Workers' Compensation: Rx for Policy Reform

Studies | Welfare

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


Making Workers’ Compensation Work Better

Why have workers' compensation at all?  If there were no externalities - costs imposed on society as a whole - employers and employees could exercise freedom of contract.  Presumably, the willingness to trade off higher wages for a greater risk of injury differs from worker to worker and occupation to occupation.  People pursuing their own interests in the private sector made these trade-offs prior to the enactment of workers' compensation laws and they could do so again. They also currently make these trade-offs with wages and other types of benefits and types of occupation.  However, workers' compensation arrangements may have external effects on the rest of society.  Injured workers without health insurance and disability coverage potentially will rely on Medicaid, Social Security disability insurance and other government programs.47  When they do so, taxpayers will have to pay the costs of decisions to which they were not a party.

However, we can protect employees' and employers' rights to choose the arrangements that best meet their needs, and society's interest in avoiding additional costs for social programs, without imposing an inefficient system with perverse incentives.  If employees and employers have the flexibility to make efficiency-improving changes in workers' compensation coverage, just as they routinely make trade-offs between wages and other benefits in the labor market, the system can be greatly improved.  The following recommendations are proposed to achieve that goal.  Short of these fundamental reforms, there are some more modest steps that states could take to improve their systems.  [See the sidebar, "Some Modest Steps."]

1.  Workers' compensation premiums should reflect real risks on a company-by-company basis, so that employers and employees can realize the full rewards of risk-reducing behavior.

“Workers’ compensation premiums should reflect the risks of individual firms.”

Small employers and their employees should have the opportunity to fully realize gains from improving safety and reducing claims costs.  In most states, self-insurance is a common alternative to private insurance for the largest employers.  A number of states also allow group self-insurance. Under this arrangement, mostly smaller employers in the same line of business (for example, restaurants) pool funds to provide self-insurance for their members.  A third alternative, large-deductible insurance policies, is also available only to relatively large employers in a number of states.  Similar in concept to self-insurance, employers with large-deductible policies are directly responsible for making claim benefit payments up to an amount (for example, $250,000) stipulated by the policy.  Claim costs in excess of the predetermined amount are covered by the employer's insurance policy. 

In many states, smaller firms are not allowed to purchase group coverage or high-deductible policies under which they self-insure for smaller claims.  Since the premiums in these cases should better reflect the firms' actual risks, the ability to self-insure is a step in the right direction.  These types of insurance arrangements should be allowed in all states.

More should be done, however.  Private insurers and state systems should re-rate companies that take steps to reduce injuries and charge them lower premiums.  Conversely, higher premiums should be charged when a firm's safety record deteriorates. 

2.  Employers and employees should be able to realize gains from choosing more efficient health coverage.

Most employer-sponsored health plans do not have first-dollar coverage or allow a completely free choice of physicians and facilities.  The reason:  there are significant savings from other types of plans.  Presumably, these savings are passed along to workers in the form of higher wages and other benefits because employees prefer extra wages and other benefits to a more expensive health plan. 

“Employers should be able to use their regular group health plan to cover injured workers.”

For companies that have employer-provided insurance, we can assume that the health plan reflects the employees' implicit trade-off between wages and health insurance.  The reason: employers have to compete for labor by making their overall compensation package as attractive as possible.  Therefore there should be no barrier to using the same health plans for workers' compensation claims.  The failure to give people this option forces them to take too much worker's compensation coverage and too little in wages and other benefits.48 

For employers who have no health plan, the law could stipulate what kinds of plans represent a reasonable trade-off between wages and health insurance coverage.  For example, any of the plans offered to state employees might be deemed reasonable per se. 

State laws and some federal regulations prevent employers (including those that self-insure) from fully integrating workers' compensation with their group health plan.49  However, so-called 24-hour medical coverage has been tried as a pilot program in a number of states and has a number of advantages.  An integrated health care plan would provide both group health and workers' compensation health benefits to employees: 

  • Employees could use the same provider networks they use for regular health coverage, and they would still have the option to change doctors or go out of network if not satisfied with the services provided.
  • Employers and insurers could use the same negotiated fee schedules for work-related injuries and illnesses as under regular health plans, which are generally lower than fees paid by workers' compensation.
  • Since employees would pay the same deductibles and copayments as in their regular health plan, there would no longer be any incentive to claim that a nonwork injury or illness is work-related or vice versa. 

Savings from the introduction of copayments and deductibles could be passed on to workers as higher wages or other types of benefits.50  Some employers give workers choices among health plans, allowing those who choose less expensive plans to "bank" the premium savings in Health Savings Accounts (HSAs) from which they can pay small medical bills, or to use the savings to obtain other, nontaxed benefits.  Employees could be given a similar choice for their workers' compensation coverage.  Employees could "bank" the workers' compensation premium savings in the same HSA as their regular health plan, or purchase other benefits.  The premium savings also could go into a disability account (described below).51

3.  Employers and employees should be able to realize gains by choosing more efficient disability coverage.

“Employers should be able to use their regular disability plan to cover injured workers.”

