At its December 1999 meeting, the Commission on Health and Safety and Workers’ Compensation (CHSWC) voted to engage in a project to analyze workers’ compensation benefit costs in relation to the larger California economic picture.

Various proposals to increase workers’ compensation benefits have been submitted to the Legislature. Concerns have been expressed that increases in benefits would have a negative impact on the California economy and on California employers and employees. This paper is intended to provide information and analyses of workers’ compensation costs in relation to the California economy.

Workers’ compensation costs and benefits will be presented in relation to various economic indicators, such as total payroll, California’s Gross State Product, and personal income. Information regarding workers’ compensation cost as a percent of payroll by industry group is also included. These analyses take into account the growth of costs that led WCIRB to recommend increases in the premium rate.

Data utilized in these analyses were derived from a variety of sources, including the Legislative Analyst’s Office, the Office of Economic Research, the Department of Finance, the Division of Labor Statistics and Research, the Workers’ Compensation Insurance Rating Bureau of California, the California Workers’ Compensation Institute and other organizations. Frank Neuhauser of the Survey Research Center at the University of California at Berkeley contributed his expertise and technical models.

As shown in the Department of Finance’s December 2000 report "Cal Facts- California’s Economy and Budget in Perspective", California is the world’s sixth-largest economy. California accounts for 13% of the nation’s output, which is the largest in the world. California’s economy trails only Japan, Germany, England and France.

According to the "Economic Report of the Governor", published September 2000 by the Department of Finance, and the "California Economic Review", published in the second quarter of 2000 by the Office of Economic Research, California’s economy during the latter half of the 1990s consistently grew faster than the nation as a whole and continued its expansion into the second quarter of 2000 with every region in the state adding jobs.

Computer industry developments and the development of the Internet sparked a boom in various high technology fields. California high technology companies received over $16 billion in venture capital investments in 1999 alone. Overall, California’s strong entrepreneurial spirit, transportation and higher education systems, coupled with and existing high-technology base – developed in part from defense-based industries – have all contributed to the state’s leadership in the new economy. The entertainment industry is a driving force in the economy as well.

"California's Fiscal Outlook: Legislative Analyst Office’s Projections 2000-01 to 2005-06", published November 15, 2000, and "The State of the State’s Labor Markets, 2000" published by the Employment Development Department report that

California has been experiencing booming economic conditions in 2000.

Employment in the state is up by over 3.5 percent this year, while personal income and taxable sales are up by over 11 percent. As with the nation, the state's peak growth rates appear to have occurred in the first half of the year, but monthly indicators such as state withholding and sales tax receipts suggest that California's expansion remains robust.

California’s expansion continues to be broad based, with large employment increases occurring in construction, professional services, transportation, tourism, and motion picture production.

The state unemployment rate is expected to be 4.9% in 2000, which would be the lowest average annual rate in 30 years. In the first seven months of 2000, California has added over a quarter of a million new jobs, which account for 19% of US job growth over the same period.

The fastest growing sector is computer-related services, which includes businesses involved in networking design and software development for the Internet and other integrated systems. Overall, employment related to computer-related services is up 14 percent over the past year, despite the widely publicized shakeout among "dot-com" enterprises -- companies that sell products and services over the Internet.

An especially positive factor in California's near-term outlook is the resumption of growth in high-tech exports to overseas markets. Primarily reflecting improved conditions in Asia, exports of computers, electronics, and instruments produced in California are up by 27 percent in 2000.

The main threats to the positive current national economic outlook originate from rising energy prices and potential further stock market volatility.

For the near term (2000 through 2002), it is expected that economic growth in California will subside from its current dramatic pace, yet still remain stronger than the nation.

Personal income growth is projected to subside from 11.5 percent in 2000 to 6.6 percent in 2001, and further to 6.5 percent in 2002. During the same period, similar moderation in taxable sales growth is expected.

