The Performance of Total Payroll as the Exposure Base for Workers Compensation

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1 NCCI RESEARCH BRIEF September 2006 by Natasha Moore and Delano Brown The Performance of Total Payroll as the Exposure Base for Workers Compensation The following examines the principle that total payroll remains the best exposure base for workers compensation. From the inception of the workers compensation system until World War II, total payroll was the industry s accepted exposure base. Between World War II and the 1970s, limited payroll was used. However, payroll limits could not keep pace with the unexpected salary increases during the 1950s and 1960s causing the premium base to erode into little else than a head count of employees. As a result, total payroll has been the exposure base for workers compensation insurance since the 1970s, and an analysis conducted by NCCI demonstrates that total payroll remains an equitable exposure base for workers compensation insurance. There are several weaknesses to proposed alternative exposure bases, such as hours worked or limited payroll, which make these alternatives inappropriate as the exposure base for workers compensation. BACKGROUND Total Payroll/High Wage Payers by Ronald Retterath, published in the September 1991 NCCI Digest, reviewed relationships between high-wage payers and low-wage payers to determine if there was truly an inequity in the lost time and medical benefits awarded. As with the 1991 study, NCCI s 2005 update demonstrates that total payroll continues to be the most equitable exposure base for workers compensation insurance. Under the updated total payroll examination, average claim costs compared to the underlying wage levels are used to determine if total payroll accurately reflects exposure to loss between high-wage earners and lowwage earners. The data is based on a sample of lost-time claims provided by carriers for accident years for the 36 states where NCCI provides ratemaking services. The data is adjusted to remove wage and benefit cost differences between years and states, which allows NCCI to perform comparisons across all states and years. Analysis is performed for all classes combined and for each industry group separately. THE DEBATE In workers compensation, premiums vary directly with total payroll, which is a direct function of wage levels. There are some components of total losses which, at least in theory, would not be expected to vary based on wage levels. Examples would be medical losses and lost-time claims affected by the cap on maximum benefits. If this is true, and without considering the premium impacts of experience rating adjustments, total payroll would not be an equitable exposure base for workers compensation. The 2005 analysis performed by NCCI concludes that benefits do, in fact, track closely with wage levels. RESULTS OF THE 2005 UPDATE Comparisons of average lost-time, medical, and overall claim costs were performed over five wage ranges. The data is grouped into ranges for those earning: Less than 50% of the average wage Between 51% and 100% of the average Between 101% and 150% of the average Between 151% and 200% of the average Over 200% of the average To arrive at the average claim cost relativity, the cost of claims for each wage range is compared to the cost of all claims over all wage ranges. Results are presented for all classes combined and for each industry group separately. Exhibit 1 illustrates the results for overall claim costs. For all classes combined, those earning less than 50% of the average weekly wage received benefits that were 50% of the average benefit. Those earning more than 200% of the average weekly wage received benefits that were 179% of the average benefit. The pattern is similar by industry group. 1

2 For contracting class codes, those earning less than 50% of the average weekly wage received benefits that were 62% of the average benefit. Likewise, those earning more than 200% of the average weekly wage received benefits that were 184% of the average benefit. 2.5 Exhibit 1 Average Claim Costs Relative to Wages Average Claim Cost Relativity All Classes Manufacturing Contracting Office & Clerical Goods & Services Miscellaneous Exhibit 1 The average claim costs rose steadily with increases in the average wage level for all classes combined and for each industry group. Furthermore, the relationship of average claim costs to average wage was strong. Actual results conclude that the benefits track strongly with wage levels. benefit levels that are two-thirds of the pre-injury wage subject to the maximum of the state average weekly wage. However, we see from Exhibit 2 that lost-time benefit costs increase with wages and continue to increase materially for claims where the wage exceeds the level associated with the maximum weekly benefit. Opponents of total payroll may expect that the average lost-time claim costs would plateau at 150% of the average weekly wage. This is because many states have 2

3 2.5 Exhibit 2 Average Indemnity Claim Costs Relative to Wages 2.29 Average Claim Cost Relativity All Classes Manufacturing Contracting Office & Clerical Goods & Services Miscellaneous Exhibit 2 The data shows similar patterns for indemnity and medical benefits separately. Exhibit 2 shows for all classes combined, those earning between 151% and 200% of the average weekly wage received lost-time benefits that were 170% of the average lost-time benefit. Those earning more than 200% of the average weekly wage receive lost-time benefits that were 207% of the average lost-time benefit. The pattern is similar by industry group. For claims involving contracting class codes, those earning between 151% and 200% of the average weekly wage received lost-time benefits that were 168% of the average lost-time benefit. Likewise, those earning more than 200% of the average weekly wage received losttime benefits that were 198% of the average lost-time benefit. Opponents of total payroll may also expect that the average medical claim costs would not track wage levels because medical benefits do not depend on wage levels. However, we see from Exhibit 3 that medical claim costs rise steadily with each increase in wage interval for all classes combined and for each industry group. The only exception is for class codes falling within the miscellaneous industry group where the pattern is more volatile. In general, medical costs track strongly with wage levels 3

