COVERAGE

Workers Compensation

THE TOPIC

MAY 2009

Workers compensation insurance covers the cost of medical care and rehabilitation for workers injured on the job. It also compensates them for lost wages and provides death benefits for their dependents if they are killed in work-related accidents, including terrorist attacks. The workers compensation system is the “exclusive remedy” for on-the-job injuries suffered by employees. As part of the social contract embedded in each state’s law, the employee gives up the right to sue the employer for injuries caused by the employer’s negligence.

Workers compensation systems vary from state to state. State statutes and court decisions control many aspects, including the handling of claims, the evaluation of impairment and settlement of disputes, the amount of benefits injured workers receive and the strategies used to control costs.

Workers compensation costs are one of the many factors that influence businesses to expand or relocate in a state, generating jobs. When premiums rise sharply, legislators often call for reforms. The last round of widespread reform legislation started in the late 1980s. In general, the reforms enabled employers and insurers to better control medical care costs through coordination and oversight of the treatment plan and return-to-work process and to improve workplace safety. Some states are now approaching a crisis once again as new problems arise.

RECENT DEVELOPMENTS

State activities:

• Florida: In May lawmakers passed HB 903 in response to a court decision that had reinstated hourly attorneys’ fees. Hourly fees had been the largest cost driver in the state’s workers compensation system. Under the new law, attorney fees in workers compensation cases will now return to the sliding scale set out in reform legislation passed in 2003.
• Workers compensation rates fell significantly after the 2003 reform measure limited the fees of attorneys who represent injured workers to a maximum of 20 percent of the first $5,000 award they obtain for their client and lesser percentages for higher amounts. A Florida Supreme Court decision in October 2008 put these savings in jeopardy. The court said that because the fee schedule—the list of allowable charges—was combined with a provision that entitled some claimants to a “reasonable” attorneys’ fee the law created ambiguity. While the court held that the fee schedule did not preclude the awarding of a higher reasonable fee it did say the 2003 amendments to the state’s workers compensation laws were unconstitutional. Legislative changes deleted the term “reasonable,” which was in another subsection of the Act and state that the retainer agreement between the client and his or her attorney may not be in excess of the statutory fee schedule.
• Prior to 2003, attorneys charged hourly rates, which in some cases far exceeded the amount of money they collected for their client. Trial attorneys argued in court that the fee limitation in the 2003 law was unconstitutional in that there are no similar restrictions on the fees of defense lawyers who represent the workers compensation insurer. Injured workers complained that attorneys were limiting the type of cases they would accept. In the case that was before the court, Murray v. Mariner Health, the claimant’s attorney submitted a bill for 80 hours. However, the claimant was only seeking an award of $3,224 in benefits, which entitled her to the statutory formula in attorneys’ fees of $685.
• Missouri Supreme Court decision: A state Supreme Court ruling in Missouri Alliance for Retired Americans v. Department of Labor and Industrial Relations, Division of Workers Compensation in February 2009 may weaken the state’s exclusive remedy provision (see Background section). The lawsuit challenges the constitutionality of the 2005 amendments to the state’s Workers Compensation Act.
• Although the court dismissed eight of the nine claims raised by the plaintiffs regarding the constitutionality of law, saying they need to be challenged in an actual case brought by an injured individual, the court upheld the plaintiffs’ request for a declaratory judgment in regard to the exclusivity clause. The plaintiffs claim that the 2005 amendments narrowed the scope of the terms “accident” and “injury” to such an extent that many workers would no longer be able to recover workers compensation benefits. They sought a declaratory judgment to determine whether such workers would be able to sue their employers in court for negligence. The court said that injuries no longer compensable under the Act are not subject to the exclusive remedy provision. Those injured workers therefore have a right to bring suit under common law.
• New Jersey: The state’s medical society is challenging a fee schedule in court even though the fees allowed are above prevailing rates. The Insurance department adopted the fee schedule in 2007 after working on it for two years. Fee schedules have been established in many states to help control workers compensation medical care costs which are often higher than those for employer-sponsored group health care. According to a 2007 study by NCCI, which seeks to determine the effectiveness of state workers compensation fee schedules, fee schedules do control costs. They are most effective for physical therapy and primary care (e.g. office visits) and least effective for specialty medicine such surgery and radiology. However, regardless of whether a fee schedule is in place or not, higher utilization of services by workers compensation claimants (more treatment and more office visits) accounts for more of the difference in costs between group health care and workers compensation than the mark-up on medical care prices.
