Academic journal article Journal of Risk and Insurance

Workers' Compensation Deductibles and Employers' Costs

Academic journal article Journal of Risk and Insurance

Workers' Compensation Deductibles and Employers' Costs

Article excerpt

INTRODUCTION

In recent years, profitability has returned to the workers' compensation insurance market. Insurers have experienced a dramatic improvement in their combined loss ratios and the frequency of workers' compensation indemnity claims has been on the decline.(1) Nationally, combined ratios after dividends were greater than 110 percent for every year in the 1983-1992 period. They dropped to 109 percent in 1993, 101 percent in 1994, and 98 percent in 1995. At the same time, the use of deductibles for workers' compensation insurance has more than doubled since 1992, accounting for approximately $8 billion in premium credits in 1994.(2) Though state workers' compensation reforms are often cited as the major reason for the improved underwriting results, this article explores the possibility that deductibles, through the creation of incentives for employers to prevent injuries and control the cost of claims, also have contributed to the downward turn in loss ratios.

A number of safety and loss control incentives are inherent in the state workers' compensation systems. These incentives include statutory waiting periods for income benefits, income replacement rates, the workers' compensation experience rating system, self-insurance, retrospective rating,(3) the deregulation of insurance rates, and insurance deductible options, and they can potentially impact the behavior of both employees and employers. For instance, an increase in the real income replacement rate creates an incentive for employees to stay off work longer and it also creates an incentive for the employer to invest more resources in safety to avoid these higher benefit payments.

To date, few empirical studies have involved risk-sharing insurance arrangements and their impact on employer costs. Although some studies found no evidence that experience rating workers' compensation premiums reduces injury rates (Chelius and Smith 1983 and 1993) or the duration of lost time from workplace injuries (Krueger 1990, Kralj 1995), most studies support the notion that loss control incentives reduce employer costs. Ruser (1985 and 1991) and Worrall and Butler (1988) found that the closer firms came to being fully experience rated(4) (i.e., their premiums are based solely on their own experience as opposed to their class experience), the lower their workers' compensation claim rates. Thomason (1993) found the probability of permanent partial disability to be lower for experience-rated employers obtaining insurance through private-sector insurance carriers. A study that tested the effects on fatality rates in Canada of a transition from a flat or manual premium rating system to an experience rating system provides strong evidence to support the hypothesis that experience rating improves workplace safety (Bruce and Atkins 1993). Moore and Viscusi (1990) found that as benefit levels increased, the risk of work-related deaths decreased. They concluded that the use of death rates, as opposed to injury rates, eliminates moral hazard problems from the analysis, and the findings of their study provide strong evidence that employers do invest in safety when faced with the risk of higher costs. Victor (1985), utilizing a simulation model to measure the injury prevention and loss control incentives associated with the experience-rating system, provides compelling arguments that experience rating may provide greater incentives than self insurance, which is not subject to experience rating.

Among the loss-control incentives cited, loss-sensitive insurance arrangements such as insurance deductibles seem to offer employers the greatest direct benefit from investing in injury prevention programs and improved claims management strategies. Large deductible policies, which incorporate elements of self insurance and experience rating, may prove to have the most powerful safety/loss control incentives yet. In theory, a firm which selects a large deductible policy (typically ranging from $100,000 to $5 million per accident)(5) takes on the majority of the policy risk and should have a strong incentive both to prevent injuries from occurring and to manage claims in a cost-effective manner. …

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