits when employees are hurt on the job. Knowing they can get medical care and return to work keeps employees from hiding minor injuries until they become expensive, disabling conditions. It protects your personal and business assets from costly litigation and company-ending bankruptcies.

Workers’ compensation typically includes:

• Full medical care, including emergency and hospital treatment and rehabilitation services
• Partial wage replacement, calculated at 80% of an employee’s average monthly wages
• Continuing treatment if a worker can return to limited or “light duty” work
• Partial or permanent disability benefits. Workers’ comp insurance covers these until the worker’s state or federal benefits kick in
• Death benefits paid to families if a worker is killed in a work-related accident

Even a single accident can drain a small business dry. Workers’ compensation lets you protect your workers while keeping your business and personal assets safe.

Common Exemptions

State laws can exempt certain types of workers from mandatory coverage. These can include:

• Independent contractors
• Domestic workers in a private home
• Agricultural and farm workers
• Railroad employees (who are covered by separate federal laws)
• Corporate officers

Be careful when classifying a worker as an independent contractor. Misclassifying a worker to avoid paying workers’ comp premiums is a serious offense with significant legal and financial consequences. If you direct the worker’s tasks and schedule, the law will likely consider them an employee, regardless of what your contract says.

What Happens if You Don’t Have Required Coverage?

Failing to carry legally required workers’ compensation insurance can be a devastating mistake for a business. State labor boards don’t take noncompliance lightly, and the penalties can cripple or even close your company. Let’s take a closer look at problems associated with not having workers’ comp.

Financial Penalties

Fines can mount quickly, sometimes reaching $1,000 to $5,000 per employee for each day you’re out of compliance. Some states may issue fines even if an employee isn’t injured. If a worker gets hurt, a court can order you to pay all medical bills and lost wages directly out of your business’s pocket.

Operational Penalties

Many states can issue a stop-work order, which forces your business to stop all operations immediately. Under a stop order, you can’t reopen until you obtain the required insurance coverage and pay any outstanding penalties.

Civil Liability

Without workers’ comp, you lose your most important legal protection: the “exclusive remedy” rule. This means an injured employee can file a personal injury lawsuit directly against your business and seek damages for medical bills, lost wages, and pain and suffering. A single lawsuit could be financially ruinous.

Criminal Charges

In some states, willfully failing to provide workers’ comp coverage is a crime. Depending on the jurisdiction, this can range from a misdemeanor to a felony. For example, under Illinois law, it can be a felony punishable by fines and up to three years in prison.

The Benefits of Coverage (Even if Not Required)

Workers’ compensation is more than just a legal requirement. It serves as a critical financial shield for your business. Workers’ comp provides workers with medical care after a workplace injury and helps them return to work sooner. Keeping qualified workers at work is essential for smaller businesses that can’t afford to hire temporary workers every time someone is injured.

The “Exclusive Remedy” Shield

In a personal injury claim, an injured party must prove the other party is liable for their injuries. This usually means filing a lawsuit to recover medical expenses and lost wages. Workers’ compensation provides an exclusive remedy for both workers and employers. The worker does not have to prove the employer was liable for their injuries. In exchange, you provide medical treatment and partial wage replacement without question. This lets you avoid costly lawsuits and lengthy negotiations with personal injury attorneys.

Protecting Your Personal Assets

Depending on your business structure, workers’ compensation protects your personal assets from potential legal action. If you’re a sole proprietor or partner, there’s no legal separation between the owner’s assets and the business. If a worker is injured on the job, a lawsuit can reach into your personal assets, including your home, bank account, and other property. Since hospital stays are expensive and a personal injury claim can seek full lost wages, a personal injury claim for a work-related accident can wipe out all your personal property.

The Competitive Edge

Contractors and self-employed workers may need to carry workers’ comp insurance in some industries. Some states require construction contractors and subcontractors to carry workers’ compensation coverage, even if they have no employees. For instance, California recently passed a law requiring all licensed contractors to have workers’ comp to maintain their licenses by 2028.

Other states have similar laws or are considering them. Having this insurance can be essential for small businesses to stay competitive in today’s litigious business environment.

How To Get Coverage and Manage Your Costs

Once you know you need coverage, your goal is to find the right policy at the best price. Most states have state workers’ compensation pools, but you can go through your own licensed insurance agent.

Types of Workers’ Comp Coverage

Depending on your state, you can typically buy workers’ comp insurance from either:

• A private insurance carrier
• A state-funded insurance pool

In some states, companies with sufficient financial reserves can self-insure. Small businesses can sometimes achieve this by forming a group self-insurance pool with other similar companies.

How Premiums Are Calculated

Insurers base your premium on several key factors, including your annual payroll, your industry’s risk classification, and your company’s specific claims history, often called an “experience modification rate.”

Tips for Lowering Costs

Initial insurance rates can be shocking. Here are a few suggestions on how to make them as reasonable as possible:

• Implement a safety program: The best way to lower costs is to reduce claims. Document your workplace safety program, as many insurers offer discounts for proactive safety measures.
• Ask about “Pay-as-You-Go”: Instead of a large upfront premium based on estimated annual payroll, this option allows you to pay your premium each pay period based on your actual payroll. This can greatly help cash flow.
• Establish a return-to-work program: Being proactive is better than being reactive. Having a formal process for bringing employees back to work with modified or light-duty assignments helps close claims faster and reduces overall costs.
• Check Your Classification: Ensure your insurer has assigned the correct industry classification code to your business. An incorrect code can cause you to overpay.

The better prepared you are, the lower your insurance costs should be.

Your Responsibilities as an Employer

Your duties as an employer extend both before and after an injury occurs. You must post required labor law notices about workers’ comp where employees can see them.

If an injury occurs, be prepared to act quickly. Ensure that the employee receives immediate and appropriate medical care. Formally document the incident and report it to your insurance carrier. Your insurer will then manage the claim.

It’s illegal to fire, demote, or otherwise retaliate against an employee for filing a workers’ compensation claim. Such an action can lead to a separate and costly wrongful termination lawsuit. For a detailed guide on the claims process, see How to Handle a Workers’ Comp Claim: A Step-by-Step Guide for Employers.

Get Legal Advice for Your Business

Navigating state-specific workers’ compensation laws and ensuring your business is fully compliant can be complex. An investment in professional advice upfront can save you from costly fines and legal battles down the road. If you’re unsure about your obligations or want to ensure your policies are sound, contact an experienced business and commercial law attorney in your area.