• New York: An analysis of the impact of workers compensation reforms passed in 2007 suggests that the key goals of the legislation are being met. More than half of claimants injured after July 1, 2007 (57 percent) received higher awards due to the increase in maximum weekly benefits from $400 to $500; disputed claims are being resolved faster; and appeals of decisions are being processed faster. In addition, as a result of the reforms, rates will fall by 5 percent in 2009, according to Gov. Paterson, bringing the reduction in rates since reforms were enacted to more than 25 percent. The state now sets the base rate calculated according to loss costs—the cost of claims only. Each insurer adds on a percentage for its administrative costs. This method of setting workers compensation rates, which is new to New York State, offers an incentive to each company to keep its part of the rate formula—administrative overhead—lower than the competition to increase its market share. Loss costs represent about 75 percent of the rate.
• The reform law raised maximum weekly benefits to $600 in 2009 and $650 in 2010. In 2011, they will increase to two-thirds of weekly earnings, the percentage that the system has traditionally aimed to provide in all states. The reduction in premiums for employers is due mainly to a limit on the number of weeks an injured worker can receive benefits for permanent but partial disability. A task force set up under the reform legislation recommended that employers be required to submit data on a quarterly basis to help legislators track costs, analyze and monitor the system, and make the appropriate policy decisions.
• In 2008, treatment guidelines for lower back, cervical spine, knee and shoulder injuries that standardize how these injuries should be treated were put in place. Treatment guidelines, which are also used by auto insurers in the treatment of common auto accident injuries in some states, help workers get faster and more effective medical care.
• California: Insurance Commissioner Steve Poizner held a hearing at the end of April on the need for a workers compensation rate increase. Earlier in March the state’s Workers Compensation Insurance Rating Bureau approved a 24 percent increase, effective July 1. Much of the requested increase, almost 18 percent, reflects rising medical care costs, the Bureau said. About 6 percent stems from decisions by the Workers Compensation Appeals Board in three cases that set out new rules for calculating permanent disability ratings. The disability rating schedule affects how much injured workers receive for permanent disability awards.
• Poizner said that the Board’s decisions will promote unpredictability and burden the system with additional costs and expenses. He filed amicus briefs arguing that the Board’s changes to the 2005 permanent disability rating schedule should apply only to current and new cases and not retroactively and has asked the Rating Bureau to withdraw the portion of the rate increase that is due to the court decisions until it is clear what the Appeals Board and the courts will do. Poizner will hold a hearing on medical cost inflation in June.
• An appeals court in San Francisco upheld numerical limits for treatments in a case where an injured worker sought to have the system pay for 76 visits to a chiropractor. The 2004 reform law set a limit of 24 visits. In its ruling in June 2008, the court said that the Constitution does not require unlimited treatments and that it is up to lawmakers to decide on the details of what is appropriate and take measures to keep the system solvent. Some labor groups have complained that the reforms of 2003 and 2004 have deprived injured workers of necessary medical care.
• A report prepared by the California Workers Compensation Institute on the impact of reform legislation shows that in five of six types of services there were fewer visits and lower amounts paid per claim. The greatest decrease was in chiropractic manipulation and physical therapy, with visits decreasing by 68.9 percent and 16.3 percent respectively between pre-reform 2002 and post-reform June 2006, and payments by 74 percent and 61 percent. Studies by the state’s Division of Workers Compensation show that more workers have returned to work after injury since the passage of SB 899 in 2004, which included incentives to return to work at the former employer.
• West Virginia, State Funds: Following the successful three-year change-over in West Virginia from a state-controlled workers compensation system to a private competitive market, Ohio and other states with state-administered systems (state funds) are looking into allowing some form of competition from private insurers. Ohio voters rejected a ballot initiative on privatization in 1981. Ohio has the largest monopolistic state fund in the nation.
