TABLE OF CONTENTS

• I. Introduction
• II. The burden of rising rates and inefficient systems
• III. The burden affects almost all employers
• IV. An overview of workers’ compensation systems
• V. Benefits under the Washington workers’ compensation system
• VI. Cost trends and drivers across the nation and in Washington
• VIII. Efficiency and effectiveness of Washington workers’ compensation system
• XIII. Policy recommendations
• IX. Conclusion

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Reforming Washington’s Workers’ Compensation System

by Allison Demeritt Research Fellow
Paul Guppy – Project Director
March 2002

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I. Introduction

The  phrase "workers' compensation insurance" often elicits vacant stares if not wrinkled brows and frowns from those who hear it.  This complex and important social program, which replaces employer liability for workplace injuries with a public system of financial support to sick and injured workers, is often confusing and tedious for employers, workers, citizens and policymakers alike.  In addition, workers' compensation programs are, by their very nature, fraught with negative emotions: workers interact with them only when they have had the worst of luck and been injured on the job, and policymakers are presented with the unenviable task of striking a cost/benefit balance that is palatable to the employers who fund the system and the workers who are its beneficiaries.  Rarely does either side register much satisfaction.

While it can be tempting to dismiss the insurance program as one that only business owners need worry about, such a reaction is imprudent.  Increasing insurance costs have been linked to large-scale job losses, layoffs and wage cuts, and poor compensation systems have a harmful effect on the economic vitality and business climate of a region.  Any citizen who is concerned with the overall economic well-being of Washington state should regard workers’ compensation insurance as a topic of prime importance.

II. The burden of rising rates and inefficient systems

Although workers’ compensation has received much attention in “crisis” states such as Florida and California, it has only recently become a topic of significance in Washington.  This is partially a result of the recent sharp rate increases adopted after many years of stable or even declining rates.  The Department of Labor and Industries, the state government agency which runs the workers’ compensation program, adopted a 29.4% rate increase in 2003, a 9.8% increase in 2004, and will likely impose a third consecutive increase in 2005.[1]  Annual inflation for these years is around 2%.  Since each year’s rate increase compounds previous ones, the average employer’s costs in 2004 are 42% higher than his 2002 costs.  This is a heavy increase for employers to shoulder in a weak economy and when health care and liability insurance costs are rising rapidly.

Employers, industry groups and workers have all raised concerns surrounding the increasing rates and the efficacy of the current program.  Some employers, for instance, feel they are losing ever increasing amounts of business to “black-market” employers who operate without workers’ compensation insurance.  Although illegal, failing to purchase insurance allows an employer to significantly cut his operational costs and offer customers lower prices than his law-abiding competitors.  Employers also point out that they cannot hire new workers when the combined costs of salaries and insurance is too much to bear, and they are worried about being forced out of the state to operate in more competitive business environments such as Idaho or the South.  Industry groups have spoken out strongly against the state’s administration of the program, insisting that it be reformed for greater efficiency before any further rate increases are imposed.  Even workers have wondered whether the increasing percentage of their paychecks that goes to fund the program is being spent wisely.[2]

III. The burden affects almost all employers

With very few exceptions, workers’ compensation insurance is a mandatory purchase for every business in the state.  While a few large, cash-rich companies may qualify for self-insurance, all others must purchase insurance from an external source.  And since Washington is one of only five states that forbids private insurers from underwriting policies, most employers are forced to purchase insurance from the sole provider: the Department of Labor and Industries.  The Department is therefore in both the government regulatory business (it oversees the safety of workplaces, among other things) and the insurance business.  The Department of Labor and Industries is the third largest agency in state government, with more than 2,600 full-time staff and an annual budget of almost half a billion dollars.[3]  Since the Department is the sole insurer for all businesses, the insurance program it administers is also extremely large: the program provides insurance to over 160,000 employers, covers roughly 1.9 million workers, and collected about $1.2 billion in premiums in 2003.[4]

The cost of purchasing the mandatory compensation insurance is a serious concern for many businesses.  A recent survey by the Washington chapter of the National Federation of Independent Business (conducted before the 2004 rate increase was announced), found that worker’s compensation costs were one of the top three “most serious problems” for small business owners, trailing only the cost and availability of liability and health insurance.[5]

Worker’s compensation insurance costs were identified by these business owners as being significantly more problematic than Business and Occupation taxes, environmental regulations, unemployment insurance taxes, transportation for moving goods and services and hiring quality employees.[6]

IV. An overview of workers’ compensation systems

One of the problems in assessing the adequacy of a particular workers’ compensation program is the lack of agreement on what a “good” system looks like.  In fact, debates over how an “ideal” compensation insurance system should be constituted have existed since the inception of such programs at the beginning of the 20th century.  Rarely do all sides agree on even the most fundamental components of a system, such as the “right” level of cost and benefits.  However, assessment of five main criteria – cost affordability, benefit adequacy, system efficiency and efficacy, customer satisfaction, and injury prevention – give some indication of how a system performs and compares to others of similar nature.