As in the case of medical benefits, the current system keeps employers and employees from choosing more efficient ways of delivering income-replacement benefits.  It also forces employees to accept too much of their compensation in the form of income-replacement insurance as opposed to higher wages or other forms of compensation.  To remedy these problems, the following reforms are needed: 

  • Employers should be able to create a self-insurance pool and pay claims directly - reserving third-party insurance for catastrophic disability claims - where there are cost savings from doing so. 
  • Employers should be allowed to offer indemnity benefits with the same waiting periods as their regular disability plans.  Allowing companies to offer workers' compensation indemnity benefits under an integrated disability plan would reduce the employers' insurance costs.  
  • Small employers without disability plans should be allowed to provide a benefit that resembles standard disability policies sold in the state or one that replicates disability benefits available to state employees. 
  • Employers should be allowed to offer employees the opportunity to gain from self-insurance on an individual basis.  Specifically, employers should be able to offer, and employees should be able to accept or deny, indemnity benefits that deviate from the statutory benefits with regard to waiting period, wage replacement rate, maximum and minimum benefit levels and duration of temporary disability.

For example, in return for an employee accepting a 90-day waiting period, the employer should be able to put the premium savings in an employee-specific disability savings account.  The build-up in this account might roll over into a retirement account when an employee is terminated or retires.52 

“Employees should be able to share premium savings through Workers’ Compensation Accounts (WCAs).”

In addition to benefiting the employers and employees who take advantage of these opportunities, there are other social benefits.  Small-size establishments - particularly in high-risk occupations such as construction - currently rely on self-employed subcontractors who are not covered under the workers' compensation system. Many of these subcontractors carry either no workers' compensation insurance or have inadequate coverage.  Their injured workers impose costs on society by utilizing the social safety net, such as Medicaid and Supplemental Security Income.  Allowing employers the flexibility to offer disability benefits that deviate from the statutory workers' compensation benefits would entice some subcontract workers back to regular employment. 

4. There should be less state regulation of workers' compensation rates.

Greater deregulation of workers' compensation rates and allowing the alternative insurance arrangements discussed above could also lower employers' premiums for workers' compensation insurance.  In the 1990s, a number of states introduced these alternative arrangements, giving some employers a greater choice of insurance coverage.53  Large deductible policies and group self-insurance made self-insurance more accessible to some businesses.  In other states the rate-making process was deregulated, allowing greater leeway to the private carriers in pricing workers' compensation insurance.  One state, Nevada, changed its laws and moved from a monopolistic state fund to an open competition state, reducing employers' insurance costs over 25 percent in just a few years. These changes generally moderated increases in employers' insurance costs, and lowered some employers' insurance premiums. 

5. The system should evolve so that workers' compensation insurance is individually owned by workers, traveling with them from job to job and selected by them rather than their employers.

Ideally, every worker should be allowed to make his or her own trade-offs between third-party health insurance and individual self-insurance.  Similarly, employees should be able to make their own individual choices between third-party disability insurance, individual self-insurance and perhaps other choices as well.  Moreover, each worker should be able to choose from among plans available in the entire market, rather than a plan selected by an employer.  However, employees should have to choose some form of insurance.  They should not be able to go bare. 

Since the cost of workers' compensation insurance would differ from job to job, employees would be better able to evaluate the trade-off between wages and safety in the job market.  Employees with good safety records would benefit financially from lower premium costs and higher wages.

A new type of health benefit, called a Health Savings Account (HSA), is portable.54  Typically, employers make periodic deposits of pretax funds to the HSAs, which the employees own and control.  HSAs are a form of self insurance that gives individuals an alternative to third-party payment of medical expenses.  Workers can use the funds in the HSA to pay small medical bills, health insurance deductibles and copayments.  Unused funds earn interest and can accumulate until the worker reaches retirement.  HSAs give workers a financial incentive to economize on the use of medical services.   The HSA is accompanied by high-deductible health insurance that provides coverage for major medical expenses.

“Workers’ Compensation Accounts could be individually owned and portable.”

Similarly, employers should be allowed to establish Workers' Compensation Accounts (WCAs).  The accounts could be funded by savings on premiums from selecting more limited conventional coverage.  Individually-owned WCAs are a form of self-insurance that would give workers an alternative to third-party workers' compensation benefits; for example, a worker might self-insure for the first three months of disability. 

Any unused balance in the WCA would move with the employee to a different job or could be paid out in cash upon retirement.  WCAs would serve two functions: First, they would provide a direct incentive to workers to avoid unsafe behavior and injuries, and to economize on the use of disability benefits when injured.  Second, they would allow employees to accumulate funds that can be used to supplement their savings upon retirement.   Employers should be allowed the flexibility to explore such alternative insurance arrangements.

6. Employers and employees should be able to take advantage of liability by contract.

Employers and insurers should be allowed to propose, and insurance commissioners should be allowed to approve, arrangements under which employers and employees voluntarily agree to selectively relax strict liability rules in return for lower premiums or higher wages or other benefits; for example, they could agree to a 90-day waiting period instead of the current waiting periods.  As long as overriding social concerns are met (we don't want taxpayers to get stuck with the bill), employers and employees should be able to change their liability relationship by contract.

Another example of the agreement might state that the employer's liability is strict only if employees follow certain safety rules, and if not, the employee bears some of the costs of the injury.  In return for agreeing to such changes, there must be a showing that employees have materially gained.

If a union represents the workforce, such agreements might be deemed reasonable per se.  If not, we may want to impose constraints.  For example, if employers want workers to accept $1,000 of exposure, we may have a rule that says they have to deposit at least $200 in a WCA each year.


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