Burton, John F.

Schmidle, Timothy P.

Thomason, Terry

English

Upjohn Research

Employment Research Newsletter Volume 8 Number 2 Article 2 4-1-2001 Workers' Compensation under Alternative Insurance Arrangements Terry Thomason University of Rhode Island Timothy P. Schmidle Cornell University John F. Burton Rutgers University Follow this and additional works at: https://research.upjohn.org/empl_research  Part of the Workers' Compensation Law Commons Citation Thomason, Terry, Timothy P. Schmidle, and John F. Burton, Jr. 2001. "Workers' Compensation under Alternative Insurance Arrangements." Employment Research 8(2): 4–6. https://doi.org/10.17848/1075-8445.8(2)-2 This title is brought to you by the Upjohn Institute. For more information, please contact repository@upjohn.org. W.E. Upjohn Institute for Employment ResearchEmployment Research - April 2001Terry Thomason, Timothy P. Schmidle, and John F. Burton, Jr.Workers’ Compensation under AlternativeInsurance ArrangementsOne of the most important differences among state workers’ compensation programsconcerns the insurance arrangements for providing workers’ compensation coverage. State lawsprescribe workers’ compensation benefits, but these laws assign to employers the responsibilityfor providing benefits. The employers obtain workers’ compensation coverage to provide thesebenefits by one of three mechanisms, depending upon the options available in their state. Theymay purchase insurance from 1) a private insurance carrier, 2) a competitive state workers’compensation fund, or 3) an exclusive (monopolistic) state workers’ compensation fund. Inaddition, self-insurance is available in almost every state upon satisfying prescribed criteria. Thiscommingling of private (insurance carrier) and public (state fund) approaches to providingworkers’ compensation benefits is a distinctive feature of workers’ compensation in the UnitedStates.Another important difference is the degree to which workers’ compensation insurancepricing has been deregulated. The private provision of workers’ compensation in the UnitedStates was highly regulated until recently. Carriers were subject to “pure administered pricing,”under which maximum permissible rates were largely determined by state rating bureaus, and therates charged by carriers were subject to prior approval by state insurance commissions.However, most states in recent years have dismantled (to varying degrees) their systems ofregulation for workers’ compensation insurance pricing. In fact, the deregulatory movementbegun by just a few states in the early 1980s has become so widespread that now only a fewjurisdictions continue to use the pure administered approach.In our recent book, Workers’ Compensation: Benefits, Costs, and Safety underAlternative Insurance Arrangements (2001, W.E. Upjohn Institute), we use a unique panel dataset of state-level data for 48 jurisdictions between 1975 and 1995 to explore the effects ofinsurance arrangements on workplace safety, the structure of the workers’ compensationinsurance market, and the employers’ costs of workers’ compensation insurance. In addition, weexamine the trade-off between the benefit adequacy and affordability objectives of state workers’compensation programs and estimate the impact that the imposition of federal standards forbenefit adequacy would have on workers’ compensation costs.There is substantial debate about the relative merits of public versus private provision ofworkers’ compensation insurance and about the regulation of private-carrier-provided workers’compensation insurance. This debate has, for the most part, centered on questions concerning theavailability and affordability of compensation insurance, since these two variables are relativelyeasy to measure. However, questions have also been raised regarding the “quality” of servicesprovided to the parties to workers’ compensation. Labor advocates, for example, have beenparticularly concerned that the profit motive causes insurers to unjustly deny claims or otherwiseimpede the delivery of benefits to workers, thus exacerbating the adverse consequences ofworkplace injuries or diseases.Here, we focus on our results and conclusions with respect to only one of the researchquestions we addressed: the impact of the deregulation of the workers’ compensation insurancemarket on employers’ costs.Deregulation and Employer CostsEconomic theory fails to offer unambiguous predictions about the impact of the regulationof rates in private insurance markets. In part this is because these effects depend on the behaviorof the regulatory agency, which is driven by political rather than economic considerations. Aregulatory body that aligns itself with employer-consumers of workers’ compensation insurancewill suppress rates below competitive levels (at least in the short run). On the other hand,regulators who are more responsive to the insurance industry may help cartelize the market,resulting in supracompetitive rates. Even those regulatory agencies that pursue the public interestcan inadvertently engender price distortions, due to lags in the rate-making process that delay theprice response to changes in market conditions.Empirical study of property-casualty insurance (principally, automotive insurance) hasusually found that rates increased following deregulation, a result consistent with the hypothesisthat regulators respond to consumer interests by suppressing insurance prices. However, theresults from those studies examining workers’ compensation insurance rates have been decidedlymixed. The empirical study of rates and deregulation is very difficult, and it is likely that noempirical study will ever surmount all of the problems and completely dispose of the issue onceand for all. Nevertheless, we believe that we improve on previous research in at least twoimportant ways.First, while earlier studies typically used relatively simple measures of the regulatoryenvironment (often states were categorized solely as “regulated” or “deregulated” jurisdictions),we use a more complex characterization of the regulatory environment in order to capture theactual practices of the regulatory agency as well as interstate differences in statutory regimes. Wecategorize state insurance market regulatory regimes as• pure administered pricing, under which all insurers must use an identical set of manualrates that a) include an allowance for benefit payments (“loss costs”) as