1.  The History and Role of “No-Fault” Workers’ Compensation Programs

 Each state has its own laws and regulations regarding the administration of its workers’ compensation program.  Despite the many differences, all state programs share a fundamental feature – they are “no-fault,” meaning that workers are financially compensated and employers are protected from lawsuits regardless of who is at fault for an injury or illness.  This is also known as the “exclusive remedy” provision: workers are statutorily guaranteed compensation as a remedy, but are supposed to be unable to seek additional indemnity benefits through lawsuits brought against their employers.[7]

The “no-fault” provision was created during the social reform period of the early 20th century.  Organized labor groups began pushing for mandates, and workplace injuries received much attention since they could be financially devastating for workers who faced two types of costs: medical bills and lost wages.  Employers at the time had no legal obligation to compensate workers for either of these monetary losses, and so a worker’s only recourse in the event of an injury was to sue his employer for negligence – an expensive, time-consuming effort that usually resulted in a favorable ruling for the employer.[8]

This does not mean the situation was rosy for employers, though.  Although lawsuits were often decided in their favor, the outcome could not be guaranteed, and employers found negligent by the courts were directed to recompense workers.  Thus, employers existed in a constant state of risk and uncertainty, subject to unpredictable and potentially significant payouts to workers who were successful in court.

A key intent of workers’ compensation systems, then, was to reduce risk and dissatisfaction for both parties, and many states moved quickly to adopt relevant laws.  Wisconsin was the first state to adopt such laws in 1911, and by 1949 all states had enacted similar legislation.[9]   Washington was among the leaders in this movement, adopting its workers’ compensation laws beginning in 1911.

2.  States use one of three different insurance models

Workers’ Compensation Insurance (also called “Industrial Insurance” in Washington state) uses the same basic model as other insurance industries.  In this model people or companies exposed to similar types of risk band together to spread the risk and resulting exposure costs across the group as a whole.  A well-known example is the auto insurance industry, in which all drivers pay a premium to insure themselves against the potentially much larger costs that an accident might produce.

Workers’ compensation insurance in Washington operates the same way.  Employers are required to pay a premium to insure their workers against the costs of on-the-job injuries and illnesses.  The state uses the collected sums to cover the medical costs and lost wages of the small number of workers who sustain an injury in any given year.  As a result, the cost of worker injuries is spread throughout the system, and no one company or worker should be financially devastated by a single accident.  All states except Texas require employers to provide workers’ compensation insurance for their employees.[10]

Each state has its own specific set of laws and manages its own workers’ compensation system.[11]  States employ different insurance models, and three distinct types exist in the United States: a fully private model, a fully public model, and a “hybrid” model in which private insurers and a publicly-run program operate in the same state.

The fully private and hybrid public/private models are by far the most common.  Forty-five states use one of the two, meaning that employers in these states have many insurers from which to choose.  Twenty-six of these 45 states have totally private systems in which insurance companies compete against each other for the business of employers.  The remaining nineteen of the forty-five use the “hybrid”, or “three-way” system, in which the state operates a program (often called a “competitive state fund”) that competes with the private insurers in the state.  Both models result in a large number of choices for employers.  Oregon, for instance, has authorized more than 430 insurance providers, and more than 200 of them underwrote policies in 2001.[12]  Washington’s other neighbor, Idaho, has more than 200 active workers’ compensation insurance providers.[13]

The remaining five states, including Washington, use the totally public model.  This model renders private insurance illegal and forces employers to purchase insurance from a state-run monopoly fund.

The table on the next page shows the type of workers’ compensation model used in each state, based on United States Department of Labor information as of January 1, 2003.    

3.  Current research does not conclusively point to a “best” model

Before embarking on an in-depth analysis of the Washington state system, it is worth noting that current research does not yield conclusive answers as to which of the three insurance models most consistently achieves all defined objectives.  Few researchers have focused on creating equitable comparisons between states, and fewer still have attempted to do so for states using different insurance models.  In what is probably the most academic and thorough research study spanning all 50 states, three national experts in workers’ compensation, Terry Thomason, Timothy Schmidle and John Burton, Jr., noted that a recurrent theme of their study was that programs are complex and achieving the defined objectives is inherently “counter-productive: achieving one objective often interferes with reaching one or more of the remaining goals.”[14]  This is especially true for the interplay of cost and benefits, for instance, because any increase in benefits must be supported and paid for by a proportional increase in costs to employers and workers. 

Furthermore, the authors of that study concluded that it is “likely that no empirical study will ever surmount all of these problems and completely dispose of the issue once and for all.”[15]  Policymakers must therefore carefully examine the system in place in their own states and encourage reforms that contain costs, promote choice for employers and improve service for injured workers.

