In a recent description of workers' compensation insurance, Liberty Mutual's CEO Edmund "Ted" Kelly said, "Prosperity hides the cracks in the facade." Are there indeed cracks in the structure of the U.S. workers' compensation insurance system?
The frequency of workers' compensation claims has been declining since 1991 with the exception of 2010. However, the severity of both indemnity and medical claim costs continues to increase. Indemnity severity is increasing at a faster pace than wages, and medical severity continues to increase more than the Medical Consumer Price Index (CPI).
One reason for the disparity between the decrease in frequency and increase in severity can be seen in an analysis of frequency trends for different types of claims. Medical only, temporary total, temporary partial, permanent partial, permanent total, and fatality claims all experienced decreases in frequency during the previous 10 years. There is a notable exception: During the past five years—although most claim types experienced frequency declines—permanent total claim frequency increased by 50%. Permanent total claims represent approximately 1% of all workers' compensation claims yet are responsible for 12% of claim costs.
The trend of increasing frequency in permanent total disability claims began in 2004. According to the U.S. Bureau of Labor Statistics, the unemployment rate was 5.4% at the end of 2004. Typically, the designation of a workers' compensation claim as permanent total does not occur until two years or longer after the date of injury. This is because most state regulations provide two or more years of temporary total disability benefits prior to the onset of permanent total disability, under which wage replacement benefits will continue for the remainder of the claimant's life. Therefore, the trends responsible for the increase in frequency of permanent total disability claims began prior to the economic downturn and the resulting increase in unemployment.
One significant factor in the increased frequency of permanent total disability claims is the rising rate of obesity nationwide, now at 30% of the population. In 2004, Duke University performed a study on the impact of obesity on workers' compensation claim costs. The study found that the average claim cost for an obese employee was 10 times higher than that for a non-obese employee, and lost workdays were 13 times higher. There is a substantial difference in the loss development of obese and non-obese claims. The ratio in medical costs of obese to non-obese claimants is 2.8 at 12-month maturity, 4.5 at the 36-month maturity, and 5.3 at the 60-month maturity. These developmental differences have a major impact on claim reserving.
While obesity and associated co-morbidities, such as diabetes and heart disease, have been increasing, state special injury recovery funds have become all but extinct. These accounts, funded by a percentage of insurance premiums, permitted insurers to recover a portion of the cost of serious injuries for which certain medical conditions (such as heart disease, diabetes or obesity) added to the cost of the injury. However, in the 1990s, states began to pass legislation to eliminate these funds, and in 2010 only a very few states still have one.
Compounding the Problem
Another probable factor in the increase of the frequency of permanent total disability claims is the influence of Medicare Secondary Payer laws on workers' compensation settlements. In 2002, the Centers for Medicare and Medicaid Services (CMS) issued guidelines regarding approval of prospective workers' compensation settlements. These guidelines essentially require CMS approval of certain settlements in which the claimant is or is likely to become a Medicare beneficiary. In 2005, CMS began requiring that these Medicare Set-Asides (MSAs) cover future prescription drug costs as a result of Medicare Part D benefits. It is probably not coincidental that the frequency of permanent total disability claims began to rise significantly around the time of this growth in MSA costs for prescription medication. The increase in the difficulty and cost of claim settlements likely resulted in more claims being accepted or adjudicated as permanent total, with insurers paying benefits rather than settling the future liability.
The current economic conditions will probably exacerbate the trend of increasing permanent total disability claims. With unemployment high and employers experiencing financial constraints, return to work becomes more difficult. An employer's ability to permanently accommodate the work restrictions that result from serious injuries, especially if there are co-morbidities such as obesity, is limited.
Even a small rise in the frequency of permanent total disability claims can be expected to have a disproportionate impact on workers' compensation costs, particularly on the future development of those claim costs, since they represent a disproportionately large segment of workers' comp costs.
There is nothing to indicate that the trend in increasing severity in workers' compensation claims will reverse. Despite moderating somewhat in recent years, medical costs continue to grow at a faster pace than the Medical CPI. The frequency of permanent total disability claims continues to rise, and this presents a poor prognosis for future claim development. Although obesity growth rates have lessened somewhat over the past few years, there is nothing to indicate a reversal of the overall weight problem in the U.S.
Insurers that were able to maintain profitability in the workers' compensation line when investment returns were good appear to be realizing that there have been cracks developing in the workers' compensation structure that are now widening with the impact of a poor economy and a low interest rate environment.
Judith Vaughan, CPCU, AIC, is director of Content Development for The Institutes.