• On July 1, 2008 West Virginia opened up its workers compensation business to any insurer that meets state requirements. Before, coverage was only available from the state-run mutual company. In readiness for the change over, 147 insurers filed rates; 23 were new to the state, according to the insurance department. The state was one of five with a so-called monopolist state fund, from which all employers, except those that are self-insured, must purchase their workers compensation coverage. The privatization process was phased in. A private mutual insurance company was created in June 2005. Nevada went through a similar change several years ago, enacting legislation to begin the workers compensation privatization process in 1999. It now has a mutual insurance company.
• Financial Results: In May 2009 the NCCI released its annual "State of the Line" workers compensation market analysis, showing that in the 2008 calendar year the workers compensation system produced a small underwriting loss, with a combined ratio of 101 for the second consecutive year, but the accident year combined ratio was 100. The NCCI said that so far in 2009, medical costs and indemnity claim costs are increasing faster than wages and that low investment yields may put pressure on underwriting results. As predicted, the drop in frequency (number of claims) has accelerated due to the economic slowdown, with claims dropping by 4 percent. The trend was first observed in the 1990s. Much of the good news can be attributed to reforms in California. Because of the size of its economy, excluding California from the 2008 results would have pushed the calendar year combined ratio to about 106 percent, NCCI noted.
• Workers compensation net premiums written (private companies and state funds) dropped more than 12 percent to $39 billion in 2008, based on preliminary calendar year data, the largest drop in many years. Private carriers accounted for 34 billion in premiums in 2008, with the remaining $5 billion going to state funds. Depopulation of the residual market continued at a rapid rate in 2008, with premiums dropping to about $700 million from $1 billion in 2007. The residual market represented about 6 percent of direct written premiums, compared with 8 percent in 2007. Market share peaked at 13 percent in 2004 in this underwriting cycle. The exodus from the residual market was greatest for large firms.
• Medical care costs in the workers compensation system continued on an upward climb, growing faster than overall Consumer Price Index medical care costs. Medical care costs accounted for 58 percent of total workers compensation claim costs in 2008, compared with 42 percent for lost income payments. In 1987 the medical component represented only 46 percent of total costs. Since that time, medical claim costs have risen by more than 200 percent. But while medical care costs are pushing up the size of claims, known as claim severity, the number of injuries reported, or frequency, is still declining, with lost-time claims falling 54.9 percent from 1991 to 2008 as the workplace becomes safer. (In the 1920s about one in four full-time workers sustained on-the-job-injuries, compared with six in 100 now.) The drop in frequency is expected to continue. The NCCI has found that frequency tends to decline in periods of economic slowdowns.
• Obesity and Workplace Injury Costs: Initial findings from an NCCI study on the cost of claims filed by workers who are obese found that their claim costs were significantly higher than those filed by nonobese workers. The findings are similar to a 2007 study of employees at Duke University. There, workers who were morbidly obese (those with body mass index (BMI) of 40 and above) filed 45 percent more claims, missed eight times the number of workdays and experienced medical costs that were more than five times higher than those of nonobese workers. Likewise, workers who were overweight (those with a BMI of 25.0 to 29.9) filed 9 percent more claims, with costs that were 1.5 times as high as people with so-called normal weights (a BMI of 18.5 to 24.9) and missed up to 3.5 times as many workdays. The NCCI study results, which will help underwriters more accurately assess how obesity is pushing up workers compensation claim costs, will be released in 2010.
• Workplace Injury Rates: Workplace injury rates are now at their lowest level since the Bureau of Labor Statistics began tracking information in the 1970s, according to the agency. BLS data show rates for private workplace injuries and illnesses dropped from 7.1 per 100 full-time workers in 1997 to 4.2 in 2007, the latest available data. In 2007, there were 4 million cases of nonfatal occupational injuries and illnesses, compared with 4.1 million in 2006. Some 1.2 million cases requiring days off work or restricted duties were reported in private industry workplaces, down from 1.3 percent in 2006. BLS data also show that 5,488 workers were killed in on-the job-accidents in 2007, a drop of 6 percent from 2006, with the greatest decrease in transportation-related deaths.
• A study by the NCCI on claim frequency published in the summer of 2008 found that the rate of decrease is dropping. The number of claims has been falling since the 1990s, with decreases of 7 percent in 2005 and 2006 but only 2.5 percent in 2007. Almost every employment category NCCI examined has experienced declines. Severity, the cost of claims, has continued to grow, however. As part of the review, NCCI looked at changes in permanent total claims, the costliest 1 percent of lost-time claims, which have risen significantly over the past three years. From 2004 to 2006 the increase in permanent total claims may have increased the cost of the medical portion of total lost-time claims by as much as 2.5 percent to 3 percent a year, the NCCI says.