4.  Self-insurance only allowed for government and large companies

Many states, including Washington, allow qualified employers to opt out of the traditional risk-sharing programs.  These companies are referred to as “self-insurers,” and they pay injured employees the legally-required workers’ compensation benefits directly from their own financial resources.  These employers bear, therefore, the full risk and cost of injuries occurring in their workplaces.

In Washington only about 400 employers, out of more than 200,000, are able to qualify for self-insurance.[16]  Although about 30% of the workforce in Washington (some 800,000 workers) is covered by a self-insurance plan instead of the state’s risk-sharing plan, this figure is misleading since it includes federal and local public workers whose employers take advantage of special provisions not available to private-sector employers.[17]  All non-public employers in Washington wishing to self-insure must first apply to and be approved by the Department of Labor and Industries.  This is no small undertaking. Generally, employers must fulfill five main requirements to be considered eligible for self-insurance.  They must:[18]

Convince the assigned Labor and Industries representative that they have sufficient liquid assets to pay injured workers statutorily-guaranteed benefits.[19]

Have a net worth of $5,000,000 or more.

Demonstrate the existence of a safety program with a proven record of accident prevention.

Establish a qualified administrative organization to manage all industrial insurance matters and ensure an adequate claims management process.

Be able to provide three years of historical financial data.

Self-insurance is clearly not a practical option for most employers.  Dave Kaplan, executive director of the Washington Self Insurers Association, has said that self-insurance really doesn’t become a viable option for businesses until they pay $150,000 a year in premiums, far more than most small businesses owe.[20]  As the state acknowledges, self-insurance is a program for only “the largest, most financially secure companies in the state and governmental entities.”[21]

Thirty-five states allow employers to take advantage of the self-insurance option by allowing small enterprises to self-insure as a group.  Washington is not one of them.  In Washington group self-insurance is so limited as to be of no practical use for businesses.  Only a few governmental entities, such as hospital districts, school districts, and educational districts, are allowed to form self-insurance groups.[22]  It is particularly ironic that the Department defends the existing restrictive system for private employers while supporting special exceptions which allow government organizations to opt out of the program.

5.  Who is covered

Almost all workers in Washington state, from clerical workers and bank executives to baristas and retail salespeople, are covered by industrial insurance laws through either the state fund or a self-insurance program.[23]  Overall, it is estimated that 90 to 97 percent of the American workforce is covered by a workers’ compensation program.[24]  In Washington and most other states, people who “employ” others temporarily for services such as house cleaning, garden work, appliance repair and newspaper delivery are not required to provide compensation insurance for the workers they hire.[25]  But almost every other type of worker who sustains an injury or occupational illness “in the course of employment”[26] is covered and eligible to receive benefits.[27]  Moreover, the injury or illness need not be solely the result of work, since job-related aggravation of a pre-existing condition is compensable in Washington.[28]

In fact, Washington has more inclusive coverage laws than many other states, which often exempt key groups to help reduce business costs to employers.  Fourteen states, for instance, exempt employers with fewer than 3 or 5 employees from purchasing insurance, and more than half have some special exemptions for agricultural workers. Washington does not have any numerical exemptions and the only agricultural exemption is for dependents under age 21 who live and work on a family farm.[29]

6.  Types of benefits provided under workers’ compensation programs

The benefits provided to injured workers are laid out in each state’s law and fall into two main categories:

Payment of all medical care and rehabilitation fees;[30]

Disability or “time-loss” compensation (includes death or “fatal” compensation). 

Medical care and rehabilitation benefits pay the fees assessed by medical service providers for treating a worker and returning him to full health.  Generally, workers’ compensation programs cover all costs that result from treating injuries, including hospital costs, surgical costs and pharmaceutical expenses.  Rehabilitation benefits are not allowed in all cases.  In Washington, the Department of Labor and Industries determines which claimants should receive rehabilitation services.  The second type of benefit, disability compensation, is a cash benefit paid to workers who lose their wages for more than three days as a result of injury.  The benefit levels for this type of compensation are set by each state government, and, as a result, vary widely.

 Disability compensation is classified according to the severity and duration of the injury.  There are three main categories: total temporary disability (TTD), permanent partial disability (PPD), and total permanent disability (TPD, also called a “pension benefit”).   A fourth type of benefit called fatal or “death” compensation is paid to the dependents of a worker killed on the job.  TTD benefits are the most common, although PPD benefits account for the greatest share of benefit costs. TPD and fatal compensation cases are not very common.

The duration of benefit payments is quite standard throughout the country.  Washington pays Total Disability benefits, both permanent and temporary, for the duration of the disability.  About 30 other states have the same policy.  Approximately 20 states apply some sort of time limit, generally ranging from 100 to 500 weeks, on the receipt of benefits.

