Expert Commentary

Achieving Cost Reductions through Workers Compensation Reform

Mick McGavin provides a list of issues that employers should consider when there is an opportunity to reform their state's workers compensation system.

Workers Compensation Issues
December 2010

Workers compensation systems are very dynamic and can change significantly from year to year. In some instances the benefits paid to injured workers become inadequate over time because maximum benefit rates have not kept pace with inflation or eligibility rules are stretched to unanticipated limits by court decisions. A workers compensation system can reach the point where it is totally out of balance because it provides either inadequate benefits to injured employees or unbearable costs for employers who must pay the bill. In some instances, workers compensation systems produce both inadequate benefits and extremely high costs at the same time.

Each year, a number of states review their workers compensation legislation and regulations and make an attempt to restore balance to the system. The process is commonly referred to as "reform." Frequently the goal of reform is to increase benefits for injured workers while making technical corrections designed to reduce fraud or waste. The reduced costs resulting from technical corrections are expected to partially offset the higher costs resulting from benefit increases.

Employers and insurer representatives are usually asked to participate in the reform process. This article provides a list of issues that employers should consider when there is an opportunity to reform their state's workers compensation system.

No Indexing of Maximum Benefit Rate

Most states began indexing maximum indemnity benefits rates several years ago and have lost one of the main drivers for keeping balance in the workers compensation system. Indexing means that the maximum benefit rate is tied to a statistical number, typically the state average weekly wage (SAWW). In most cases, the maximum benefit rates for temporary total disability benefits, temporary partial, and permanent partial are all set at a percentage of the SAWW. If the SAWW increases, maximum benefit rates increases as well.

The problem with indexed benefits is that they eliminate one of the greatest drivers for legislatures to review workers compensation statutes. When benefits could only increase as part of a legislative package, there was an impetus to periodically review the workers compensation statute to make sure benefits kept pace with inflation. The need for benefit rate increases also served as an incentive for employee groups, such as labor unions, to compromise and agree to changes that cured abuses and tightened eligibility requirements.

Once benefits are indexed, they automatically keep pace with inflation and there is little incentive for employee groups to agree to reform and there is little for employer groups to offer in exchange for cost-cutting changes to eligibility standards. Because of this, employers should oppose indexing of benefits so that benefits can only be increased as part of a broader reform effort that looks at all aspects of the workers compensation system.

Develop Rational Benefit Calculations and Reasonable Minimums

Benefit calculations and minimum benefit rates can produce irrational results that make cases difficult and expensive to resolve. One problem is with seasonal employees where the average weekly wage (AWW) of an injured worker can be inflated. The average weekly wage is important because the benefit rate is set at a percentage of the AWW, usually 66 2/3 percent.

A typical problem is that the employee's AWW is influenced by the business cycle. For instance, an employee's AWW may be based on wages in the 13 weeks preceding his or her injury. If so, an employee injured right at the end of the employer's busy season, where significant overtime was worked, would have an abnormally high average weekly wage and an abnormally high benefit. The employee's workers compensation benefit could be more than he or she would earn during a normal workweek outside the employer's peak season. If so, the inflated rate would clearly create a disincentive for the employee to return to work.

Minimum benefit rates can cause a similar problem. In some states the minimum benefit rate is more than most part time employees earn in a typical week. Under this rule, an injured part-time employee would receive more in workers compensation benefits, which are tax-free, than he or she would earn in taxable income if on the job. Obviously, this too creates a disincentive to return to work.

In addition to the disincentives, irrational AWW calculations cause a fairness issue. For instance, two employees injured while working the same job for the same pay may be eligible for dramatically different compensation rates depending on when during the year they are injured. If one was injured before the busy season, his or her benefit rate would be much lower than the rate paid to an employee injured just after the busy season.

In the case of part-time employees, it is also unfair for injured workers to collect tax-free "wage replacement" benefits that exceed the taxable earnings of fellow employees who were not injured and remain on the job.

AWW calculations and benefit rates should not be set so that they result in unreasonable compensation for some employees and inequities in the system. AWW calculations should be based on actual annual earnings for a 52-week period, and there should be no minimum compensation rates.

Employer Medical Control

Control of medical care is an important cost control tool for employers and their insurers. Medical control allows the employer or its insurer to select the medical providers that will treat injured workers.

A few states allow employers to fully control care for the life of a claim. Some allow employers total control, but for a limited period of time. In some, employers can limit care to a "panel" of providers, which is a list of providers chosen by the employer. The majority of states allow the employee complete freedom to choose medical providers.