Note that the marked expected slowdowns in personal income and taxable sales reflect the absence of special factors that contributed to dramatic increases in these two measures. Specifically, personal income in 2000 was boosted by an extraordinary increase in stock options exercised during the year, while taxable sales have been boosted both by these income gains and by increased expenditures on gasoline, the latter attributable to higher oil prices.

 

California's economy will continue to expand at a healthy pace through 2006.

California employment and income will again outpace the nation during this forecast period.

This positive long-term outlook is supported by California's dominant position in key "new economy" industries, including the production of computers, electronics, communications equipment, and software.

 

 

California’s workers’ compensation costs for all California employers for the past decade and projected into the future are shown in the following chart.

(Please see Appendix A for a discussion of the methodology used to derive past costs and future projections.)

Note that workers’ compensation costs decreased from 1992 through 1995 due in large part to declining claim frequency and the elimination of the minimum rate law governing workers’ compensation premiums. As "open rating" took effect, insurers competed for business by lowering the premium rates.

Increases in the costs from 1995 to 1998 are due in part to the growth of the California workforce. Projected increases in costs from 1999 to 2006 also take into account projected workforce growth. These estimates reflect underlying cost increases calculated by the Workers’ Compensation Insurance Rating Bureau of California (WCIRB) that led WCIRB to recommend increases in the premium rate. Please note that these estimates would be lower if they were indexed for inflation.

What do these workers’ compensation costs mean in relation to the economy?

Payroll is probably the best measure against which to compare the cost to employers and labor of workers' compensation. Payroll is the most significant variable cost faced by employers. Employment and wage decisions are made after considering the full cost of an employee, including wage, benefits (health insurance, pension, workers compensation, etc.) and comparing that to a worker's expected productivity.

Using payroll also keeps in perspective that benefit costs tend to rise with wages, and comparing workers' compensation costs to payroll will tend to remove overall wage and employment trends from the evaluation of whether benefits are rising or falling. For example, if benefits remain fixed, but wages rise, cost as a percent of payroll will decline (as will workers' replacement rates). On the other hand, if benefits are indexed to wages (e.g., the state average weekly wage) then benefits as a percent of payroll (and workers' wage replacement after injury) will tend to remain steady over time.

The following chart shows total payroll in California from 1990 through 2006.

As can be seen, the rate of increase of workers’ compensation costs is significantly lower than the rate of increase of total payroll.

Consequently, workers’ compensation costs as a percentage of payroll have declined substantially, as shown in the following graph.

After peaking in the early 1990s at slightly over 3% of payroll, workers’ compensation costs have declined to under 2%. The decline was driven primarily by declining claim frequency. In the absence of a change in benefits, costs are projected to continue declining, driven mainly by increasing wage rates subject to fixed benefit maximums.

These overall average costs mask substantial variation across broad industry groups. For the construction industry, workers compensation costs peaked at over 10% of payroll in 1991 while for professional and clerical professions, costs, even at their peak, were less than 1% of payroll.

However, for all industries, the significant downward trend of workers’ compensation costs as a percentage of payroll can clearly be seen in the following graph.

Data Source: Workers’ Compensation Insurance Rating Bureau of California

Workers’ Compensation Costs compared with Other Economic Indicators

Although ‘total payroll’ is the preferred indicator against which to compare workers’ compensation costs, comparisons of workers’ compensation costs against other economic measurements result in similar findings.

For example, when comparing workers’ compensation costs against the Gross State Product, we find that costs have dropped from 1.40% of GSP in 1990 to 0.9% of GSP in 2003.

Similarly, when comparing workers’ compensation costs against the Total Personal Income, we find that costs have dropped from 1.69% of Total Personal Income in 1990 to 1.03% of Total Personal Income in 2006.

Workers’ Compensation Benefits

This section concerns the effect of employment growth on the estimated impact of benefit increases. That is, if employment (or another economic dimension) grows, then the dollar size of a benefit increase will be larger, simply because the economy was larger.