BACKGROUND

The Workers Compensation Social Contract: The industrial expansion that took place in the United States during the 19th century was accompanied by a significant increase in workplace accidents. At that time, the only way injured workers could obtain compensation was to sue their employers for negligence. Proving negligence was a costly, time-consuming effort, and often the court ruled in favor of the employer. But by the early 1900s, a state-by-state pattern of legislative proposals designed to compensate injured workers had begun to emerge.

Wisconsin enacted the first permanent workers compensation insurance law in 1911 (New York had enacted a law a year earlier but it was found unconstitutional), and by 1920 all but eight states had enacted similar laws. By 1949 all states had a workers compensation system that provided compensation to workers hurt on the job, regardless of who was at fault. The costs of medical treatment and wage loss benefits were the responsibility of the employer which were paid through the workers compensation system. As part of the compromise that made the employer liable for work-related injury and disease costs regardless of fault, the employee gave up the right to sue the employer for injuries caused by the employer's negligence.

The scope of workers compensation coverage has broadened considerably since its early beginnings. In 1972, states amended their laws to meet performance standards recommended by the National Commission on State Workmen's Compensation Laws. Many states took action not only to expand benefits but also to make the coverage applicable to classifications of employees not previously covered.

However, compensation levels are not uniform. In some states benefits are still inadequate, while in others, they are overly generous. Some states were slow in adopting the National Commission's guidelines and have still not embraced the entire package of 19 recommendations published in 1972. Many states exempt employers with only a few workers (fewer than five, four or three, depending on the state) from mandatory coverage laws. A major benefits issue still to be resolved in some states is the imbalance between levels of compensation for various degrees of impairment; permanent partial disabilities tend to be overcompensated and permanent total disability undercompensated.

Some coverage is provided by federal programs. For example, the Longshoremen's and Harbor Workers Compensation Act, passed in 1927 and substantially amended in 1984, provides coverage for certain maritime employees and the Federal Employees' Compensation Act protects workers hired by the U.S. government.

Employers can purchase workers compensation coverage from private insurance companies or state-run workers agencies, known as state funds. In 14 states, state funds compete with private insurers (competitive funds) and in four states, the state is the sole provider of workers compensation insurance. West Virginia, which used to have a monopolistic state fund, now has a private system. (See list at the end of Recent Development section of this report.). State funds also function as the insurer of last resort for businesses that have difficulty getting coverage in the open market.

The only state in which workers compensation coverage is truly optional is Texas, where about one-third of the state’s employers are so-called nonsubscribers. Those that opt out of the system can be sued by employees for failure to provide a safe workplace. The nonsubscribers tend to be smaller companies, but the percentage of larger companies opting out is growing. Some 25 percent of the state’s workers were employed by nonsubscribers in 2008, compared with 23 percent in 2006.