well as forloadings for factors such as underwriting expenses, b) were developed by a rating bureau,and c) have been approved by the state regulatory agency;• comprehensive deregulation, under which rating bureaus only publish loss costs andinsurers are permitted to set their own rates without first seeking approval of stateregulators; or• three forms of partial deregulation, where at least one of the elements of the pureadministered pricing system has been dismantled.Second, because workers’ compensation insurance rates vary among employers bothwithin and among jurisdictions, it is difficult to measure the costs of workers’ compensationinsurance actually paid by employers. Consequently, most previous research has relied on proxiessuch as the ratio of incurred losses to premiums written. We use measures that accurately reflectthe workers’ compensation insurance costs actually paid by the average employer in a particularstate during a particular year.Figure 1 depicts summary statistics of rate estimates for 48 U.S. jurisdictions in the period1975-1995. On average, the employers’ costs of workers’ compensation insurance rose markedlyover the study period, from 0.95 percent of payroll in 1975 to 2.97 percent in 1995. The cyclicalnature of insurance pricing is also evident from the figure. Finally, the data reveal that interstatevariation in adjusted manual rates increased considerably between 1985 and 1990; thereafter, thevariation generally declined.Since workers compensation insurance costs are affected by a variety of factors in additionto the regulatory environment, a simple comparison of costs under different regulatory regimes isinappropriate. Consequently, we estimated multiple regression equations predicting employers’workers’ compensation costs as a function of the regulatory regime variables as well as a varietyof controls. These controls included the levels of cash and medical benefits, the injury rate, andthe proportion of the workforce covered by the state workers’ compensation program, as well asstate and year dummies to control for unobserved state- and time-invariant factors affectingemployer costs. In addition, we also attempted to examine the interaction among the regulatoryregime, the state of the insurance market, and the behavior of the regulatory agency prior toregulation.Empirical ResultsMost forms of partial deregulation are, on average, associated with higher employer costsfor workers’ compensation. On the other hand, the most comprehensive form of deregulation—loss cost systems that do not require prior approval—is, on average, associated with loweremployer costs. In addition, the impact of deregulation on costs depends not only on the statutoryform of deregulation, but also on the behavior of the regulatory agency prior to deregulation;where the regulatory agency has suppressed rates, deregulation is more likely to lead to increasedcosts. The behavior of the regulatory agency is apparently related to the state of the insurancemarket; regulatory agencies are more likely to suppress rates during a hard market (wheninsurance demand exceeds supply and prices are increasing) than during a soft one. Consequently,the impact of deregulation varies over the insurance cycle.What may we conclude from these results? Given the contradictory findings for partial andcomprehensive deregulation, it is difficult to draw clear inferences concerning the nature ofregulation, i.e., whether regulatory agencies are more likely to respond to employers and suppressrates or whether they are more likely to help the insurance industry cartelize the market. Ourinability to do so leads us to conclude that regulators do neither, at least not consistently. Lagsinherent in the regulatory process may be responsible for the inconsistent findings. However, itmay also be due to the ebb and flow of political pressure over the course of the insurance cycle.As the market hardens, political pressures from employers may force regulators to become moreconcerned with the impact of insurance rates on the state’s business climate, and as a result, ratesare suppressed. When the market softens once again, the political pressures ease and,concomitantly, regulators’ concerns over the effect of workers’ compensation rates vanish andrates are allowed to rise to competitive (and, perhaps, supracompetitive) levels.Insurers respond to this pattern of regulatory behavior by increasing prices during the softphase of the insurance cycle, which is easier to accomplish where the market has been partiallyderegulated. Anticipating rate suppression when the market hardens again, insurers in partiallyderegulated systems are likely to keep market rates higher than the competitive level during thesoft phase of the cycle. In a partially deregulated environment, this is facilitated by the ratingorganization, which promulgates rates that serve as a pricing point for insurance carriers. Thisaccounts for the asymmetry between comprehensive and partial deregulation. comprehensivederegulation results in lower prices during both phases of the insurance cycle, while insurers takeadvantage of regulatory indifference to increase rates, during the soft phase, in anticipation of thecoming crunch when the market hardens once again.This interpretation of our results leads us to conclude that a completely deregulatedmarket is a more efficient delivery system and is, therefore, preferable to either partialderegulation or administered pricing. The latter two alternatives seem to be associated with theinefficiencies resulting from insurer uncertainty over their ability to respond to market changes.Furthermore, anecdotal evidence from states such as Rhode Island and Maine suggest thatinsurance rate regulation can sometimes have near-catastrophic consequences for all thestakeholders in the workers’ compensation program.Terry Thomason is director of the Charles T. Schmidt, Jr., Labor Research Center at the University of RhodeIsland. Timothy Schmidle is a senior research associate at the Cornell University School of Industrial and LaborRelations. John Burton is a professor and former dean of the School of Management and Labor Relations atRutgers University.

Workers\u27 Compensation under Alternative Insurance Arrangements

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Workers\u27 Compensation under Alternative Insurance Arrangements

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