Workers’ Compensation

Price V. Fishback, University of Arizona

Workers’ compensation was one of the first social insurance programs adopted broadly throughout the United States. Under workers’ compensation employers are required to make provisions such that workers who are injured in accidents arising “out of or in the course of employment” receive medical treatment and receive payments ranging up to roughly two-thirds of their wages to replace lost income. Workers’ compensation laws were originally adopted by most states between 1911 and 1920 and the programs continue to be administered by state governments today.

The Origins of Workers’ Compensation

The System of Negligence Liability

Prior to the introduction of workers’ compensation, workers injured on the job were compensated under a system of negligence liability. If the worker could show that the accident was caused by the employer’s negligence, the worker was entitled to full compensation for the damage he experienced. The employer was considered negligent if he failed to exercise due care. If the worker could show the employer had been negligent, the worker still might not have received any compensation if the employer could rely on one of three defenses: assumption of risk, fellow-servant defense, and contributory negligence. The employer was no longer liable, respectively, if the worker knew of the danger and assumed the risk of the danger when accepting the job, if a fellow worker caused the accident, or if the worker’s own negligence contributed to the accident.

Compensation to Accident Victims before Workers’ Compensation

These common law rules were the ultimate guide for judges who adjudicated disputes between employers and workers. As in many civil situations, the vast majority of accident cases were settled long before they ever went to trial. The employers or their insurers typically offered settlements to injured workers. Various studies done by state employer liability commissions suggest that a substantial number of workers received no compensation for their accidents, which might have been expected if the employer’s negligence was not a cause of the accident. In samples of fatal accidents, about half the families of fatal accident victims received some payments for the loss of their loved ones. For those who received payments, the average payment was around one year’s income. There were a few cases where the accident victims and their families received substantial payments, but there were far more cases where no payment was made.

To some extent workers received some compensation for accepting accident risk in the form of higher wages for more dangerous jobs. Workers had relatively limited opportunities to use these higher wages to buy accident or life insurance, or pay premiums into benefit societies. As a result, many workers and families tried to rely on savings to sustain them in the event of an accident. The problem they faced is that it would take quite a few years to save enough to cover the losses of an accident, and if they were unlucky enough to have an accident early on, they would quickly exhaust these savings. The system of negligence liability, although without the three defenses, continues to determine the nature of accident compensation in the railroad industry.

Adoption of Workers’ Compensation Laws in the 1910s

In the late nineteenth century a number of European countries began to introduce workers’ compensation in a variety of forms. Among industrial countries the U.S. was relatively slow to adopt the changes. The federal government generally considered social insurance and welfare to be the purview of the states, so workers’ compensation was adopted at the state and not the federal level. The federal government did lead the way in covering its own workforce under workers’ compensation with legislation passed in 1908. As shown in Table 1, the vast majority of states adopted workers’ compensation laws between 1911 and 1920. The last state to adopt was Mississippi in 1948.

Table 1
Characteristics of Workers’ Compensation Laws in the United States, 1910-1930

Source: Fishback and Kantor, 2000, pp. 103-4.

a Some general laws were enacted by legislatures but were declared unconstitutional. The years that the law was permanently established are in parentheses. New York passed a compulsory law in 1910 and an elective law in 1910, but the compulsory law was declared unconstitutional, and the elective law saw little use. New York passed a compulsory law in 1913 after passing a constitutional amendment. The Kentucky law of 1914 was declared unconstitutional and was replaced by a law in 1916. The Missouri General Assembly passed a workers’ compensation law in 1919, but it failed to receive enough votes in a referendum in 1920. Another law passed in 1921 was defeated in a referendum in 1922 and an initiative on the ballot was again defeated in 1924. Missouri voters finally approved a workers’ compensation law in a 1926 referendum on a 1925 legislative act. Maryland (1902) and Montana (1909) passed earlier laws specific to miners that were declared unconstitutional.

b Competitive state insurance allowed employers to purchase their workers’ compensation insurance from either private insurance companies or the state. A monopoly state fund required employers to purchase their policies through the state’s fund. Most states also allowed firms to self-insure if they could meet certain financial solvency tests.

c California and New York established their competitive state funds in 1913.

d The initial laws in Ohio, Illinois, and California were elective. Ohio and California in 1913 and Illinois later established compulsory laws.

e Illinois’ initial law was administered by the courts; they switched to a commission in 1913.

f Employees have option to collect compensation or sue for damages after injury.

g Compulsory for motor bus industry only.

h Compulsory for coal mining only.

