Workers' Compensation: Rx for Policy Reform
Table of Contents
Problems Caused by the Current System
In general, the current system gives rise to six underlying problems: 1) imperfect incentives to create safer workplaces, 2) inability to choose more efficient health coverage, 3) inability to choose more efficient disability coverage, 4) inefficient markets for workers' compensation insurance, 5) lack of portability of insurance coverage, and 6) inability to modify strict employer liability.
These problems result from state laws that prohibit employers and employees from choosing workers' compensation arrangements other than those mandated by the state, and from state controls over the insurance markets.
Problem 1: Imperfect Incentives to Create Safer Workplaces.
“Employers who self-insure have better incentives to promote safety.”
In general, the insurance premiums employers pay are actuarially determined to cover benefit and claim management costs in each state. Rating bureaus collect data from private insurers and state funds, and actuarially determine insurance rates by occupation in each state. These rates - quoted as a premium per $100 of payroll per occupation class - apply when policies are renewed and require approval by state insurance departments.
However, not every employer in the insurance pool has the same incentive to promote safety. Large employers are generally experience-rated - their premiums vary according to employee claims history - relative to losses in the industry or occupation. Employers that have lower than expected losses for their occupation or industry are rewarded with lower premiums than the average for their occupational class when their policies are renewed, and those with greater than expected losses are punished with higher premiums. Employers with large deductible policies and self-insurance have added incentives to promote workplace safety because increases in workers' compensation costs tend to be paid by the employer directly.
Smaller firms, by contrast, pay state-regulated premiums based on occupation; because they are not individually rated, the connection between their workplace safety practices and the premiums they pay is very imperfect. Thus they have less incentive to promote safety. They are also more likely to be in the assigned risk pools because they are unable to obtain private insurance coverage, and pay a substantial assigned-risk premium. Imperfect experience-rating means that these firms do not reap the full rewards of safety improvements; nor do they bear the full cost if safety deteriorates.
Problem 2: Inability to Choose More Efficient Health Coverage.
The workers' compensation system does not allow insurers and employers the flexibility to use cost-control mechanisms that are common in employer-sponsored group health plans. For instance, employer-sponsored group health plans frequently require employees to pay some of the costs through copayments and deductibles. This encourages employees to economize on the use of services. But employees treated under workers' compensation receive medical services at no cost to them.
“Workers’ compensation pays more than group health plans to treat similar injuries.”
As a result, treatment costs for similar injuries are higher when paid for by workers' compensation insurance compared to group health plans. A 1996 study that compared medical costs in workers' compensation with employers' group health insurance in Florida, Illinois, Oregon and Pennsylvania found that the average cost of treating the same injuries or conditions was twice as much under workers' compensation as under group health plans.37 The medical services in workers' compensation were provided under fee-for-service arrangements, while services in group health plans were under a mix of fee-for-service and managed care arrangements. The study found, for example, that back injury cases received treatments over an average of 241 days under workers' compensation compared to 68 days under group health plans, and average payments for treatment were 2.25 times greater ($2,629 vs. $1,166) under workers' compensation.38 The higher costs were entirely due to more service use and a different (more expensive) mix of services in workers' compensation. The researchers attributed the higher costs largely to perverse incentives to maximize the use of medical benefits [see Figures VII and VIII].
“Back injuries covered by workers’ compensation take three times longer to treat than under group health insurance.”
Some of these cost differences may arise from the fact that managed care was not available in workers' compensation until the mid-1990s.39 Historically, workers' compensation paid medical providers on a fee-for-service basis, which is still the only payment method in 26 states. However, since the 1990s a number of states have allowed managed care networks that reimburse medical providers a fixed amount per covered employee - known as capitation - rather than on a fee-for-service basis.40 Managed care programs use in-network physicians who receive payment based on the number of employees covered under the program - called capitated fees - in addition to the number of procedures and types of procedures performed.
Incentives for physicians are different when they are paid on a fee-for-service basis by workers' compensation but receive fixed capitated payments under group health plans. Further, a 1997 study found significant cost shifting by managed care providers to workers' compensation when their services were provided on a fee-for-service basis. The reason: managed care physicians have financial incentives to misclassify claims as compensable under workers' compensation in order to maximize their income.41
Instead of using managed care techniques, state workers' compensation agencies attempt to control medical costs through various administrative measures. In the 1990s, state agencies implemented fee schedules for treatment providers. These generally lower the unit cost of services, but providers often respond to the lower fees by increasing the use of services (such as scheduling more office visits) and changing the mix of services (such as ordering more diagnostic tests), with unpredictable results on costs.