The benefit increase will be larger in dollars (not percent change) because the economy is larger. However, the effect is a second order condition that changes the numbers only slightly and the percent change not at all. For illustration purposes only, a simplified example follows where we look at employment change in a growing economy and the impact on estimates of a benefit increase.

The chart above shows briefly the impact of employment growth on estimates of the size of a benefit increase. Here we are applying a 10% benefit increase. Employment growth makes the size of total WC costs larger, but this affects the baseline costs as well as the estimate of costs after application of a benefit change. For the most part, these two effects cancel out.

So a 10% benefit increase raises costs by $1 billion in a system with no growth in employment and $1.05 billion when there is 5% employment growth. In this example, the effect of the employment growth on a $1 billion benefit increase is $50 million.

Permanent Disability benefit payment levels have been adjusted several times since 1984. These adjustments have included changing both the weekly maximum and the number of weekly payments. In addition, greater distinction was drawn between disability levels by adding higher maximum benefit levels for more severe claims. At the same time, inflation reduced the value of benefits.

The maximum weekly benefit level was increased most for the very highest disability levels. Because the highest disability categories include a small fraction of PD claims, the impact of the increases since 1991 for the majority of PD recipients have been more than offset by the effect of inflation on the value of the benefit.

The following chart shows the average weighted permanent disability benefit for each year from 1984 to 2001. The average weighted PD benefit was calculated at the midpoint of the various permanent disability rating intervals (.25-9.75, 10-14.75, 15-19.75, 20-24.75, 25-29.75, 30-49.75, 50-69.75, and 70-99.75) and at the weekly benefit maximum for each interval, which applies to over 90% of the recipients. Finally each PD interval was weighted according to the percent of all disability ratings that fell in that interval to compute the PD benefit level.

The PD benefit levels were then adjusted for inflation each year using the Consumer Price Index for California. These adjusted levels depict the value of the PD benefit, expressed in 1984 dollars. The following chart shows how the level of the weighted-average PD benefit has increased over time, while the value of the benefit has declined.

By 2001 the overall value of the average permanent disability benefit after adjustment for inflation will have declined to about 73% of its value in 1984, as illustrated in the following chart.

PD Changes by Rating Level

The benefit increases that went into effect from 1992 to 1996 applied in the main to the higher permanent disability ratings. For the highest PD interval 70-99.75%, benefit levels were increased substantially, enough that even after the effects of inflation, the level of benefit exceeded that in 1984.

However, for the lowest PD ratings, those under 15%, no benefit increase has been enacted since 1984 and the inflation adjusted value of the benefit is 57% of what it was in 1984. The following chart shows the inflation-adjusted value of the PD benefit for each interval relative to 1984.

In summary, the value of the permanent partial disability benefit has lost over a quarter of its value in the last 15 years. This has been most seriously felt by the over 40% of permanent disability participants who receive ratings under 15%. For this group of lower rated claims, the inflation adjusted value of the benefit is 57% of what was paid in 1984.

Workers’ Compensation Insurance Market

The WCIRB reports that the written premium for calendar year 1999 is $7.1 billion, with a net of deductible of $5.7 billion. For the first six months of 2000, the written premium is estimated to be about $4.4 billion.

The following chart shows how the indemnity claim frequency has changed from accident year to accident year. Decreases have been noted since 1991-92.

The decline in frequency has continued despite the robust growth in the number of persons employed in the California economy.

The Workers’ Compensation Insurance Rating Bureau of California (WCIRB) has published the following estimates of the ultimate total loss per indemnity claim by accident year, as of June 30, 2000.

The WCIRB predicts that the average cost of a 1999 indemnity claim will be $33,022, which is 14.9% greater than in 1998 and 42.4% greater than in 1994. Please note that the ‘mix’ of injuries may have changed during this time, which could have led to higher average costs. Certain types of injuries, such as stress injuries, may have decreased substantially.