Provisions of Workers’ Compensation Laws

The adoption of workers’ compensation led to substantial changes in the nature of workplace accident compensation. Compensation was no longer based on the worker showing that the employer was at fault, nor could compensation be denied if the worker’s negligence contributed to the injury. An injured worker typically had to sustain an injury that lasted several days before he would become eligible for wage replacement. Once he became eligible, he could expect to receive weekly payments of up to two-thirds of his wage while injured. These payments were often capped at a fixed amount per week. As a result, high-wage workers sometimes received payments that replaced a smaller percentage of their lost earnings. The families of workers killed in fatal accidents typically receive burial expenses and a weekly payment of up to two-thirds of the wage, often subject to caps on the weekly payments and limits on the total amounts paid out.

Gains to Workers from Workers’ Compensation Laws

Most workers appeared to benefit from the introduction of workers’ compensation. Comparisons of the typical payments under negligence liability and payments under workers’ compensation suggest that a typical worker injured on the job was likely to receive more compensation under workers’ compensation than under negligence liability. Partly this rise was due to the fact that all workers injured under workers’ compensation were eligible for compensation; partly it was due to higher average workers’ compensation payments when compared with the typical settlement under negligence liability. Studies of wages before and after the introduction of workers’ compensation show, however, that non-union workers’ wages were reduced by the introduction of workers’ compensation. In essence, the non-union workers “bought” these improvements in their benefit levels. Even though workers may have paid for their benefits, they still seem to have been better off as a result of the introduction of workers’ compensation. Many workers had faced problems in purchasing accident insurance at the turn of the century. Workers’ compensation left them better insured, and allowed many of them to spend some of their savings that they had set aside in case of an accident.

Employers and Insurers Also Favor Workers’ Compensation

Employers were also active in pressing for workers’ compensation legislation for a variety of reasons. Some were troubled by the uncertainties associated with the courts and juries applying negligence liability to accidents. Some large awards by juries fueled these fears. Others were worried about state legislatures adopting legislation that would limit their defenses in liability suits. The negligence liability system had become an increasing source of friction between workers and employers. In the final analysis, the employers were also able to pass many of the costs of the new workers’ compensation system back to the workers in the form of lower wages. Finally, insurance companies also favored the introduction of workers’ compensation as long as the states did not try to establish their own insurance funds. Under the negligence liability system, the insurers had not been selling much accident insurance to workers because of information problems in identifying who would be good and bad risks. The switch to workers’ compensation put more of the impetus for insurance on employers and insurers found that they could more effectively solve these information problems when selling insurance to employers. As a result, insurance companies saw a rise in their business of insuring workplace accidents.

In the final analysis, the adoption of workers’ compensation was popular legislation. It was supported by the major interest groups-employers, workers, and insurers-each of whom anticipated gains from the legislation. Progressives and social reformers played some role in the adoption of the legislation, but their efforts were not as important to the passage as often surmised because so many interests groups supported the legislation.

Interest Groups Battle over Specific Provisions

On the other hand, the various interest groups fought, sometimes bitterly, over the specific details of the legislation, including the generosity of benefit levels and whether or not the state would sell workers’ compensation insurance to employers. These battles over the details at times slowed the passage of the legislation. The benefit levels tended to be higher in states where there were more workers in unionized industry but lower in states where dangerous industries predominated. Reformers played a larger role on the details as they promoted higher benefits. In several states the insurance companies lost the battle over state insurance, most often in settings where the insurance industry had a limited presence and reformers had a strong presence. As seen in Table 1, several states established monopoly state insurance funds that prevented private companies from underwriting workers’ compensation insurance. Some other states established state insurance funds that would compete with private insurers.

Trends in Workers’ Compensation over the Past Century

Changes in Occupational Coverage

Since its introduction, workers’ compensation has gone through several changes. More classes of workers have been covered by workers’ compensation over time. When workers’ compensation was first introduced, several types of employment were exempted, including agricultural workers, domestic servants, many railroad workers in interstate commerce, and in some states workers in nonhazardous employments. Further, workers hired by employers with fewer than 3 to 5 workers (varying by state) have been typically exempt from the law. As seen in Table 2, by 1940 employees earning wages and salaries accounting for 75 percent of wage and salary disbursements were covered by workers’ compensation laws. At the time that Mississippi adopted in 1948, the percentage rose to about 78 percent. Since that time a decline in domestic servitude, railroading, and agricultural employment, as well as expansions of workers’ compensation coverage have led to payroll coverage of about 92 percent.