Medical control is important because it allows the employer to provide quality care from a provider experienced in treating occupational injuries. The employer can familiarize the provider with its work site, the exposures in the work site, and in the return-to-work process. This facilitates the fastest possible recovery and return to work.

Medical control is an advantage that employers should seek to gain, retain, or improve as part of reform efforts. As a practical matter, absolute control may be difficult to win. If a compromise is required, a time limit is preferable to a panel. The problem with panels is that it is often difficult to find enough quality providers to fill a panel. It is also difficult to keep all the providers on a panel up to date on exposures and return-to-work practices. Moreover, in smaller cities a panel may need to include almost every provider in the vicinity.

Avoid Mandates for Managed Medical Care

Some states have implemented mandates for some forms of managed medical care at a time when many employers are beginning to question its effectiveness and are becoming more reluctant to use it. Some states now require that a case manager be assigned to every case that meets certain guidelines, such as 60 days of lost time. Others require a managed care nurse to review all requests for medical services.

From an employer's or insurer's perspective, there is no need for such a mandate because managed care can already be used in any situation where it adds value. If an onsite nurse case manager is needed, or if a medical professional is needed to review a request for service, one can be assigned. Therefore, the mandate only serves to require that a case manger be assigned if the employer or insurer would not otherwise assign one because it would not add value.

Mandating that case managers review all requests for medical services can also cause problems if medical personnel infringe on the role of adjusters. This is possible because many of the issues that are presented under the guise of medical utilization review are actually claims issues that should be managed by a trained adjuster. For example, an employee with a low back injury may request approval for an MRI of the cervical spine. Whether the MRI should be authorized is not strictly a medical question. It may indeed be appropriate based on the clinical findings, but the other question a medical person cannot answer is if the cervical problem is related to the original work injury and whether it should be allowed as part of the initial claim. This is a distinction many medical reviewers are not trained to make and often fail to make properly.

There is definitely a role for managed medical care and medical case management in workers compensation, but that role should not be mandated by the state. Perhaps a state should pass legislation enabling the use of managed medical care, but the decision on whether to use it or not should be a claim-by-claim decision made by an experienced claims handler.

A Rational Permanent Partial Disability System

Permanent partial disability (PPD) can be a major cost-driver in a workers compensation system. This can be seen in the statistics in many states that show PPD payments to be a significant portion of all payments. While alarming, these statistics alone do not show the full picture because the full cost of PPD can be far in excess of the direct cost of PPD benefits. That is because there are many system costs that are driven by the PPD process that do not show up as up as PPD payments.

All PPD systems must contain an element of subjectivity because there is no way to precisely and objectively measure permanent disability. The subjectivity is itself a problem because it leads to unpredictability, disputes, and litigation, all of which drive costs.

In some states, the amount of PPD awarded is partially dependent on the amount of time the injured employee missed from work due to the injury, the amount of medical care received, and the final disposition of the employee's work status. This creates an incentive for employees to stay off work, treat more, and fight for the most significant permanent work restrictions. Therefore, the true cost of PPD is the direct benefits paid plus the additional temporary disability and medical benefits paid because of the conflicting incentives plus the cost of litigation arising from the uncertainty in the process.

A logical argument could be made for eliminating PPD altogether. The theoretical basis for PPD is that it compensates injured workers for future wage loss that could result from the permanent effects of their injuries. In all likelihood, few employees understand the purpose of PPD awards, and most employees probably spend awards rather than investing them in case of a future wage loss. Although a logical case can be made for eliminating PPD, it is probably not a realistic expectation. Therefore, the goal should be to institute the most reasonable guidelines possible.

One way to improve the PPD system is to base awards strictly on medical impairment rather than on vocational impairment. Medical impairment ratings are determined by measuring the residual loss of function after an employee has reached maximum recovery. Vocational awards are based on the employee's loss of earning capacity. Loss of earning capacity is determined using a number of factors, including the medical impairment rating, age, training, skills, experience, and the applicable labor market.

Medical ratings are far more predictable and have a basis in science. They are usually assigned by a medical provider using an objective tool, such as the American Medical Association's guide to rating permanent impairment. By contrast, vocational disability is determined by a much less scientific process and one that is often little more than speculation by a hearing officer. This makes vocational ratings highly unpredictable. Moreover, vocational ratings often produce illogical results. It is possible for employees with relatively minor injuries to receive extremely high awards even if they return to their pre-injury job. There have even been cases of employees who returned to full-time work after being awarded 100 percent vocational disability.

