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Workers' comp basics for small contractors

Workers' compensation pays the medical bills and lost wages when one of your people gets hurt on the job. The concept is simple. The billing is where contractors get confused — so here's how it actually works.

Who needs it

Nearly every state requires workers' comp once you have employees — including many that set the threshold at a single employee. The details vary by state: some exempt sole proprietors with no employees, some let owners opt out, and the rules for how your state treats day laborers and 1099 subs have their own fine print. But the broad pattern holds: if people work for you, you almost certainly need it.

And even when the state doesn't require it, your clients might. Plenty of GCs and project owners write workers' comp into their contracts regardless of state minimums. No comp, no contract — same story as the COI.

What class codes are

A class code is a four-digit number that describes the kind of work being done, and each code carries its own rate. The rates come from either the National Council on Compensation Insurance (NCCI), which most states use, or the state's own rating bureau.

The logic is plain: riskier work costs more to insure. Roofers hurt themselves more often and more seriously than bookkeepers, so the roofing rate runs much higher than the office rate. This is the single most important thing to get right on your policy, because the wrong classification means you've been paying the wrong premium all year.

How the pricing math works

Workers' comp premium comes down to one formula:

Two things to notice. First, the premium is driven by payroll, not by revenue. Second, because the rate multiplies every $100 of payroll, a misclassified worker or an inflated payroll estimate compounds fast.

What "premium audit" actually means

Here's the part that surprises people. When you buy the policy, you pay an estimated premium based on estimated payroll. At the end of the policy year, the carrier does a premium audit: they check your actual payroll records — real wages paid, not the estimate — and reconcile.

If you overestimated, you get money back. If you underestimated, you get a bill. It's not a penalty or an investigation; it's the carrier truing up the math. The way to stay out of trouble is simple: keep clean payroll records and give your agent realistic estimates up front. The contractors who get hit with big audit bills are usually the ones who guessed low and hired more people than planned.

The experience modifier, briefly

Once your business is big enough (the threshold varies by state), you get an experience modifier — often called a MOD. It compares your claims history to the average for your kind of work. A MOD of 1.00 is average. Below 1.00, your claims have been better than average and your premium drops; above 1.00, it's been worse and your premium climbs. The practical takeaway: every claim avoided genuinely lowers your future costs.