Getting workers' comp costs under control: workers' comp insurance costs may accelerate as employers with good records continue to opt for self-insurance

Risk & Insurance, March 3, 2003 by Peter Rousmaniere, Phil Denniston

Comparable workers' compensation insurance costs vary by as much as a factor of two among many neighboring states. Between the five lowest- and five highest-cost states, the average difference is a factor of more than three. For the highest-cost states, the difference may be much more.

The variances provide a laboratory in which to explore the forces that drive workers' comp costs. The lab results show that costs come from employer behavior and from the relative efficiency of a state's system of workers' comp laws and regulations.

But that's only half the story. Employers with good loss experience and discipline can avoid high insurance costs by self-insuring or by using high deductibles. Even in states with relatively high insurance costs, employer costs can be quite low.

Therein may lie the real trouble for insurers and regulators in the next few years. Employers have an increasing appetite for self-insurance. If employers with good workers' comp practices can cut insurance purchases, the insurance industry may be stuck with an adverse selection of risks. This gap can help fuel a spiral in workers' comp insurance.

These findings lead to three conclusions: States should devote more effort to improve employer practices; states saddled with high cost structures should reduce the inefficiencies generated by laws and regulations, and critics of interest groups, such as insurers, lawyers and doctors, should be wary of oversimplification.

Placing the Blame

The data supporting these conclusions are not as current as one would want. But one statement is certain: The range of insurance costs among and within states is not due solely to insurers. Blaming insurers for high costs also requires praising them for low costs, yet insurer practices do not change much--if at all--among states and among insureds. It would be similar if we tried to explain the rise and variations in health care costs among households based just on the proficiency of hospital administrators.

Average insurance costs among states vary widely. Table A, column [B.sub.2] shows the ratio of insurance costs in each state and compares it to the e national average for a hypothetical manufacturing firm. States are so sorted in order of cost. These ratios reflect premiums in each state for the average firm--the average insured manufacturer with identical staffing. For example, if a manufacturing firm located entirely within

Connecticut had insurance costs of $121,000 (21 percent above national average), and moved to Iowa, the manufacturer's costs would decline to $80,000, or 20 percent below the national average. In California the insurance bill would jump to $227,000. In Arizona, it would be $36,000.

Actuarial & Technical Solutions of Ronkonkoma, N.Y., has over the past 10 years produced a comparative profile of insurance costs of most t states. ATS creates a hypothetical company whose workforce mirrors the nation's manufacturing workforce. It then acquires insurance data from 45 states, leaving out states with monopolistic funds. For the report effective Jan. 1, 2002, ATS calculated net insurance costs per $100 in payroll for these 45 states. The firm's data can be correlated with OSHA injury data compiled by the Work Loss Data Institute, and compared with findings of the Workers Compensation Research Institute and the National Academy of Social Insurance. Other comparative rankings of workers' comp costs support ATS' findings of the most--and least--expensive states, as well as the huge variances among states.

Employers have for some time been shedding conventional workers' comp insurance for self- insurance or high-deductible plans. Between 1990 and 2000, the share of workers' comp benefits paid directly by employers rose from 20 percent to 30 percent of all benefits paid. With today's hard market, this percentage is certainly increasing.

The impetus for shedding conventional workers' comp is partly due to the success employers have had in controlling losses. Injury rates have been dropping for years. Work-site managers can jump on fresh injuries and employ early-return work policies. Without slighting the dedication of insurer loss-control staffs, these work-site-based improvements occurred mainly at the instigation of employers, not insurers. This productivity juggernaut continues, separating the better-managed employers from the pack. It is no longer useful to refer to the "average" employer. There are those that perform well, and those that do not. The better employers run such tight ships that any lost-time injury of more than 30 days can today be called a long-term injury.

High-Cost States

Very high-cost states such as California may suffer a triple whammy in their workers' comp systems. First, the frequency of long-term injuries in California is higher than average. Employers can do a much better job at resolving injuries faster. Second, the laws and regulations are inefficient, making the long-term injuries even more expensive. Third, as more employers exit standard insurance contracts, the insurance sector may enter an adverse selection spiral.