The amount of benefits paid, on the other hand, varies greatly depending on the state.  Benefits are usually a percentage of a worker’s pre-injury wages.  Washington uses this system for TTD and PTD benefits, but the state’s PPD benefits are lump sum payments that correspond to the type and severity of a particular injury.  Complete loss of hearing in both ears, for example, is compensated with a single $43,200 payment and the amputation of a little finger is compensated with a $2,430 payment.[31]  Although Washington’s PPD calculations differ in method from other states,  the overall level of Washington’s PPD benefits appears to be relatively in line with those in the rest of the country.

V. Benefits under the Washington workers’ compensation system

1.  Generosity of benefits in Washington state

As mentioned, benefits fall into two main categories: medical and time-loss.  Since medical costs are generally fully covered in all states, the question of generosity pertains mainly to the time-loss portion of benefit payments that have been established by state legislatures.

Time-loss benefits differ markedly among states, and by several measures.  Washington has one of the most generous programs in the nation.  A 1998 audit commissioned by the Joint Legislative Audit and Review Committee (JLARC) – a bipartisan committee composed of senators and representatives – found that benefits received by Washington claimants were “substantially above the average.”[32]  Workers in other jurisdictions received an average of $10,988 per claim, but workers in Washington received on average 21% more at $13,109 per claim.[33]

Moreover, the gap between the level of benefits in Washington and other states is growing.  The following chart illustrates the high growth rate of Washington’s cash benefits compared to that of other states.  Washington’s benefits surpassed the nationwide 75% percentile mark during the late 1980s and have remained there since.  The “sawtooth” pattern (see chart) reflects legislative enactments that have steadily raised PPD benefit levels.[34]

Permanent and temporary total disability payments are calculated as a percentage of a worker’s pre-injury wages.  The reasons for this are two-fold.  First, replacing wages in full would add extraordinary cost to the system.  Sustainable workers’ compensation systems must keep rates affordable, a standard generally taken to mean that costs are not so high as to bring about “serious adverse consequences such as loss of jobs.”[35]  Second, common sense indicates that reduced pay provides workers with an incentive to participate actively in their own recovery and re-enter the workforce without unnecessary delays.  Replacing wages at 100% of pre-injury levels would almost certainly cause the number and average length of claims to rise sharply: under such a system, workers would receive the same amount of money whether they worked or not.  Also, workers’ compensation benefits are not subject to federal income, Social Security or Medicare taxes.[36]

Time-loss benefits paid to injured workers in Washington range from 60% to 75% of the worker’s pre-injury wages, depending on the worker’s marital status and number of dependent children.  This calculation of benefits is unique and very complex.  Every other state simply uses a flat replacement rate, generally 66 2/3%, that applies to all workers, regardless of family status.

Washington’s workers’ compensation system replaces injured lost wages in the following percentages:

As the table illustrates, replacement rates in Washington often exceed the 66 2/3% flat rate used in other states.

Benefits are also capped  to ensure that workers with higher than average salaries do not receive more in benefits than most people in the state receive in wages.  Most states set maximum benefits equal to 100% of the average weekly wage for the state.  Washington, however, allows benefits to run as high as 122% of the state’s average wage as a result of cap increases adopted in the mid-1990s.[38]

The following table shows:  1) how each state’s maximum benefit level compares to the average worker’s wage, and 2) the dollar amount of maximum weekly time-loss benefits receivable in each state.

Source: “State workers’ compensation laws in effect on January 1, 2002 compared with the 19 essential recommendations of the national commission on state workmen’s compensation laws,” U.S. Department of Labor Standards Employment Administration, Office of Workers’ Compensation Programs, Division of Planning, Policies and Standards, Branch of Planning, Policy and Review, data as of January 1, 2003.

Washington’s use of a high allowable percentage means injured workers receive more money per week here than they would in all but five or six other states.  In 1999, the cap yielded a maximum weekly time-loss payout of $870 a week, or more than $45,000 a year, in comparison to the national average of  $688 a week.  Certainly, a portion of this difference is attributable to the higher-than-average cost of living in Washington as suggested by the average weekly wages in the table above.  But were Washington simply to reinstate a 100% cap to be more in line with other states, the system would save approximately $157 per week per claimant receiving benefits at the maximum level.  The Department has estimated that approximately one to two percent of the annual 25,000 claimants are granted benefits at the maximum level, meaning that total savings to the system would be approximately $59,000 per week.[39]  And, as noted, every workers’ compensation dollar is more valuable than a regular wage dollar because state benefits are not subject to federal income, Social Security and Medicare taxes.

State benefit levels are sometimes compared to “ideal” benefit levels recommended by various organizations, such as the National Commission on State Workmen’s Compensation Laws and the Council of State Governments.  Activists who believe injured workers are not receiving enough benefits say that few, if any, states are living up to the recommendations in these reports.  While this is technically true, Washington’s high level of benefits approaches, and in some cases exceeds, the “ideal” level promoted by activists.  Also, it is important to remember that in practice, adding benefits equates to adding costs.  And these higher incremental costs may be impractical for businesses to sustain.