Some businesses finance their own workplace injury benefits through a system known as self-insurance. Large organizations with many employees can often estimate the cost of routine types of injuries. Self-insurance, along with large deductibles, which are in effect self-insurance, now account for more than one-third of traditional market premium. Put another way, workers compensation accounts for more than 40 percent of the alternative market, see also Captives report. Businesses that self-insure their workers compensation losses must prove that they are financially able to do so. They usually protect their assets by purchasing insurance coverage for catastrophic losses or losses in excess of a specific threshold.

Data on sources of workers compensation benefits, presented in the 2007 November/December issue of Workers Compensation Policy Review, show the relative size of the different segments. In 2005, just over half of benefits (50.8 percent) were paid by private insurers, with the other half coming from state funds (19.4 percent), federal programs (5.9 percent) and self-insured employers (23.8 percent).

About nine out of 10 people in the nation’s workforce are protected by workers compensation insurance. Laws vary by state for domestic workers, see chart.

How the System Works: Workers compensation systems are administered by the individual states, generally by commissions or boards whose responsibility it is to ensure compliance with the laws, investigate and decide disputed cases, and collect data. In most states employers are required to keep records of accidents. Accidents must be reported to the workers compensation board and to the company’s insurer within a specified number of days.

Workers compensation covers an injured worker’s medical care and attempts to cover his or her economic loss. This includes loss of earnings and the extra expenses associated with the injury. Injured workers receive all medically necessary and appropriate treatment from the first day of injury or illness and rehabilitation when the disability is severe.

To rein in expenditures and improve cost effectiveness, many states have adopted cost control measures, including treatment guidelines that spell out acceptable treatments and diagnostic tests for specific injuries such as lower back injuries and fee schedules that set maximum payment amounts to doctors for certain types of care.

Most claims are medical only, but lost-time claims, those with both medical and lost income payments, though few, consume most resources. Claims are categorized according to the degree of impairment—partial or total disability—and whether the impairment is permanent or temporary. Cash benefits can include impairment benefits and, when the impairment causes a loss of income, disability or wage loss benefits.

Impairment can be defined in several ways. Payments may be based on a schedule or list of body parts covered and the benefits paid for a loss of that part. For injuries not on the schedule, benefit payments may be calculated according to the degree of impairment or the loss of future or current earnings capacity, often using the American Medical Association’s definitions.

Most states pay benefits for the duration of the injury. But some specify a maximum number of weeks, particularly for temporary disabilities. For workers with a total disability, the benefit amount is some percentage of the worker’s weekly wage (actual or state average). Cash benefits may not be paid until after a waiting period of several days.

Costs to Employers: Costs to employers include premiums, payments made under deductibles and the benefits and administrative costs incurred by employers that self-insure or fund their own benefit program. In the mid-1950s, private sector employers paid an average 0.5 percent of payroll for workers compensation. By 1970 this figure was 1 percent.

Employer costs escalated steeply in the 1980s and 1990s, reaching a record high in 1994 of 2.99 percent. Since then they have fluctuated. Estimates by John Burton in the Workers Compensation Policy Review, January/February 2008 put workers compensation costs as a percentage of payroll in 2007 at 2.28, up from a 10-year low of 1.92 in 2001. However, there is a wide variation in costs among states and industries, so that the highest rated (the inherent riskiest) groups could pay several hundred times that of the lowest rated (safest) groups, as a percentage of payroll. Also taken into account is the firm’s own safety record.

Workers compensation premiums dropped considerably from 1994 to 1999, declining every year during that period by an average of more than 5 percent. The favorable workers compensation insurance environment during that time drew more insurers into the marketplace, pushing rates down. The discounting of premiums, in part as a result of high investment income at that time, together with intense competition, reduced premiums by 38.8 percent over the six-year period. Also contributing to the decline in premiums in the 1990s was growth in self-insurance and large deductible programs and, in some states, alternatives to workers compensation such as combined health and disability policies.

