Staying alive: how your business can survive the killer costs of workers' compensation

Entrepreneur, Jan, 2004 by Joshua Kurlantzick

Over the past year, California businesspeople have grown increasingly infuriated over a variety of perceived economic problems. High taxes. Politicians' indifference to corporate issues. Deteriorating physical infrastructure. Ultimately, this anger became so strong that it partially led to the termination of Gov. Gray Davis and the installation of Governator Arnold Schwarzenegger.

But despite companies' myriad complaints about the Golden State, when Scott Hauge, president of CAL Insurance & Associates Inc., a San Francisco insurance firm targeting the small-business market, did a survey of roughly 1,200 Californian entrepreneurs earlier this year, he found their biggest problem wasn't taxes or roads--it was the skyrocketing cost of workers' compensation. Workers' comp premiums in California rose by more than 100 percent in the past two years alone, and insurers paid out nearly $20 billion in comp claims in California last year. "It's the number-one issue [for small companies]," Hauge says.

California is a bellwether for the nation. In many states, workers' comp premiums have soared in recent years. These costs fall hardest on entrepreneurs, who have limited resources and often don't have many insurance options. In some places, workers' comp has become so expensive that it's putting small companies out of business or prompting them to skirt the law. Others are fighting back, trying to keep workers' comp costs down or fighting for reform.

It Begins

Workers' compensation, a program begun in the early 1900s that forced employers to give health insurance and cash benefits to employees hurt on the job, has always been a significant expense for entrepreneurs-particularly those in manufacturing, where serious injuries are more common. According to the National Academy of Social Insurance, a research organization, workers' comp is the third-largest source of support for injured workers, surpassed only by Medicare and Social Security.

But over the past five years, workers' comp has become an even bigger expense. Jack Hannah of the Workers' Compensation Insurance Rating Bureau of California, a nonpartisan research agency in San Francisco, says that before recent legislative reforms in Sacramento, workers' comp insurance premiums in California were likely to rise by about another 12 percent in 2004. In Florida, workers' compensation premiums rose by nearly 14 percent annually as of April 2003; while in Missouri, premiums rose by about 15 percent annually. The Insurance Information Institute, a research organization, estimates the average cost of workers' comp nationwide has increased by 50 percent since 2000. "Rates are stratospheric," says Richard Millman, 52, president of Millman Lumber, a 100-employee lumber wholesaler in St. Louis.

Worse, in industries with higher accident rates, workers' comp can become almost a second payroll. Michael Hamman, 56, a general contractor in San Francisco with three employees, pays 54 cents in workers' comp premiums for every salary dollar his carpenters earn. "For roofers, you pay 99 cents," he says. "I'm going broke."

A storm of factors is pushing workers' comp premiums through the roof. "The driver of workers' comp is health-care costs," says William S. Custer, an expert on workers' compensation at Georgia State University in Atlanta. As health-care costs have gone up, workers' comp costs have risen, he says. And in the '90s, states like California and Missouri deregulated the workers' comp market, allowing private insurers to set their own rates. Competition for workers' comp business became fierce. To win market share, many insurance companies tried to undercut their rivals; several went out of business. With fewer companies in the market, there is now less competition, higher rates and less monitoring of workers' comp fraud. Fraud drives premiums up because insurers have to increase their cost reserves to cover potential fraud. In fact, in California, the number of fraud cases prosecuted by district attorneys fell by more than 30 percent between 1999 and 2000, and again in 2001 and 2002.

Meanwhile, increased litigation has also impacted workers' comp costs. Over the past decade, many states have loosened rules on where lawyers can advertise. As a result, experts say, lawyers can easily target people hurt on the job and take claims to court rather than settling them out of court with the employer and insurer, which is what workers' comp originally intended. These are only a few of the factors creating a crisis in workers' comp. (See "What Caused the Crisis?" on page 60 for more information.)

Fighting for Their Lives

Entrepreneurs are trying anything and everything to manage rising workers' comp costs. "I'm not buying new capital equipment, and I'm trying not to lay off employees I've had for a long time," says Hamman. He says he isn't taking on new hires, yet still fears that if workers' comp continues to rise, he may go out of business.

Other small companies are adopting similar strategies. "Some have held back salary increases or say they're not going to add employees," says Hauge. At worst, he says, entrepreneurs are entering the underground economy--not carrying workers' comp or giving cash payoffs to injured employees and not reporting the claims to insurers, both of which are illegal.