Workers' Compensation: Rx for Policy Reform

Studies | Welfare

No. 287
Wednesday, September 13, 2006
by N. Michael Helvacian


How the System Works

Figure I - Number of Fatal Accidents

Each state has designed its own workers' compensation system, and no two are exactly alike.  The types and levels of benefits, the cost of claims and the structure of the system vary widely.  The premiums paid by employers also vary widely by state, size of firm and industry.  However, the rising cost of workers' compensation to employers - a cost implicitly borne in part by workers - is a common problem.  In this section we will examine major features of state systems and the effects they have on claims and costs.

Employers Are Required to Provide Benefits.  Employers are held strictly liable for workers' compensation benefits.  [See the sidebar, "The Genesis and Evolution of Workers' Compensation Systems."]  Specific state statutes generally replaced the tort liability system - but not completely or in every state:

  • Currently, Texas is the only state that routinely allows employers to opt out of the statutory system.1  Employers that opt out, however, are still liable for workplace injuries under the negligence standard. 
  • In five states - North Dakota, Ohio, Washington, West Virginia and Wyoming - employers are obligated to either buy insurance coverage from a state-owned fund or obtain approval from the state agency to self-insure. 

In a number of other jurisdictions, state or residual (assigned risk) funds provide insurance as a last resort to employers that are unable to obtain insurance from private carriers.  Such risk pools are necessary because, when employers are required to have coverage, the state must make an alternative available.

“Benefits vary widely among the states.”

Benefits to Replace Wages and Compensate Injured Workers.  There are three main types of wage replacement (or indemnity) benefits.  When the employee is recuperating and unable to work he can receive temporary total disability (TTD) payments.  [See the "Glossary of Terms."]  When workers are permanently disabled and unable to work, the system provides permanent total disability (PTD) benefits.  A third type of benefit is permanent partial disability (PPD), generally paid when an injured employee attains the maximum medical improvement expected for an injury but still has either a residual physical impairment or occupational disability that prevents the worker from continuing in his former occupation.  

The maximum amount of wage replacement benefits and the length of time a worker can receive them varies considerably among the states.  In 2005, for example:2 

  • The maximum weekly benefit for TTD ranged from a high of $1,133 per week in Iowa to a low of $351 in Mississippi, and in most states is equal to the state's average weekly wage.
  • The maximum duration of payments ranged from a high of 500 weeks (nearly 10 years) in Virginia to a low of 104 weeks (two years) in South Carolina and a number of other states. 

PPD benefits also vary widely among the states:

  • The weekly maximum payment for PPD ranged from a low of $220 in Alabama to a high of $1,070 in New Hampshire in 2005.3 
  • The maximum duration of weekly payments was shortest in New Hampshire (262 weeks) in 2005, but many states have no maximum, implying weekly benefits may be paid for as long as the disability lasts.4
  • For workers' compensation policies effective 2000 to 2001, the costs incurred for PPD benefits averaged $61,327 and ranged from a high of $184,257 in Michigan to a low of $32,425 in Missouri.5
Table I - Frequency of Claims Reported by Private Insurers Countrywide

“The cost of claims varies widely among the states.”

State statutes provide the greatest cash benefits for the most serious injuries, fatalities and permanent total disabilities where employees lose the ability to work.  The definition of PTD depends on the state, but it generally includes, for example, the loss of eyesight or both hands.  Overall, in 2000 to 2001:6 

  • The costs of fatal injuries averaged $242,770 per case, with Missouri having the highest average cost ($462,484) and California the lowest ($149,370).
  • The costs of PTD are higher than for fatal injuries and averaged $381,909, with Nevada having the highest ($2,496,678) and Utah the lowest ($93,185).

Decline in the Frequency of Claims.  Data on accidental fatalities indicate that workplaces are now arguably safer than workers' homes.  Throughout the second half of the 20th century, as deadly home accidents increased, workplace injuries resulting in death declined steadily in the United States [see Figure I]. 

The frequency of workers' compensation claims has also declined over the last decade.  As Table I shows, between 1992-93 and 2000-01: 7

  • The frequency, or number of claims filed per 100,000 covered employees, declined 29 percent.
  • The nationwide decline occurred in virtually every claim category, including claims that resulted in lost time from work (35 percent) and claims requiring only medical intervention (28 percent).
  • The declines were similar in magnitude for high- and low-risk occupations and industries; thus, we can rule out any explanation of the countrywide trend in frequency based on the mix of employment in U.S. industries.
Figure II - Employer Costs of Workers' Compensation Insurance

The decline in claim frequency, however, was not the same in every state.  For example, in California the frequency of all claims declined 22 percent between 1992 and 2001, considerably less than the countrywide decline (29 percent), while permanent partial disability (PPD) cases actually increased 13 percent.  This suggests that features of the California state system encourage more claims for PPD, relative to other types of claims and other states' systems.  

“Workers’ compensation costs more than health insurance or payroll taxes in high-risk industries.”

Rise in Premium Costs.  Even though workplace safety has increased dramatically and the frequency of claims has declined, workers' compensation

costs have soared.  As a result, employers face increasingly higher insurance premiums and self-insurance costs, which reached nearly $60 billion in 2000 [see Figure II].8

Although the average cost of workers' compensation premiums nationwide is less than 3 percent of payroll, employers' premium costs vary widely by industry [see Figure III].  In high-risk industries, employers' workers' compensation premiums are often higher than health insurance costs or Social Security payroll taxes.  For example, in Texas:

  • Workers' compensation in the hatchery and poultry industry account for 17 percent of payroll costs.9
  • However, workers' compensation in some building and window-cleaning occupations account for a staggering 76 percent of payroll costs!