The National Commission’s publication in 1972, for example, originally caused a “flurry of activity….which resulted in higher benefits,” but by the early 1990s, “an almost inevitable backlash against higher costs” occurred, causing widespread reforms to be enacted.[40]  The Thomason study estimated that adoption of the National Council’s “essential recommendations” would raise rates by 15% to 20%, and that implementing the Council of State Government’s revised Model Act, published in 1974, would be even more damaging.  The researchers found that implementation of the Model Act would likely raise rates by 60% to 75% while simultaneously widening the cost differences among states.[41]  This latter result, they noted, was particularly troubling due to its implications for firm location decisions.  As the “gap between high and low-cost states” grows, there are “adverse consequences for employment in those high-cost states.”[42]

2.  Recent judicial decisions have expanded benefits and increased costs of Washington’s system

Several recent state court cases have re-interpreted statutory guidelines for calculating benefits, thereby increasing benefit payouts and threatening to drastically increase employers’ premiums to support these payouts.  Court decisions that imposed some of the highest costs are:

• Cockle v. The Department of Labor and Industries (2001) in which the state Supreme Court reversed 30 years of benefit law by ruling that benefits such as health insurance must be included in the calculation of a worker’s benefits.[43]  The decision leaves unanswered many questions regarding which other benefits must be included in wage calculations and resulted in the Department requesting a $2.4 million budget increase simply to administer the complex and ambiguous decision.[44]  It has been estimated that this decision costs employers $40 million annually in workers’ compensation funds.[45]

  Avundes  v. Department of Labor and Industries (2000) in which the state Supreme Court decided that the earnings of a seasonal worker could be based on the worker's earnings at the time of injury instead of his historic annual earnings.[46]  This decision could greatly increase the benefits paid to workers in seasonal industries and discourage their return to work.  Senator Jim Honeyford (R-Sunnyside) pointed out that the “Avundes decision requires employers to pay many seasonal workers far more in benefits than they ever earned working.”[47]

• Birklid v. The Boeing Company (1995) which increased the potential liability of employers by expanding the definition of “deliberate intention to injure” in a way that makes it easier for workers to sue their employers.  The decision undermines the social purpose of workers’ compensation by eroding the protection employers are supposed to have against costly lawsuits in return for paying into a state-mandated fund.[48]

Even before many of these cases were decided in the courts, the Joint Legislative Audit and Review Committee (JLARC) recommended that the state find a way to “clarify and simplify” the calculation of benefits to reduce costs in the system.[49]  Unfortunately, recent court decisions have only added to the system’s complexity and cost.  Legislation to clarify wage calculation was introduced in both the 2003 and 2004 sessions, but the issue remains unresolved.

3.  Costs in the Washington workers’ compensation system

Cost is one of the most difficult aspects of workers’ compensation systems to assess.  First, involved parties rarely agree on a definition of “acceptable” costs.  Second, each state has a unique industrial composition that drives underlying costs in a unique way, so meaningful comparisons between states are difficult.  Third, the theoretical and empirical research conducted to date is “limited, inconsistent and inconclusive” and does not provide any specific conclusions regarding the costs of public versus private systems.[50]  Finally, comprehensive studies tend to focus on average costs across all industrial classifications within a state, but employers are really only concerned about the rates that apply to their particular business.  Averages will continue to be developed as a measure of a state’s overall competitiveness, but their usefulness in this regard is dubious and they should not be invoked to describe a specific employer’s true circumstances.

On the theoretical front, arguments on both sides of the private versus public debate abound.  Proponents of state monopoly workers’ compensation say public systems are cheaper because they eliminate some costs associated with the private sector such as marketing expenses and profits.  Proponents of free market systems, on the other hand, assert that the lack of competition and profit discipline in public monopoly systems creates top-heavy bureaucracy, administrative inefficiency and over usage of benefits because the eligibility and duration of claims are not stringently evaluated.  One indicator that points to greater efficiency among private companies is that Washington firms that self-insure experience lower claims costs than the state fund when managing similar cases.

Furthermore, researchers have pointed out that many of the well-exposed costs in private systems are simply hidden and unaccounted for in public systems.[51]  States with private insurance systems receive income tax revenue and other state and local tax revenue from insurance carriers, while states with monopoly funds do not.  Monopoly-fund states must therefore increase the tax burden on the remaining employer base to support the same overall level of government services.  Prominent researchers have concluded that the existence of hidden costs means rates for monopoly state funds are “probably under-stated relative to private-carrier rates,” but that ascertaining and quantifying these hidden costs is “extremely problematic.”[52]

The lack of conclusive answers on the theoretical front is matched by a paucity of reliable data on the empirical front.  Most empirical cost analyses attempt to calculate an average rate that spans all industrial classifications for each state and then rank the states accordingly in a single list to determine which are “relatively expensive” and which are “relatively cheap” or “competitive.”  Calculating comparable averages is inherently problematic, though, because each state is a closed system with its own unique set of several variables.  These variable include:

Industrial composition (states with a high percentage of jobs in “dangerous” industries, such as mining, necessarily have higher rates than states with a preponderance of jobs in “safe” industries, even if all other factors are equal).