“Back injuries covered by workers’ compensation cost more than twice as much to treat as under group health insurance.”
However, there is still a wide variation in medical claim costs for treating similar injuries in different areas within a typical state. Costs vary from area to area because the number of services per case vary, and because the number of treatments for similar injuries varies. For similar claims and diagnoses in Texas, for example, workers' compensation medical claim costs were 58 percent higher in Houston than in Austin, with excessive use of services accounting for 76 percent of the differences.42
“In Texas, medical costs for treating the same injuries were 58 percent higher in Houston than in Austin, mostly due to excessive use of services.”
A number of states allow employers to choose the medical providers who treat injured workers, and some of these states allow employees to choose another provider if they are dissatisfied with the employer's initial choice. In employer-choice states, average medical claim costs are lower than in states that do not allow employers to choose.43 This is because employers have an incentive to choose lower-cost health care providers and to avoid those who shift costs for treating nonwork-related conditions to workers' compensation claims.
Problem 3: Employers and employees are not allowed to realize gains by choosing more efficient disability coverage.
Workers' compensation laws prevent employers from offering the same type of coverage that is common in disability insurance markets. Disability insurance could provide direct financial incentives and disincentives to workers for safe behavior and impose financial penalties for unsafe behavior. Such incentives would discourage excessive claim filings, and when a worker is injured, encourage prompt return to work. (Some of these incentives are discussed in greater detail below.) By contrast, the mandatory benefit provisions of the current system (discussed previously) give rise to excessive claims for lost time that are longer than medically necessary to recover from injuries.
Long disability periods also impose substantial financial costs on the workers who make the claims, because statutory benefits do not replace all wage losses - due to statutory waiting periods before employees can start receiving benefits and because a lower percentage of higher-wage workers' wages are replaced. As a result, benefits typically replace only about half of a worker's lost wages. Additionally, research indicates that employees who miss work for long periods have lower future wages than others in their cohorts.44
Problem 4: The Market for Workers' Compensation Insurance Is Inefficient.
There are a number of inefficiences in state workers' compensation insurance markets. As noted, premiums are not fully adjusted for the claim experience of individual firms, particularly smaller ones. This means that small firms with good safety records pay higher premiums than they would otherwise, while firms with poor safety records can pay less than their risk warrants.
In addition, premium rates are regulated by the states, and the time lag created by the rate-approval process destablizes insurance markets because insurers' premium revenues do not match their claim losses. At the margin, this encourages insurers to stop writing policies, making the market less competitive.
“Small firms aren’t rewarded enough for good safety records.”
Smaller firms are more likely to be in a state-assigned risk pool because they cannot find a private insurer willing to sell them a policy, and their cost of insurance is higher than for larger firms. A study by James Chelius and Robert Smith found that workers' compensation premiums as a percentage of payroll were 53 to 58 percent higher for small firms of less than 500 employees, compared to larger firms.45 In Texas, where workers' compensation insurance is voluntary, almost half of the state's smallest employers (1 to 4 employees) do not participate in the system, versus 20 percent of firms with 500 or more employees. The cost of premiums is a major reason why many of these employers do not participate.46
Problem 5: Workers' Insurance Lacks Portability.
If we experience-rate firms, shouldn't we to some degree experience-rate employees? Today, workers' compensation premiums are based on the collective claims history of all the firm's employees rather than individual workers, but it might be possible to reward and penalize workers for their individual behavior.
How? Through individually owned and portable workers' compensation coverage. Insurance portability refers to the ability of a worker to carry coverage from job to job. Like group health insurance, workers' compensation coverage is not portable. Today, most health insurance is provided by employers, and the incentive of workers is to consume as much medical care as possible - since they have a use-it-or-lose-it benefit. Similarly, in the workers' compensation system, employees have an incentive to consume as many benefits as they can. They have weakened incentives to prevent workplace injuries or to economize on the use of benefits if injured.
Problem 6: Inability to Modify Liability.
“Employers are strictly liable for workers’ injuries, regardless of fault.”
Under the current system, employers are strictly liable for workers' injuries, whether or not the worker is at fault. Therefore, workers' compensation pays 100 percent of a worker's medical costs and replaces wages after a short period away from work. The incentive for injured workers is to prolong the period away from work in order to receive cash benefits. But what if workers were willing to trade less complete coverage for higher wages - or other benefits? For instance, they might be willing to agree to pay a deductible toward their medical costs or receive wage replacement only after 90 days away from work if they shared in the resulting premium savings. Since each individual has a different tolerance for risk, workers would make different trade-offs. Under the current system, they cannot do so.