Insurance, particularly commercial insurance, is a cyclical industry marked by hard and soft markets. Premiums rose again starting in 2000 as the economy expanded and the hard market in insurance, when demand outstrips supply, drove prices up. In 2007, with a generally soft market for most types of commercial insurance and a weakening economy, premiums began dropping again.

Claim Costs: As mentioned earlier, there are two components to workers compensation claims costs: payments for lost income, which are usually linked to a state’s average weekly wage, known as indemnity costs, and payments for medical care. Two decades ago, indemnity costs made up the greater part of total losses. In 1986 indemnity costs represented 55 percent of the total. By 1996 indemnity and medical had changed places, with indemnity at 48 percent of losses. In 2007, as medical care costs continued to rise, indemnity accounted for only 41 percent.

Growth in workers compensation medical costs has been much steeper than in the healthcare industry as a whole. The annual average rate of increase in workers compensation medical care costs was 3.9 percent from 1991 to 1995. Since then the rate of increase has more than doubled and, in most years, was more than twice the rate of increase in the medical Consumer Price Index (CPI). Between 1995 and 2007, the medical cost per lost-time claim -- where the employee was forced to take time off work because of the injury as opposed to just seeking treatment for the injury—increased by 8.2 percent, compared with an increase of 4.0 percent in the medical CPI.

NCCI Holdings suggests that much of the difference between the cost of a healthcare claim and a workers compensation claim is due to the volume, duration and mix of services used by injured workers and group health claimants.

But while the size of claims (dollar amount) has been climbing due to the increasing cost of medical treatment, the number of claims filed (frequency) has been dropping steadily as insurers and their policyholders focus on safety. The frequency of lost-time claims dropped by 52.3 percent from 1991 to 2006. NCCI also attributes recent declines in the frequency of accidents to the use of robots, which reduce workers' exposure to hazardous activities; power-assisted devices that reduce physical stress, lighter and stronger materials; ergonomic designs that reduce strains; and cordless tools, which reduce the incidence of tripping over cords. Frequency declines, which first showed up among small employers are now evident also in large firms.

Insurance company financial results often report profitability in terms the combined ratio (the percentage of each premium dollar spent on claims and expenses). The combined ratio for workers compensation is reported in two different ways: by calendar year and by accident year. In 2007 the calendar year combined ratio started to deteriorate, moving to 99 from 93 in 2006. The accident year combined ratio also deteriorated from 84 in 2006 to 92 in 2007, according to NCCI. The accident year combined ratio hit a peak of 140 in 1999.

Calendar year results reflect claim payments and changes in reserves for accidents that happened that year or earlier. Insurance companies have to set aside reserves for accidents that have happened but where claims have not been settled. Workers compensation claims may not be settled for many years, if the accident victim needs increasingly more treatment, for example. Accident year results, in that they include only losses from a specific single year, may present a better picture of the industry's performance at a given point in time.

Reducing Costs: Workers compensation system costs are rarely static. Reforms are implemented and then, over time, one or more element in these multifaceted systems get out of balance. Soon employers and legislators complain that the cost of coverage is hurting the state’s economy by reducing its ability to compete with other states for new job-producing opportunities.

In the 1980s, with a view to increasing competition within the insurance industry in order to bring down rates, legislation was introduced in more than a dozen states to change the method of establishing rates from administered pricing, where rating organizations recommended rates that included expenses and a margin for profit, to open competition. Now insurers base their rate filings on more of their own company's specific data, rather than using industrywide figures in such areas as expenses and profit and contingency allowances. Rating organizations still provide industrywide data on "losses"—the costs associated with work-related accidents, which help small companies that lack access to large amounts of data.

More recently, states have begun to disband Second Injury Funds. Set up mostly after World War II, these funds were designed to protect employers that hire disabled workers from having to bear the full cost of the first disability when an injury that further disabled the worker occurred in their workplace. Many believ