Statutory provisions (benefit levels and limitations).

Wage levels and distribution systems.

Health care delivery systems and costs.

Attorney activity and lawsuits.

Rate setting practices.

All of these factors and many more can influence costs in unpredictable and immeasurable ways, making it extremely difficult to find a common basis for rate calculation that allows for valid comparisons among states.  The difficulty of comparing Washington’s rates with those of other states has also been exacerbated by the fact that Washington is the only state in the country that bases premium rates on hours worked instead of payroll.  The reliability of all published rankings is lessened by this idiosyncrasy.[53]

This is not to say that attempts have not been made.  They have, and several analyses enjoy a significant amount of popularity and press coverage, so it is worth looking at a few of these in brief.  One of the longest running analyses is conducted yearly by the National Foundation for Unemployment Compensation and Workers’ Compensation (UWC).  This analysis ranks states by two separate statistics: “Cost per Covered Employee” and “Cost per $100 of Payroll.”  In the 2003 report (data from 2001), Washington was ranked as the fourth most expensive state in both measures, with an average cost of $625 per worker per year (almost twice the national average of $350 per worker per year) and an average cost of $1.68 for every $100 of payroll covered by the system (compared to the national average of $1.08 per $100 of payroll).[54]

There are, however, many inadequacies that limit the usefulness of these calculations and rankings:[55]

The calculations include only the portion of benefit payments made in a calendar year.  In reality, benefit payments for a single injury may be paid over several years.

• The data do not control for differences in states’ industrial compositions.

• The data are based on benefits paid to workers rather than the cost to employers, and so some costs, such as administrative expenses, are not captured by the analysis. 

A second oft-cited report is the “Oregon Workers’ Compensation Premium Rate Ranking” published bi-annually by the Oregon State Department of Consumer and Business Services.  While the UWC report ranks Washington among the five most expensive states, the 2002 Oregon report ranks Washington among the five cheapest, making it especially popular with Washington state officials.  The Oregon report attempts to improve on the UWC data in several ways and has gained a level of acceptance within the industry, but its methodologies create a similar set of problems:

• All states’ average rates are calculated using the Oregon economy as a base, and the 50 code classes used (of 450 total) represent only 67% of Oregon’s payroll and only 62% of losses.[56]  The more a state’s industrial composition and loss profile differs from Oregon’s, the more its calculated rate misrepresents true costs in that state.

• The calculated “average” rates do not include many rate-modifying factors such as experience ratings, deductibles, premium discounts, dividends and participation in retrospective rating programs.

• The Washington rate may be understated as a result of the method used to convert Washington’s “hourly rates” into the “payroll rates” used by all other states.[57]

Thus, rankings that compare states provide only limited insight into cost affordability.  An alternative way to evaluate costs is to examine what those who pay get for their dollars.  Just about any system could lower costs by dropping services to a minimum level, but this would not benefit employers or workers or fulfill the objectives of the program.  Successful workers’ compensation programs must fulfill the objectives its funders expect within a price range they feel is affordable.

In summary, many employers feel the cost of workers’ compensation in Washington is no longer affordable, and statistics also suggest that Washingtonians may receive a lower level of service from their government-run program than residents in other states receive from programs based on private competition.  While “service” can be a difficult concept to quantify, the historically low (though improving) rates of customer satisfaction and disproportionately high injury rates in our state suggest that Washington’s monopoly program may be providing an insufficient level of service for the fees it charges.[58]

4.  Cost differentials between states

This is not to say Washington should raise rates even higher to make more money available for services, rather policymakers should ensure that current funds are being spent wisely.  In addition, it is in the state’s best interest to ensure that Washington’s rates do not greatly exceed those in other states: large cost differentials between states can produce strong disincentives for businesses to locate in the more expensive states.  Policymakers in California, for example, are struggling to keep businesses in their state, after several years of skyrocketing rates.

The extent of cost differentials is well highlighted in The Costco Wholesale Corporation’s 2003 financial report.  On March 5, 2003, the company announced that its second-quarter earnings results had been hurt by the need to set aside $26 million to pay for increased workers’ compensation costs, particularly in California.  Richard Galanti, Costco Wholesale’s Chief Financial Officer, called the rising cost trend in California “alarming,” stating that even though only one-third of the company’s workforce is employed in California, two-thirds of the company’s compensation costs are generated there.[59]  Costco spends an average of $26,000 per claim nationwide, but it spends an astounding $70,000 per claim in California.[60]

The California workers’ compensation system is generally regarded as one of the most expensive in the nation.  As costs have risen in recent years, the issue has moved to the forefront of the state’s political agenda.  The cost increases are due in part to an expansion of benefits: in 2002, the legislature adopted a benefit increase that raised maximum benefits from $490 a week to $602 a week.[61]  ( Washington’s maximum benefit, in comparison, is even higher.)  California’s high costs have also been attributed in part to the prevalence of litigation – in 2002 California employers and insurers needed to hire lawyers to handle 29% of claims involving employees who missed a week of work, and California lawyers pocketed $226 million in fees that year from workers’ compensation cases.[62]  These are, indeed, alarmingly high additional costs for a system that is supposed to have the elimination of litigious court battles and the standardization of benefits at its core.  While Washington is not yet facing the same level of crisis, California’s experience serves as a warning for states like Washington that have seen a broad expansion of benefits and increased court involvement.