4 Average Claim Cost Relativity Exhbit 3 Average Medical Claim Costs Relative to Wages All Classes Manufacturing Contracting Office & Clerical Goods & Services Miscellaneous Exhibit 3 Exhibit 3 shows that, for all classes combined, those earning less than 50% of the average weekly wage received medical benefits that were 62% of the average medical benefit. Those earning more than 200% of the average weekly wage received medical benefits that were 154% of the average medical benefit. The pattern is similar by industry group. For contracting class codes, those earning less than 50% of the average weekly wage received medical benefits that were 73% of the average medical benefit. Likewise, those earning more than 200% of the average weekly wage received medical benefits that were 165% of the average medical benefit. Exhibit 4 gives a perspective as to why the average claim costs continue to rise with wage level. In this chart, the temporary total duration of claims for each wage range is compared to the temporary total duration of all claims over all wage ranges to arrive at the average duration relativity. The average duration relativity increases as the wage increases. This implies that injured workers earning higher pre-injury weekly wages take longer to return to work. 4

5 Exhbit 4 Temporary Total Disability Duration Relative to Wages Average Duration Relativity All Classes Manufacturing Contracting Office & Clerical Goods & Services Miscellaneous \ Exhibit 4 NCCI plans to conduct further investigation, which may provide other explanations as to why average claim costs rise with wage levels. Such research will consider the severity of claims, injury type distribution, attorney involvement, mix of medical services, age of workers, and tenure of workers. Other characteristics of claims will also be investigated. WEAKNESSES OF ALTERNATIVE EXPOSURE BASES According to Amy Bouska in her paper Exposure Bases Revisited, published in the November 1989 CAS Proceedings, an exposure base should accurately reflect the overall exposure to loss, be simple to compile, not be subject to manipulation, and reflect differences in exposure to loss. Total payroll as an exposure base for workers compensation meets all of these conditions. Alternative exposure bases, such as hours worked and limited payroll, have been suggested to replace total payroll. However, there are weaknesses in these alternatives, which make them less desirable compared to total payroll: Since records of hours worked and limited payroll are not required to be reported by law, these alternatives are costly for employers to supply, are not easily verifiable, and are subject to increased manipulation. Auditing expenses would increase because records of hours worked and limited payroll are not easily verifiable. 5

6 This study shows that high-wage earners receive higher benefits. If the alternative exposure bases were used, the lower-wage earners would subsidize higher-wage earners. Hours worked and limited payroll are not inflation sensitive. Higher apparent annual rate increases would be needed to capture the rise in costs due to wage inflation. A system using limited payroll would be costly to maintain because of the possibility of varying limits by state. Also, additional administrative costs would burden the system each time the limits change. CONCLUSIONS Based on the results of the 2005 study of the Performance of Total Payroll as the Exposure Base for Workers Compensation, in conjunction with the results of the 1991 study, total payroll as an exposure base is an appropriate reflection of loss potential for all classes and for each industry group. In reference to alternative exposures base, such alternatives would be significantly more difficult to record and verify and would be costly to maintain. Furthermore, no credible study has demonstrated an exposure base that is better than total payroll. NCCI is planning to conduct further research of the characteristics of claims by wage range in order to explain the results of this study. Copyright 2006 National Council on Compensation Insurance Inc. All Rights Reserved. THE RESEARCH ARTICLES AND CONTENT DISTRIBUTED BY NCCI ARE PROVIDED FOR GENERAL INFORMATIONAL PURPOSES ONLY AND ARE PROVIDED AS IS. NCCI DOES NOT GUARANTEE THEIR ACCURACY OR COMPLETENESS NOR DOES NCCI ASSUME ANY LIABILITY THAT MAY RESULT IN YOUR RELIANCE UPON SUCH INFORMATION. NCCI EXPRESSLY DISCLAIMS ANY AND ALL WARRANTIES OF ANY KIND INCLUDING ALL EXPRESS, STATUTORY AND IMPLIED WARRANTIES INCLUDING THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. 6