Workers’ Compensation Rate Regulation: How Price Controls Increase Costs

Abstract

In the 1980s, regulation constrained workers’ compensation insurance premiums in the face of rapid growth in loss costs. We develop and test the hypothesis that rate suppression exacerbates loss growth, leading to higher losses and premiums. The empirical analysis using rating class data for eight states for the period 1985–91 confirms that rate suppression, measured by lagged residual‐market share of payroll, increased loss growth. The cost‐increasing effects are greater in the residual market than in the voluntary market, but premiums increased more rapidly in the voluntary market. The resulting pattern of cross subsidies between and within classes is consistent with a simple model of political influence, with subsidies to high risks and small firms at the expense of low risks and insurer equity.