What is the “right” premium rate for workers’ compensation?

Most people would agree that workers’ compensation is an important form of social insurance. How should it be administered, what benefits should be offered, and how permanent partial and total disability ought to be calculated are all matters of debate. Every jurisdiction makes up its own rules on workers’ compensation through public policy, legislation, and practice. The unique combination of these public policy positions and how they are administered set the stage but work-related injuries are what drive the financial cost of workers’ compensation in each jurisdiction. And costs are mainly met by premiums paid (almost) exclusively by employers.

Premium levels and the cost of workers’ compensation have been in the news a lot lately. The Oregon Workers’ Compensation Premium Rate Ranking study and the National Academy of Social Insurance’s publication on Workers’ Compensation Benefits, Coverage and Costs are perhaps the highest profile studies to hit the headlines, but there are many jurisdictions where workers’ compensation premium levels have been the focus of attention. Morley Gunderson’s report, The Impact of High Worker's Compensation Premiums on Newfoundland & Labrador, WorkComp Strategies’ Consultation Services on Workers’ Compensation Laws, Processes, and Costs in Tennessee, and the recently announced external review by Paul Petrie on Workers’ Compensation Process for Setting Employer Rate in Manitoba are but a few of the many examples recently garnering attention.

At the basis of all this attention is the fundamental question: “What is the right premium for workers’ compensation?”

As with all insurance, premiums must ultimately cover benefits and administration costs. There are other costs in workers’ compensation that may be included in premiums (reserve funding, second injury funds, uninsured employer protection, insurance guarantee funds, prevention, oversight, appeal bodies, and more) although many jurisdictions pay for these through additional assessments. Premiums may also be adjusted up or down to cover changes in funded status, investment returns, or changes in actuarial valuations. These costs generally pale to the main financial costs of medical, indemnity, rehabilitation, and permanent disability benefits.

In the best possible world, workers and workplaces are safe, healthy, and free from work-related injury, illness, disease, and death. In that world, a workers’ compensation premium at or near zero makes perfect sense. However, in the real world of today, workers and their families pay a huge personal cost for work-related injuries and the total cost of compensation is significant. Without slashing benefits or externalizing costs to others, what is the right workers’ compensation premium?

Perhaps the best way to approach this question is to first look at the extremes, while assuming the true benefit cost is somewhere in between. Suppose workers’ compensation premiums paid by an employer to cover one employee were greater than the payroll cost of that employee for a year —don’t laugh, this sort of premium has existed for certain classifications in certain states in the recent past. What sort of behaviour would we expect this high rate to incentivize?

On the positive side, such high rates may spur technological innovation, training, investment in new plant, improved supervision — all aimed at reducing the costs associated with workplace injuries in this sector. On the negative side; however, the extremely high premiums set up conditions where underreporting of payroll, hours of exposure, and injuries may have extremely high payoffs. Think about it: if I have to pay $100 in premium for every $100 of payroll, then for every $100 of payroll I pay under the table I cut my effective labour cost at least in half.

On the other hand, what if premiums were effectively $0.00 per $100 of payroll? The employer pays nothing, zilch, nada. Some classification are close to that. In B.C., for example, the Interior Design classification’s base premium is $0.10 per $100. On the positive side, there would be no incentive to hide or suppress the report of a workplace injury. We would have, perhaps, a more accurate grasp of what is happening in the workplace. On the flip side, extremely low premiums could lead to under-investment in health and safety. In the extreme case, a very uncaring (and unethical employer) would ask, “why buy safety equipment, invest in safety training, or purchase safer technology if the cost to the employer of workplace injuries is essentially zero? Assuming replacement labour is readily available, why not spend money elsewhere on expansion or other initiatives to raise profit or shareholder value?”

I’ve presented the moral hazards at the extremes to make a point. The “right” workers’ compensation premium is not necessarily the lowest possible one. High variation in competing jurisdictions may be an issue for concern but a relatively low dispersion rate among nearby competitors may simply indicate that the employers and workers in these jurisdictions are facing similar risks and cost structures. The right base premium, in my view, should always be close to the total benefit cost. It's at that point where the investment in safety, health and return-to-work/stay-at-work initiatives will have their greatest impact.

That’s my perspective. I would be interested in hearing yours.