According to the WCIRB, both average indemnity and medical claim costs have shown significant increases over the last several years, as shown on the following graph.

Please note that these cost estimates have not been indexed to take into account wage increase and medical inflation. The Consumer Price Index for Medical Care, compiled by the US Department of Labor’s Bureau of Labor Statistics (BLS), is not directly applicable to medical costs in California’s workers’ compensation. Also, workers’ compensation costs operate within fee schedules, which are likely to have an effect on price increases, which again may not be reflective of price changes in the general health arena.

For purposes of illustration, the following chart depicts total losses indexed for inflation -- indemnity costs are indexed by the Consumer Price Index (CPI), and medical costs are indexed by the Consumer Price Index for Medical Care (CPI Medical). However, please note that the Consumer Price Index for Medical Care (CPI Medical) compiled by the US Department of Labor’s Bureau of Labor Statistics (BLS), is not directly applicable to medical costs in workers’ compensation. The BLS CPI Medical reflects increases in the costs of medical procedures for all patients nationwide, not just for workers’ compensation in California.

Source: WCIRB, BLS and DLSR

Data for the chart above was adjusted for inflation using the following indices:

According to the Workers’ Compensation Insurance Rating Bureau of California, the following table shows the total workers’ compensation premium amounts paid by employers compared with the estimated ultimate losses and expenses borne by insurers.

Source: Workers’ Compensation Rating Bureau of California

Since 1994, the number of disabling work injuries has continued to decline even though California’s economy was growing.

This improvement has been ascribed to a number of factors including shifts in the workforce, greater emphasis on work-place safety, continued efforts to combat workers’ compensation fraud, and changes in employer reporting patterns.

Injury and illness lost time rates in all industries have declined in total by 48% between 1988 and 1998. The largest decreases in rates over the decade were seen in the wholesale trade, retail trade, manufacturing, and mining industries with rates of decline of 63%, 56%, 55% and 55% respectively.

Occupational Injuries and Illness Lost Time Rates by Sector

The occupational injury and illness lost time rates in the private sector have declined overall in the same decade, except for a period of leveling off from 1996 to 1997.

Those rates in the State and Local government sectors declined by approximately 40% between 1988 and 1998, leveling off in 1997 and 1998.

Conclusions

California has the largest and most diverse economy in the nation. The California economy is robust and is projected to continue to do very well. Economic growth in California is expected to continue to exceed that of the nation as a whole, reflecting faster population growth and the state’s favorable mix of high-tech industries. The resources appear to be there to provide adequate compensation to those workers who lose their ability to compete in the labor market.

California's industrial injuries and illness rates have declined significantly in all industries and sectors between 1988 and 1998 even though California’s economy was growing. This improvement has been ascribed to a number of factors including shifts in the workforce, greater emphasis on work-place safety, continued efforts to combat workers’ compensation fraud, and changes in employer reporting patterns.

Workers’ compensation benefits have not kept up with inflation. For example, the value of the permanent disability benefit after adjustment for inflation has declined to below 75% of its value in 1984. Consideration should be given to indexing benefits.

Workers’ compensation costs decreased from 1992 through 1995 due in large part to declining claim frequency and the elimination of the minimum rate law governing workers’ compensation premiums.

Increases in workers’ compensation costs from 1995 to 1998 are due in part to the growth of the California workforce. Projected increases in costs from 1999 to 2006 also take into account projected workforce growth. These estimates reflect underlying cost increases calculated by the Workers’ Compensation Insurance Rating Bureau of California (WCIRB) that led WCIRB to recommend increases in the premium rate.

The ratio of workers’ compensation costs to total payroll (and to the Gross State Product and to Personal Income) has dropped significantly during the 1990s. Proposed increases to benefits do not seem to significantly impact the ratio of benefits to total payroll (and to GSP and PI), but such increases could affect certain sectors more than they might others.