Awards based on medical impairment are not perfect and are somewhat susceptible to the biases of the examining doctor, but they are far more predictable and rational than vocational impairment awards. Employers should prefer them to vocational awards.

The Issue of Attorney Fees

A second area to consider is the method for dispute resolution and the process for awarding attorney fees. It is best to handle disputes similar to binding arbitration where attorney fees are only awarded on the actual increase in benefits earned for the client. This is best illustrated with an example.

Suppose an employee is injured on the job and is ultimately entitled to a $4,000 PPD award based on the rating assigned by the employer's doctor. The employee retains an attorney who files a claim and sends the employee for another opinion. The second examiner opines that the employee has disability entitling him to $6,000 in PPD. After several months in the litigation process, the case is ultimately settled for $5,000.

Following the traditional process, $500 would be deducted from the employee's award to pay for the medical examination used to support his case. An attorney fee of $675 (15 percent of the settlement net the expense of the medical examination) would also be deducted. The employee would ultimately receive $3,825, which is less than he would have received if the case had never gone to litigation.

The way the system should have worked is that the employer should have paid the employee $4,000 immediately based on its medical examiner's opinion. The $4,000 was not in dispute because the employer had no basis to argue that it was not owed. There is no reason for the employee to wait for the litigation process to run before receiving payments that are not disputed, and there is no reason for the employee to pay an attorney fee on them.

If an attorney represented the employee and obtained the second opinion indicating that a $6,000 award was appropriate, the employee could have filed for additional compensation. If the employee prevailed, the attorney could deduct the cost of the medical examination from the additional $2,000 in compensation and a fee based on the incremental award. The attorney would not be entitled to a fee on the $4,000 undisputed portion of the award.

Managing disputes in this fashion would lead to bigger payments being made more quickly to injured workers. It would reduce the frictional cost of litigation because it would discourage frivolous litigation. Attorneys would have no incentive to file cases unless they legitimately believed they could earn a significant increase in benefits for their client. Employers and insurers could totally avoid litigation by fairly and promptly paying the compensation that was due to injured employees.

Restrict Permanent Total Disability Awards

Permanent total disability (PTD) is a major cost driver in some of the states with high cost workers compensation systems. PTD is awarded to injured workers if it is determined that their injuries are too severe for them to ever work again. In most states, PTD awards are limited, as they should be. The goal of the workers compensation system should be to return injured workers to productive employment. Even severely injured workers should have a goal of returning to a productive lifestyle, and the entire system should be geared toward encouraging and facilitating this goal. Indeed, it is quite possible for paraplegics to return to gainful employment, and many do.

In a few states, PTD awards are not very difficult to obtain and are routinely granted even for injuries that hardly seem severe enough to merit such treatment. PTD cases are expensive because many states have a built-in cost of living adjustment so that benefits keep pace with inflation. The inflationary increases can ultimately exceed the initial benefit entitlement if the employee lives for several years after being declared permanently and totally disabled. Moreover, PTD awards are usually paid for life, and benefits continue long after an employee would normally have retired. This means an employee who becomes permanently totally disabled would be expected to collect benefits for more than 30 years with an annual increase in the benefit rate. Insurers and employers must reserve for the full expected cost of benefits once an award is made, and this can amount to several hundred thousand dollars for every PTD case.

Regardless of how much a PTD award costs, few would argue that they are not justified when there is a tragic and severe injury. The problem is that the criteria for awarding PTD in some states has become too liberal and considers issues other than the work injury. For instance, some state systems would allow a 55-year-old employee with relatively minor knee injury to qualify for PTD if there were extenuating circumstances. If the employee's activity was further limited because he was morbidly obese, and if he had little training and education, he might qualify for a PTD award based on all the vocational factors combined.

Like many other issues, a liberal PTD system can lead to inequitable results. In the instance describe above, the employee with a relatively minor knee injury would receive the same compensation as an employee rendered a paraplegic by a work-related fall. Also, the award of PTD is hardly fair to fellow employees who remain on the job. The injured employee will essentially retire at age 55 with a guarantee of lifelong income adjusted for inflation. The entitlement to benefits is only partially due to the work injury, but that alone would not have qualified the employee for an award of PTD. The award of PTD is based largely on the employee's personal lifestyle-related obesity and his failure to gain any skills or education while in the workforce.