VI. Cost trends and drivers across the nation and in Washington

Nationally, the real cost of worker’s compensation to employers has oscillated over time, although the overall trend has been upward.  In the mid-1950s, private sector employees paid an average 0.5% of payroll for workers’ compensation.  By 1970, the figure was 1%, by 1987 it was 2%, and in 1994 it was 2.9%.  The figure dropped to 2.0% in 2000, but has been rising again since then.[63]  It is particularly interesting that costs have continued to rise even while injury and illness rates have declined, as the following chart indicates.[64]  The American workplace is safer today than it ever has been, yet the cost of workers’ compensation is still going up.

Several factors are contributing to workers’ compensation premium increases across the nation: 1) rising medical costs; 2) an increasing number of claimants using the courts and 3) falling investment returns.

Rising medical costs are a result of several key factors: [65]

A broader definition of “workplace injury.”

An increased number of medical visits made per claimant.  Although the frequency of claims has fallen almost 40% since 1990 and 27% since 1997, the number of medical visits per claim has increased steadily.

Rising prescription drug costs.

Increasing medical treatment costs. The chart below illustrates how the medical costs of workers’ compensation claims have grown much more rapidly than medical costs in general as measured by the medical Consumer Price Index (CPI).  For the period 1995 - 2002, lost-time-claim medical costs increased 82%, while the medical CPI increased just 36%.

Source: National Council on Compensation Insurance (NCCI), Issues Report 2003

The investment climate is a final factor worth highlighting because it has been implicated in Washington’s rate increases.  Insurance companies often rely on investment returns for profitability.  The premiums collected can amount to sums slightly less than the amounts that must be paid out in benefits, and investment income from assets can make up the difference.  Assets in Washington’s monopoly workers’ compensation fund, for instance, generated about $500 million in both 1999 and 2000, an amount equivalent to about half the amount of premiums collected from employers in each of those years.[66]

While the Department of Labor and Industries’ financial statements do not show precipitous drops in investment income for the two-year period ending June 2002, they do record some impressive capital losses.  Whereas the fund yielded about $330 million in net realized equity gains for the two year period ending June 2000, it recorded over $400 million in equity losses for the two year period ending June 2002.[67]

Investment returns are separate from many of the other issues at hand, however, such as the adequacy of benefits and the efficiency of the system.  While it is true that investment losses have altered the Department’s financial earnings in recent years, this phenomenon is not a substantive reason for employers and workers to blindly accept rate increases handed down by the Department.  The extraordinary investment earnings of the late 1990s may simply have masked the underlying financial weaknesses in the system.  The recent steep rate increases must be assessed in the context of actual services and benefits provided, not on how poorly the Department’s investment portfolio has performed.

Injury Prevention under Washington Workers’ Compensation System

One key measure of workers’ compensation systems is how well they keep accidents and injuries from happening in the first place.  A reduced number of injuries benefits everyone.  Fewer injuries mean less physical, emotional and financial stress for workers and lower costs and improved productivity for employers.  Of course, injuries and illnesses can never be completely eliminated, but this fact should not diminish the importance of a system’s ability to reduce injuries to a minimum.

The Department of Labor and Industries has historically done a very poor job of reducing injuries in comparison to other states.  Only three other states have higher overall injury rates. While some of this could be due to a higher-than-average concentration of “dangerous” jobs in Washington, the incidence rate of occupational injuries and illnesses is actually higher across every industrial category.  In other words, any type of worker in any job is more likely on average to be injured on the job in Washington than in most other states.  Recent research also suggests that Washington is not an anomaly.  States with monopoly funds have on average more injuries than states which allow private insurers to sell workers’ compensation coverage.[68]

The table below illustrates how Washington workers are getting injured more often than their counterparts in other states.  Injuries in Washington are more prevalent in every major industrial category.  Washington workers sustained, on average, 37% more injuries than the average U.S. worker in 2001 and 38% more injuries in 2002.

