Permanent Partial Disability in Workers' Compensation: Probability and Costs

Introduction Workers' compensation costs, as a percentage of covered payroll, have more than doubled since 1960, rising from 0.93 percent in that year to 2.15 percent in 1988. These increased costs have been attributed to changes in workers' compensation programs following the 1972 report of the National Commission of State Workmen's Compensation Laws, which criticized program benefits as inadequate. (1) Among other things, states responded to this report by increasing indemnity benefits and reducing the waiting period prior to benefit eligibility. In addition to the direct effect of such changes, a number of studies have found that liberalization of benefits increased program utilization. Specifically, several studies have found that higher compensation benefits are associated with higher claims incidence and longer durations of temporary total disability--the period of disability occurring prior to the point of maximum medical improvement (see Krueger, 1990a, and Ehrenberg, 1988, for recent reviews of the literature). A substantial portion of the increased cost of workers' compensation may be due to higher permanent partial disability costs. Permanent partial disability benefits represent approximately two-thirds of the total cost of workers' compensation benefits. In addition, while the incidence of permanent partial disability claims as a portion of total claims declined from a high of 26 percent in 1958 to 24 percent in 1982, the portion of total benefits attributable to permanent partial disability claims rose from 60 percent to 65 percent during that same period (Berkowitz and Burton, 1987). Krueger and Burton (1990) have shown that permanent partial disability benefits are an important determinant of overall program cost; that is, employer premiums are positively related to the proportion of total benefits accounted for by permanent partial compensation. Policy-makers have become increasingly concerned with permanent partial disability as overall costs have risen. Berkowitz and Burton (1987) have argued that increasing costs since the National Commission report have triggered a "second wave" of reform, centering on the compensation of permanent partial disability. (2) A number of jurisdictions have reassessed or changed their criteria or procedures for permanent partial benefits, including Florida, which implemented fundamental reform in 1979. Despite their importance as an element of compensation costs, there is little research examining the factors that influence the probability and costs of a permanent partial disability claim. This article explores three issues related to permanent partial disabilities. First, the process determining whether a claim becomes a permanent partial disability is modeled, as is the process determining the size of the permanent partial disability award. In particular, I estimate the extent to which each of these processes is affected by claimant moral hazard. Second, alternative empirical specifications of these processes are compared, one which assumes that the process determining the probability of permanent partial disability is identical to the process determining the size of the permanent partial disability award, and another which assumes that these two processes are different. (In this article, the probability of a permanent partial disability is estimated using a sample of injured workers rather than a sample of all workers. Therefore, the probabilities estimated in this study are not unconditional probabilities, but are conditional on a compensation claim having been initiated.) Finally, based on these results, estimates of the elasticities of permanent partial disability claims and costs with respect to changes in benefits are obtained. The next section of this article describes relevant aspects of workers' compensation programs; it is followed by a discussion of the potential effect of claimant moral hazard on the probability and size of a permanent partial award and a review of the empirical literature. …