Claims Reporting and Risk Bearing Moral Hazard in Workers' Compensation

Abstract

Claims Reporting and Risk Bearing Moral Hazard in Workers' Compensation Workers covered by workers' compensation insurance generate two types of moral hazard: moral hazard in which higher benefits induce workers to take more ex ante job risks given a higher level of ex post injury compensation and moral hazard in which higher benefits have no effect on actual injuries (risk is unchanged) but does induce more claims filings. In this empirical study of indemnity and medical trends the quantitative impact of these two types of moral hazard are separated. In our specifications a positive claims reporting moral hazard more than offsets the negative risk bearing moral hazard. The presence of claims reporting moral hazard suggests that even though workplace injuries may be declining over time (i.e., real safety has increased), reported claims will actually increase as real benefits increase. If changes in workers' compensation indemnity benefits (more generally, in any insurance coverage) affect workers' real or reported safety behavior then there is a classic moral hazard problem: the liability of the firm (or its insurer) is affected by actions of the workers about which the firm has incomplete information. In the absence of moral hazard effects, an increase in the expected indemnity payment will still increase expected costs in a naive acturial sense: when the expected weekly indemnity payment increases by 10 percent this increases expected costs by roughly 10 percent as long as the higher benefits do not induce any change in the real or reported behavior of the workers. However this one to one relationship between benefits and costs is broken when moral hazard is present. The worker's incentive to file a claim for any level of risk will increase as benefits rise since this lowers the cost (mostly in terms of forgone earnings) of being on a claim. This results in two types of moral hazard response: an increase in benefits will increase the propensity to file a claim either because the worker will be willing to undertake more risk than before and consequently more injuries will occur, or because the worker has a greater incentive to file a claim for any given level of risk (and its concomitant level of injuries). This article makes the first empirical distinction between the former real and the latter nominal types of moral hazard, presenting estimates of the empirical magnitude of each. Figure 1 provides the context for various types of incentive effects due to changes in the level of indemnity payments. Were the additional claim losses arising from higher benefits generated by the firm or by the worker? Did they represent a real change in safety behavior (risk bearing moral hazard) or did they simply reflect a greater propensity to report claims (claims reporting moral hazard)? While the real and nominal incentives facing the worker are mentioned above, note that the firm also faces similar incentives to alter its behavior. In terms of the nominal incentives of the firm, if experience rated, then higher benefits increase insurance costs on average. Consequently, the firm has an incentive to engage in nominal (and perhaps real) claims reduction practices. One way is simply by resisting more claims that arise (i.e., by discouraging claim filing without improving real safety conditions). Without experience rating, the firm faces no such nominal incentives, but may still have real incentives with respect to benefit increases.(1) Real firm effects exist when changes in the indemnity benefits affect the safety behavior of the firm. Higher levels of real benefits could conceivably increase safety. The argument is that as benefits increase, risk bearing is shifted from the worker to the firm and there are unrealized economies of scale in risk shifting. …