Rate of non-fatal injuries in Washington compared to the national average, 2001

	Total Non-Fatal Injuries & Illnesses per 100 workers		Percent Difference
Job Category	National	Washington
Private Industry Overall	5.7	7.8	37%
Agriculture, forestry, and fishing	7.3	9.9	36%
Mining	4	6.1	53%
Construction	7.9	13.2	67%
Manufacturing	8.1	10.4	28%
Transportation & public utilities	6.9	8.9	29%
Wholesale and retail trade	5.6	7.7	38%
Finance, insurance, real estate	1.8	2	11%
Services	4.6	5.7	24%

Source: U.S. Department of Labor, Bureau of Labor Statistics. Data shown is for 2001.

This phenomenon is a troubling one.  The high injury rates are almost certainly a function of two factors: insufficient safety services and/or a high number of fraudulent claims.  As mentioned, the Department’s safety consulting and compliance units may be too closely linked to be effective.  In addition, the Department has a much weaker incentive than private insurers to work cooperatively with employers to improve safety.  The Department can raise rates at will to cover costs, but private insurers must contain costs to keep their premiums competitive with the rest of the market.  As a result, private insurers are extremely vigilant about tracking down the causes of injuries and working with employers to improve dangerous environments.  Private insurers are in the business of mitigating risk, and the best way to reduce risk is to improve safety.

It is important to note that Washington’s high injury rates do not signify the need for expanding burdensome safety regulations.  Rather, they suggest that Washington would benefit from the kind of competitive system in place and working effectively in other states.  States that have reduced injuries to equal or below the national average do not have expansive sets of regulations:  they simply allow normal market forces and economic incentives to shape the safety improvement efforts of insurers and employers.

VII. Efficiency and effectiveness of Washington workers’ compensation system

A third key measure by which workers’ compensation systems can be evaluated is efficiency:  How well does a particular system process claims, resolve disputes and dispense benefits compared to other systems?  Does the system appear to do a good job of managing administrative costs?  Does it provide an equivalent level of service to other, comparable systems for the costs it incurs?  Is it focused on the right goals and outcomes?

This aspect of workers’ compensation systems is difficult to measure since there are qualitative as well as quantitative components, but some key data points and the testimonies from the audit team and employers suggest that the Washington state system is “not as effective nor as efficient” as that found in other states.[69]  In fact, the (Joint Legislative Audit and Review Committee (JLARC) audit team which reviewed the system found that “everything in the Washington state system is more formal and more process oriented” than in private systems.[70]  The team’s assessment of the Department’s efficiency in fulfilling some of its key roles is disheartening:

1.  Premium rate setting creates cross-subsidies and raises problems of fairness within the system

Workers’ compensation systems strive to set fair rates for employers that correlate premiums with expected (and, where possible) historical losses.  Two processes are employed to achieve this goal.  First, employers are classified into one of over 300 main and 1200 sub classification codes (or SICs, Standard Industrial Classifications) that express the expected “hazard” and consequent losses of employers engaged in a particular industry.  All employers in a given code thus share the same “base rate” premium, or workers’ compensation tax.  This first classification step results in a vastly differentiated spectrum of premiums.  In 2003, for instance, some logging jobs carried a rate of more than $10.00 an hour, but the rate for clerical workers and executive officers was 11 cents an hour.[71]

The second classification step applies to medium and large employers with three years of history and further differentiates rates for employers by adjusting the “base rate” with an “experience rating” which expresses the employers’ actual average loss experience compared to others in the same classification.  Employers with a relatively high loss experience for their code pay higher tax rates while those with less loss experience are rewarded with lower rates.  The experience rating is thus also meant to function as an incentive for employers to continuously improve workplace safety.

The audit team determined that the classification and experience rating practices used by the state system do not function as well as they should.  In a free market environment, the rigors of competition require insurers to determine the most accurate rates for each classification since employers will seek out the lowest rates.  The discipline of the market provides managers with current, accurate and detailed information about how to set rates within the system.  Managers in the Department of Labor and Industries, though, are not necessarily concerned with fairness or accuracy since employers have no practical choice but to accept the rates ordained by the Department.  As a result, administrative ease triumphs over fairness and accuracy, allowing several types of cross-subsidies within the program.  Cross-subsidies involve revenue from one program activity being used to pay for another.  They are clearly unfair to employers, and they undermine the public policy goals of the system by weakening the direct relationship between losses and rates, which in turn weakens safety incentives.

The audit team identified many different cross-subsidies in the Washington system.  One such subsidy results from the arbitrary division of serious and non-serious claims for the purpose of rate assignment.  Since the basis for these decisions had “no statistical foundation,” the team felt there was no certainty that costs were fairly distributed.[72]

2.  Consulting services create a conflict of interest

An inherent conflict of interest exists as a result of the Department’s oversight of two worker safety services that are normally separated: consultation and compliance.  Consultation services are supposed to be a confidential, voluntary means for employers to get help making their workplaces safer without fear of retribution from regulators.  Compliance and enforcement services are meant to enforce the worker safety and health law and penalize employers who do not comply.

In Washington, both safety consulting and compliance functions are carried out by the Department of Labor and Industries under the oversight of the same director, and many employers worry that asking for consultation se