In some states PTD awards are linked to entitlement to Social Security disability income (SSDI) benefits. In those states, receipt of SSDI creates a presumption that the employee is permanently and totally disabled. This can be a problem because SSDI is far more liberally granted than PTD should be. States should not link PTD to SSDI, and eligibility for PTD should be determined by the state independently of SSDI rights.

States should also establish very restrictive requirements for PTD so that injured workers do not qualify for the benefit unless they have a severe injury that would make it impossible for most properly motivated people to return to work. In making this determination, injured workers should not be "given credit" for failure to gain reasonable skill or training while in the workforce or for personal medical conditions.

An Orderly Litigation Process

Costs can be reduced by creating a more orderly litigation system where dates and rules of practice are enforced. In many states, the litigation process is too forgiving, and cases are not managed well by attorneys. This causes delays in the system and a general perception that "anything goes." In this environment, some plaintiff attorneys file claims with no understanding of whether legitimate issues exist. Some attorneys are slow to prepare cases for hearings and move them toward resolution. In many states, it is common to find dozens of cases scheduled for hearing on most days even though it would only be possible for a commissioner or hearing officer to hold one or two hearings. It is simply understood that most of the parties scheduled for a hearing will not be prepared and will not be able to proceed.

This sort of system clearly does not benefit employees who may be forced to wait months or years for a hearing, perhaps with no income. It also costs employers who must pay attorneys over the entire course of the case, and it burdens workers compensation boards that must deal with hundreds of cases that should never have been filed or should have been more quickly resolved. A workers compensation system should have clear dates and timeframes for managing litigation and resolving disputes and these should be enforced.

Contribution and Apportionment

Finally, work comp laws should be amended so that employers do not absorb the cost of disability and life-long medical treatment for normal conditions of the aging process. This happens when employees with pre-existing or congenital conditions "aggravate" them at work.

One change employers should seek is to increase the "contribution" from work required to bring a condition under the coverage of workers compensation. Unfortunately, the prevailing standard in most states is that work must only be "a" cause of a condition for work comp coverage to respond. This means that a congenital condition like degenerative disc disease can be fully covered under workers compensation if a doctor will opine that it was aggravated to even the slightest degree by a minor back strain at work. If the precise percentage of causation could be known, this would extend coverage to a condition that is 99.99% the result of the aging process and .01% caused by a minor injury at work.

Many states have adapted a more equitable and more reasonable approach in recent years by limiting coverage to conditions where work is the "major," "predominant," or at least a "substantial" cause of the condition.

Costs for congenital conditions can also be minimized by a fair system of "apportionment." Many states have adapted rules where liability is now apportioned between work and non-work causes and the employer is responsible for only the specific worsening caused by work. The employer is still responsible for a condition that occurs partly due to an underlying condition that made the employee more susceptible to injury, but not for the pre-existing underlying condition. For instance, an employee who suffers a back strain in part because he was more susceptible to injury because of underlying disc disease would be compensated for the strain, but would not be compensated for the underlying condition unless it could be shown that the strain aggravated or accelerated the underlying condition. In that case, the employee would be compensated for the additional disability caused by work, not the disability in totality.

As eminently logical as this sounds, this sort of apportionment exist only in a minority of jurisdictions. Where it is not in the law, adapting apportionment for prior injuries should be a major goal of reform.

Apportioning for prior disability will cure another frequent problem and that is the failure to apportion liability for prior awards made under the work comp system. Some states do not apportion for prior awards or do not apportion in all cases. This can lead to even more illogical results. For instance, an employee with a minor back strain superimposed on underlying disc disease could receive a permanent disability award based on the injury and the underlying condition. A week later the employee could suffer another back injury and later receive a second permanent disability award compensating him for the same underlying condition that he has already been compensated for even though that underlying condition pre-existed his original work injury. Where this is allowed employees can—and do—collect more than 100% loss of a body part even while continuing in their regular pre-injury job.

Certainly there should be apportionment for prior awards if not apportionment for any pre-existing condition.


These are just a few of the more significant areas employers and insurers should be attuned to when it is time for workers compensation reform. Those in states where these problems already exist should attempt to fix them when they can. Those in states that do not have them should be aware of the potential problems that can result from seemingly minor and seemingly technical changes, and do everything possible to prevent them from affecting their states.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week, including links to free articles from industry experts. Discover practical risk management tips, insight on important case law and be the first to receive important news regarding IRMI products and events.

Learn More


Social Media

User ID: Subscriber Status:Free