Whenever a benefit increase goes into effect, the Commission on Health and Safety and Workers’ Compensation should study the impact of benefit increase on wage loss of workers, time-out of work, the benefit adequacy and equity, costs and utilization. This should include an ongoing evaluation of the adequacy of workers’ compensation benefit levels and recommendations for adjustments as needed.

 

 

Appendix A

Estimating Costs

An estimate of the cost of workers’ compensation as a percent of employer payroll requires the construction of time series data on both insured employer and self-insured employer costs. Because the data are presented as employer costs relative to payroll, the estimates developed here are for the ultimate cost to employers. For insured employers, these costs are represented by net premium (premium after dividends and rebates). For self-insured employers premium data are not available, consequently, employer costs have to be estimated based upon the relationship between direct loss costs (indemnity + medical) and actual employer costs (including administrative costs).

Insured employer costs:

1. For insured employers, historical data on workers’ compensation premiums for 1989-1998 were available from the WCIRB.

2. These numbers were available as costs before dividend/rebates. Data on dividend and rebates were not available by year at the time of this report. Instead, generally accepted estimated averages were used. 11% was used for the period 1989-1994. For 1995 to 1998, 2% was used as the estimate. Consequently, premia for insured employers were reduced by 11% and 2% respectively.

3. For the period 1999-2006 estimates of insured and self-insured ultimate losses provided by the Workers’ Compensation Insurance Rating Bureau were utilized to forecast costs.

Self-insured employer costs

1. Both past and future self-insured employer costs are constructed as a multiple of employer estimated direct loss costs. Time series data on actual direct loss costs for self-insured employers is incompletely and inconsistently reported and unreliable for the calculations here. Consequently, self-insured direct loss costs are estimated as a fraction of insured employers’ direct loss costs for which consistent time series data are available.

2. The market share of self-insured employers was estimated in a separate paper by Frank Neuhauser. The market share estimate for self-insured employers has changed since deregulation. Prior to deregulation, the market share estimate customarily used was 33%. Current estimates place market share at approximately 28%. Market share estimates for the self-insured market are reduced from 33% in 1994 to 28% in 1998 by reducing the market share 1% per year over this period. Direct loss costs for self-insured employers are then

(Insured employer loss costs) * (self-insured market share)/(insured market share)

3. The estimated direct loss costs are then multiplied by a factor which represents the difference between direct loss costs and employer actual costs. In the estimates presented here, we assume that the employer cost for self-insured employers has been a constant multiple of underlying direct losses. The multiple represents the combined effect of investment income and administrative costs. Insured employers’ premium-to-direct loss ratio in the competitive post-deregulation period is probably a close approximation of long-term self-insured actual cost-to-loss cost. Self-insured employers may obtain some savings over insured employers on premium taxes and commissions. Many observers feel, however, that the insurers have priced insurance below cost in the post-deregulation market. Consequently we use the post-deregulation multiple of 1.16 calculated for insured employers to adjust self-insured employers direct loss costs to actual costs.

4. For the period 1999-2006 estimates of insured and self-insured ultimate losses provided by the Workers’ Compensation Insurance Rating Bureau were utilized to forecast costs.

Total employer costs and total wage and salary income

1. Total costs are the combined actual and/or estimated costs for insured and self-insured employers for each calendar year.

2. Total wage and salary income amounts are from actual figures (1989-1999) and projections (2000-2006) from the California Department of Finance (DOF). Projections for 2003-2006 were estimated using the personal income growth estimated by the Legislative Analyst’s Office (LAO) for those years (6.8%).

Industry group estimates

The relative relationship of employer costs between broad industry groups was developed by the WCRIB from 1995 and 1996 policy year data. These relativities are used to estimate employer costs as a percent of payroll for these broad industry categories. While these relativities are based on data for 1995 and 1996, to the extent that the relationship between industries is stable overtime, the relationships are applicable to other years.

It should be noted that the category "Professional and Clerical Services" represents more than half (55%) of all payroll for these industry groups.