Growth in Expenditures on Workers’ Compensation

Since 1939, real expenditures on workers’ compensation programs (in 1996 dollars) have grown at an average annual rate of 4.8 percent per year. The growth has been caused in part by the expansions in the types of workers covered, as described above. Another source of growth has been expansions in the coverage of types of injuries and occupational diseases. Although workers’ compensation was originally established to insure workers again workplace accidents, the programs in most states were expanded to cover occupation-related diseases. Starting with California in 1915, states began expanding the coverage of workers’ compensation laws to include payments to workers’ disabled by occupational diseases. By 1939 23 states covered at least some occupational diseases.¹ As of July 1953 every state but Mississippi and Wyoming had at least some coverage for occupation diseases. By the 1980s all states had some form of coverage. More recently, some states have begun to expand coverage to include compensation to persons suffering from work-related disabilities associated with psychological stress.

Increased Benefit Levels

Another contributor to the growth in workers’ compensation spending has been an increase in benefit levels. The rise in benefits paid out has occurred even though workplace accident rates have declined since the beginning of the century. Workers’ compensation costs as a percentage of covered payroll (see Table 2) generally stayed around 1 percent until the late 1960s and early 1970. Since then, these costs have risen along a strong upward trend to nearly 2.5 percent in 1990. The rise in compensation costs in Table 2 was driven in part by increased payments for benefits and medical coverage, as well as the introduction of the Black Lung program for coal miners in 1969. The rise in benefits can be explained in part by a series of amendments to state laws in the 1970s that sharply increased the weekly maximums that could be paid for benefits.

Table 2
Long-Term Trends in Workers’ Compensation Coverage and Costs

Sources: 1939-1967, Alfred M. Skolnik and Daniel N. Price, “Another Look at Workmen’s Compensation,” in U.S. Social Security Administration, Social Security Bulletin 33 (October 1970), pp. 3-25; 1968-1986, U.S. Social Security Administration, Social Security Bulletin, Annual Statistical Supplement, 1994, Table 9.B1, p. 333; 1992-1993, Jack Schmulowitz, “Workers’ Compensation: Coverage, Benefits, and Costs, 1992-93,” Social Security Bulletin 58 (Summer 1995), pp. 51-57. For 1987 through 1998, National Academy of Social Insurance, “Workers’ Compensation: Benefits, Coverage and Costs, 1997-1998 New Estimates.” The publication is available at the National Academy of Social Science website: http://www.nasi.org/.

a The workers’ compensation series on costs as a percentage of the covered payroll (pvf.b.18.10) contains some employer contributions to the Black Lung program while the benefits series (pvf.b.18.11) does not include benefits associated with the Black Lung program

Expenditures on Medical Care, Disability and Survivors

Over time, and particularly during the 1980s and early 1990s, rising medical expenditures have been a prime contributor to rising costs. Expenditures on medical and hospital benefits have risen from less than 0.2 percent of the payroll to over 0.6 percent in the early 1990s. At that time employers and insurers began managing their health care costs more closely and have slowed the growth of workers’ compensation medical costs during the 1990s. Similarly, the disability benefits paid to replace lost earnings have also risen sharply over times as reforms of workers’ compensation expanded the range of workplace injuries and diseases covered. Payments of replacement wages to disabled workers have increased relative to the size of payrolls from 0.3 percent of wages and salaries covered by workers compensation to as high as .9 percent around 1990 (see Table 2). In contrast, the percentage of the payrolls spent on paying benefits to the survivors of the victims of fatal accidents has stayed relatively constant at below 0.1 percent from the 1940s through 1970 and again from the 1980s to the present (see Table 2). The upward surge in the percentage of payroll paid out to survivors between 1970 and 1973 was driven by the introduction of the federal Black Lung program. The impact of Black Lung was so dramatic because of the accumulation of a number of years of survivors all being added to the system in the span of three years. Once the Black Lung program had stabilized, the survivors’ benefits reached a steady state of about 0.1 percent of the payroll and have declined in the 1990s.

Declining Injury and Illness Rates

The general rise in workers’ compensation benefits as a share of the payroll should not necessarily be considered a sign that workplaces have become more dangerous. Workers’ compensation has increasingly provided benefits for a wide range of injuries and diseases for which compensation would not have been awarded earlier in the century. Data on occupational injury and illness rates for all occupations shows that number of cases of injury and illness per 100 workers in the private sectors has fallen by 32 percent since 1972, while the number of lost workday cases has stayed roughly constant.