Uniquely, Texas permits firms to "opt out" of workers' compensation insurance coverage.10  But payroll costs in Texas are not unique.  Even in states that require participation in the workers' compensation system, employers' costs of insurance as a percentage of payroll are steep.  In Maine, for example, where workers' compensation insurance is mandatory:

  • Workers' compensation in the local trucking industry accounts for almost 19 percent of payroll costs.11
  • In the sawmill industry, it consumes about 20 percent of payroll costs.
  • In logging and lumbering, premiums cost up to 30 percent of payroll.
Figure III - Texas Workers' Compensation Costs for High Risk Occupations as a Percentage of Payroll

“Permanent partial disability cases account for almost 60 percent of claims.”

Increase in Claim Costs.  A sharp nationwide increase in claim costs at the same time claim frequency declined (from 1992-93 to 2000-01) offset any savings in total benefit costs in the system that would have resulted.12  The nationwide average cost for all claim types (including medical-only claims and indemnity claims for lost time from work) increased 53 percent; the average cost for claims resulting in lost work time (beyond states' statutory waiting periods for receiving indemnity benefits) increased 66 percent, from $19,060 in 1992-93 to $31,684 in 2000-2001.13  [See Table II.]

Following sharp increases in health care costs and utilization of medical services over the last two decades, medical services now account for 54 percent of total benefit costs incurred in workers' compensation systems.  [See Figure IV.]  Only a decade earlier, roughly half of total costs were for indemnity benefits and half were for medical benefits, and in previous decades a majority of costs were for indemnity benefits.

Composition of Costs.  It is noteworthy that the most serious cases - fatal injuries and PTD - make up less than 11 percent of total benefit costs in the system, as Figure V shows.  In contrast, PPD cases, which often involve more subjectivity in evaluating the disability and more discretion about treatment, account for a majority of system costs (nearly 60 percent).  PPD cases average $61,327 per claim and make up 33 percent of all lost-time cases.14  Note also that these cases often involve disputes between the employees and employers, and result in negotiated settlements with a lump-sum payment.  This phenomenon is discussed in greater detail below.15 

“Back sprains and other soft tissue injuries account for the majority of claims for wages.”

A clear majority of diagnoses in lost time claims are back sprains and other soft-tissue injuries.  Sprain of the lumbar region (back sprain) is the most common diagnosis and accounts for 36 percent of all cases that result in lost time from work, which are more serious than claims that require only medical intervention (medical-only claims).  [See Figure VI.]  The second most common diagnosis is carpal tunnel syndrome (16 percent), a type of soft-tissue injury. Other back-related problems account for an additional 18 percent of all lost time cases.16

Table II - Average Claims Costs Reported by Private Insurers Countrywide

Over a relatively short period, between 1980 and 1989, back sprains and soft-tissue injuries increased from 45 percent of all lost time claims to more than 50 percent in a 15-state claim sample. 17  In contrast, crushing and fracture injuries declined from 18 percent to 14 percent.  Controlling for other factors that potentially could account for these injury trends, such as employment rates in high-risk industries, researchers have found that the increase in back sprains and soft-tissue injuries are related to increases in wage replacement benefits that result in shifting costs to the workers' compensation system.  

Coverage When Employees Contribute to Their Injury.  More than 80 years of litigation and legislative changes have failed to definitively resolve the question:  Which claims are compensable under workers' compensation? 18  For example:

  • In 1918, a Connecticut court found that a worker who died of sunstroke shoveling coal on a hot day was entitled to compensation because of his increased risk of exposure.
  • In 1935, a Massachusetts court found that a worker was not entitled to compensation for a foot that froze as he cleaned a street on an extremely cold day, since the risk was no greater for him than for anyone else outside. 
  • But a 1950s-era New York court decision expanded workers' compensation to cover a worker injured when a workshop collapsed due to an explosion next door, because his work put him at the particular location where he was imperiled.
Figure IV - Percentage of Costs for Medical Treatment and Wage Replacement%2C 2000-2001

“Back sprain is the most frequent injury involving lost time from work.”

Furthermore, courts and legislatures have taken a variety of stances on the extent to which workers' compensation should cover injuries when an employee's own behavior contributed to or caused the injury.  For example:19

  • Five states deny coverage for injury resulting from workplace horseplay.
  • Thirteen states deny compensation if an injury resulted from a safety rule violation (while various other states reduce indemnity benefits by 10, 15, 25 or 50 percent).
  • And in the majority of states, when an intoxicated worker is injured, "the burden of proof is on the employer to demonstrate that the intoxication was the proximate cause of the workplace injury."  (In some states intoxication must be the sole cause, or the worker must be so drunk that he is unable to perform his job duties.) 

“Higher benefits raise the number of claims filed.”

The reluctance of courts and legislatures to limit benefits for workers whose behavior contributes to workplace injury indicates that the workers' compensation system is more of an entitlement program than an insurance system.  It is health insurance that supplements regular employer-provided health plans and disability insurance that replaces lost wages when an employee is unable to work.  Commenting on the above-mentioned New York case, a Kentucky appeals court judge noted that it "...is a big step toward complete coverage of all injuries suffered by an employee during working hours without regard to whether the injury results from risk connected with the employment."20

Figure V - Cost of Workers' Compensation Claims by Type%2C 2000-2001Figure VI - Workers' Compensation Claims by Type of Injury%2C 1996-2000

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