What Every Small Business MUST Know About Workers’ Compensation

 

If you're running a small business, protecting yourself with business insurance is crucial. One essential aspect of this protection is workers’ compensation insurance. Many business owners don’t fully understand how workers’ compensation works, how it impacts their budget, or the best way to manage it. In this guide, we’ll break down everything you need to know about workers' compensation and the two main coverage options—pay-as-you-go and traditional policies—so you can make informed decisions for your business. 

What is Workers’ Compensation Insurance?

Workers’ compensation is a type of business insurance that covers medical expenses and lost wages for employees who get injured or fall ill due to job-related activities. It’s required in most states to ensure employees get the care they need and protect businesses from lawsuits related to workplace injuries.

However, not all workers’ compensation insurance policies are the same, and small businesses must choose between a traditional workers’ compensation policy and a pay-as-you-go workers’ compensation model. Understanding these options will help you manage costs and minimize risks.

Looking to learn more about business insurance in general? Check out our article on the six crucial steps to take after forming your new business

Traditional Workers’ Compensation Policy

A traditional workers’ compensation policy is structured around the number of employees your business has when the policy begins. The insurance company estimates your workers' compensation insurance cost based on your payroll and the nature of your business, with the premium (cost) for the insurance being billable up front. The cost of the employer’s workers’ compensation insurance is also estimated based on the nature of the business. For example, if you own a construction company, you can expect higher premiums than a business with lower injury risks, like an office-based company.

What to Know for Your First Workers’ Compensation Insurance Policy

  1. Accurate Reporting is Key: The workers’ compensation insurance cost is initially determined based on the estimated number of employees and payroll at the time of purchase. If your business grows or shrinks, your policy needs updating.

  2. End-of-Year Audits: Insurance companies conduct audits to verify the accuracy of payroll and employee numbers. If you’ve overestimated or underestimated the number of employees, you’ll either receive a refund or owe more money.

Pro Tip: When working with subcontractors, you must collect a Certificate of Insurance (COI) from every subcontractor you hire. If a subcontractor doesn’t carry their own workers’ compensation insurance, you could be held responsible, and their coverage would be added to your policy, increasing your premium.

Pay-as-You-Go Workers’ Compensation

Pay-as-you-go workers’ compensation insurance offers a more flexible alternative, especially for businesses with fluctuating employee numbers or seasonal workers. Instead of estimating your payroll and paying a lump-sum premium upfront, pay-as-you-go workers’ compensation is based on actual payroll numbers. As you process payroll each pay period, a certain percentage is allocated to workers' compensation costs.

Pros of Pay-as-You-Go Workers’ Compensation

  1. Accurate Payments: Because premiums are tied to your payroll, you only pay for the coverage you need at that moment. This can help avoid overpaying and surprises during the year-end audit, as your payments already align with actual employee counts.

  2. Improved Cash Flow: Since payments are spread out over the year, pay-as-you-go plans prevent the large upfront costs associated with traditional policies. This is especially helpful for small businesses that need to keep cash flow steady.

  3. Better for Seasonal or Contract Work: If you run a construction business or hire seasonal workers, pay-as-you-go provides flexibility by matching coverage with workforce changes. Premium adjustments occur with actual payroll changes.

Cons of Pay-as-You-Go Workers’ Compensation

  1. Not Available Everywhere: Not all states allow pay-as-you-go workers’ compensation. State laws vary widely regarding premium amounts, coverage details, and exemptions. For example, Texas allows businesses to opt out of workers’ compensation coverage, while other states require it. You’ll need to check your state’s rules to see if this option is available for your business.

  2. Potential for More Administrative Work: While it aligns with payroll, managing a pay-as-you-go workers’ compensation policy can require extra attention to detail. Accurate payroll reporting is essential, and mistakes can lead to coverage issues.

How to Choose the Right Option

When deciding between a traditional workers’ compensation policy and a pay-as-you-go workers’ compensation plan, consider your business type and cash flow. For small businesses with stable payrolls, a traditional policy might be easier to manage, as it requires fewer payroll updates throughout the year. However, if your business experiences frequent employee turnover, or if you work with subcontractors on short-term projects, pay-as-you-go might be the better option due to its flexibility.

It's important to remember, too, that certain workers, such as commission-based employees, part-time workers, and volunteers, may be exempt from workers’ compensation requirements, depending on state laws. Some businesses with fewer employees may also be exempt.

Keeping Your Policy Up to Date

Whether you choose a traditional policy or pay-as-you-go workers’ compensation, keeping your policy updated is crucial. Regularly reviewing your workforce and subcontractor agreements will help avoid surprises during audits. For example:

  • Notify Your Insurer About Layoffs: If you’ve had layoffs or fewer employees, updating your insurer can result in lower workers' compensation insurance costs.

  • Track Subcontractors: Always ensure subcontractors have their own workers’ compensation insurance. If they don’t, their labor gets added to your policy, inflating your business insurance cost.

Note: When you purchase a workers’ compensation policy, you typically work with an agent who acts as the mediator between you and the insurance broker. For the pay-as-you-go insurance option, you could also partner with a payroll service provider that integrates workers' compensation and automates premium payments, streamlining the entire process.

Workers’ Compensation: Audits and Compliance

At the end of the policy term, your insurer will conduct an audit to reconcile the premium paid with the actual payroll and employee data for the year. To make this process smooth:

  • Keep Accurate Records: Maintain up-to-date records of employee counts, payroll figures, and all subcontractor Certificates of Insurance.

  • Prepare Financial Documents: Be ready with your profit-and-loss statements, payroll summaries, and a list of all employees and subcontractors for the year.

Failure to comply with audits can result in hefty fines or an increase in your business insurance cost, so it's essential to stay organized.

Final Thoughts

Workers’ compensation is an integral part of running a responsible business, and understanding your options can save you both time and money. Whether you choose a traditional workers’ compensation policy or opt for the pay-as-you-go method, aligning your insurance with your business's specific needs will help you avoid unnecessary costs and ensure you remain compliant with state laws.

No matter the size of your business, having the right workers' compensation insurance in place protects both your employees and your company, allowing you to focus on growth and success.

Need help choosing the right workers' compensation policy? Book an intro call with JLS Accounting today for personalized guidance!