Trends in the Shares of Payments Made by Types of Insurers

Although the states establish the basic rules for compensation, employers can obtain insurance to cover their compensation responsibilities from several sources: private insurance carriers in the majority of states, government-sponsored insurance funds in roughly half of the states, or the employer can self-insure as long as they demonstrate sufficient resources to handle their benefit obligations. Between the end of World War II and 1970, the distribution of benefits paid by these various insurers stayed relatively constant (see Table 3). The percentage of benefits paid by private insurers was roughly 62 percent, by state and federal funds roughly 25 percent and by self-insurers was about 12 to 15 percent. The introduction of the Black Lung benefit program in 1970 led to a sharp rise in the state and federal insurance funds, as a large number of workers not previously covered received federal coverage for black lung disease. Since 1973 the trend has been to return more of the insurance activity to private insurers, and many employers have increasingly self-insured.

Table 3
Shares of Workers’ Compensation Payments Made by Types of Insurer

Sources: See Table 2.

The Moral Hazard Problem and Accident Compensation

The provision of accident compensation is potentially subject to problems with moral hazard, which is a situation where people reduce their prevention activities because their net losses from the injury are reduced by the presence of compensation. Over the course of the century, there have been two trends that have contributed to the potential for greater moral hazard problems. First, the character of the most common injuries has changed. In the early 1900s the common workplace injuries were readily identifiable, as the probability of accidents leading to broken bones, lost body parts, and fatalities were far more common. The most common forms of workers’ compensation injuries today are soft tissue injuries to the back and carpal tunnel syndrome in wrists. These injuries are not so easy to diagnose effectively, which could lead to excess reporting of this type of injury. The second trend has been a rise in benefit levels as a share of after-tax income. Workers’ compensation payments are not taxed. When the workers’ compensation programs were first introduced, the federal income tax was first being put into place. Through 1940, less than 7 percent of households were subject to the income tax. Since World War II, however, the income tax rates have been substantially higher. As a result, workers’ compensation benefits have been replacing a higher share of the after-tax wage. The absence of much taxation in the early 1900s meant that workers’ compensation benefits often replaced less than two-thirds of the after-tax wage, and sometimes weekly maximums on payments led to replacement of a substantially lower percentage. In the modern era, with greater taxation of wages, workers’ compensation benefits are replacing up to 90 percent of the after-tax wage in some states. Both the trends toward more soft-tissue injuries and the higher after-tax replacement rates have led to improvements in the compensation of injured workers, although there is evidence that workers pay for these improvements through lower wages (Moore and Viscusi 1990). On the other hand, the trends increase the risk of problems with moral hazard, which in turn lead to higher insurance costs for employers and insurers. Employers and insurers have sought to limit the problems with moral hazard through closer monitoring of accident claims and the recovery process. The tensions between improved accident compensation and moral hazard have been a constant source of conflict in the debates over the proper level of compensation for workers.

Conclusion

Workers’ compensation is now one of the cornerstones of our network of social insurance programs. Although many of the modern social insurance programs were proposed at the state level during the 1910s, workers’ compensation was the only program to be widely adopted at the time. Unemployment insurance and old-age pension programs later joined the network through federal legislation in the 1930s. All of these programs have faced new challenges, as they have become a central feature of our economic terrain.

References

Aldrich, Mark. Safety First: Technology, Labor, and Business in the Building of American Work Safety, 1870-1939. Baltimore: Johns Hopkins University Press, 1997.

Fishback, Price V. and Shawn Everett Kantor. A Prelude to the Welfare State: The Origins of Workers’ Compensation. Chicago: University of Chicago Press, 2000.

Moore, Michael J., and W. Kip Viscusi. Compensation Mechanisms for Job Risks: Wages, Workers’ Compensation, and Product Liability. Princeton, NJ: Princeton University Press, 1990.

Data and descriptions of trends for workers’ compensation are available from the National Academy of Social Insurance website: http://www.nasi.org/. The NASI continues to publish annual updates. In addition, detailed descriptions of the benefit rules in each state are published annually by the U.S. Chamber of Commerce in Analysis of Workers’ Compensation Laws.

¹ The states include California 1915, North Dakota 1925, Minnesota 1927, Connecticut 1930, Kentucky 1930, New York 1930, Illinois 1931, Missouri 1931, New Jersey 1931, Ohio 1931, Massachusetts 1932, Nebraska 1935, North Carolina 1935, Wisconsin 1935, West Virginia 1935, Rhode Island 1936, Delaware 1937, Indiana 1937, Michigan 1937, Pennsylvania 1937, Washington 1937, Idaho 1939 and Maryland 1939. Balkan 1998, p. 64.