The Empire State strikes back; in trying to fix troubled workers' compensation systems, New York and other states can learn from California and Pennsylvania.

In creating a federal republic, the founding fathers designed states to serve as "laboratories of democracy" that would adopt policies and initiatives designed to meet the specific needs of their citizens. This spirit of local experimentation exists in the nation's patchwork of 51 workers' compensation systems, each with its own benefit levels and employer contribution requirements. As with pure science, some laboratories produce failed results while others produce more successful ones. Some states, such as New York, have workers' comp systems that are broken; they are costly to businesses and they provide low benefit levels to employees. Other states, such as California and Pennsylvania, recently have had success in reducing workers' comp costs to businesses. Recent reforms adopted in Sacramento and Harrisburg provide two very different blueprints for how New York can mend its broken workers' comp system if it has the stomach to do so.

Each state establishes procedures for workers to follow to challenge medical diagnoses or determinations that their injuries are not work related, as well as for medical providers to challenge medical reimbursements. Businesses shoulder the cost of these and other procedures in the form of premiums paid to insurers (which tend to be higher in states with higher administrative costs) and, in some states, in the form of contributions to state workers' comp funds.

Problems in New York

The New York workers' comp system is plagued by high costs to businesses and low benefit levels for employees. Premiums paid by New York businesses exceed the nationwide average by approximately 70%. The high New York premiums are the result of two factors: out-of-control administrative costs and a lack of limits on long-term disability benefits.

As a measure of the scope of the problems facing New York, while maximum cash benefits for injured workers in New York are $400 per week, injured workers in Pennsylvania, New York's neighbor to the south, receive a maximum cash benefit level of $745 per week, even though Pennsylvania businesses pay lower premiums than New York businesses. Not surprisingly, these higher overall costs have made the state less attractive to businesses. There is obviously a pressing need for reform to improve the climate in the Empire State for businesses and workers.

As recently as 2000, California's premium and claims costs were the highest in the nation, and its benefits levels for injured workers rivaled the lowest. Although the roots of the high costs paid by California employers differed substantially from the roots in New York, New York can learn from the reform in California that dramatically has improved that state's workers' comp system.

California's Solution

In the 1990s. California deregulated pricing on workers' comp insurance with the objective of promoting competition. However, the state's elected

insurance commissioners failed to regulate a price war that ultimately led 28 insurers to insolvency and many others to flee the state's workers' comp market. As a result, the market share of the state-operated workers' comp fund, which was substantially more costly than private sector insurance in other states, went from 20% before deregulation to more than 50% in 2003. At the same time, a California statute enacted in 1993 and clarified by a 1996 court ruling created a presumption in favor of the diagnosis of the treating physician regarding the nature and extent of care that was difficult for an employer or an employer's insurer to overcome. This presumption in favor of physicians dramatically increased costs.

In 2003 and 2004, the California Legislature enacted a package of sweeping reforms directed at cost containment. Among other things, the reforms:

* established a "medical treatment utilization" schedule to eliminate doctor discretion for certain medical services, drugs, fees and goods (to address the burden-shifting statutory change);

* eliminated fights of employees to bring civil actions to recover penalties in connection with the workers' comp provisions of state law;

* required pharmacies to prescribe generic drugs for workers' comp patients, with few exceptions;

* substantially increased penalties for insurance fraud; and

* obligated employers to pay claims timely (thus, reducing dispute costs).

California's reforms made a marked difference in the state's hospitality for businesses in a short period of time. Indications suggest that the reforms already have saved California businesses at least $5 billion annually. Loss ratios on workers' comp lines have declined by more than half between 2002 and 2005, from 87 to 38.5. Moreover, since January 2004, workers' comp insurance rates have decreased by 37.7%.

Pennsylvania's Success

Pennsylvania has taken a different approach to driving down costs in its workers' comp system. In March 2003, Pennsylvania Gov. Ed Rendell implemented a workplace safety initiative called WorkSafe PA, which provided businesses and employees with information geared toward enhancing safety practices in the workplace. Since that time, the state has given premium reductions to businesses that set up workplace safety committees satisfying certain requirements. As of May 2006, 6,804 Pennsylvania businesses covering 916,125 employees saved more than $223 million in premiums by participating in this program, which significantly has reduced workplace accidents.

In order for a New York workers' comp reform effort to achieve success on the scale of the results in California and Pennsylvania, it must address the most pressing problems plaguing the system. First, the state must find a way to rid the system of the gross administrative inefficiencies that add time and expense to the processing of claims. Today, administrative costs are higher in New York than they are in 48 other states. According to the National Council on Compensation Insurance, the average cost of a workers' comp case in New York is $11,793. By comparison, the average cost of a workers' comp case in Pennsylvania is $6,516.

Second, the state must impose some limits on long-term cash benefits. Today, a New York employee who claims a chronic injury on the job, such as one causing back pain, is eligible to receive cash benefits for the rest of his or her life, while an employee who loses a limb only receives cash benefits for a limited time period. While these "permanent partial disability" awards make up 11.7 % of claims in New York, they account for 73% of all incurred losses.

New York's Plan

New York Gov. George Pataki's budget proposal for the 2007 fiscal year, introduced in early 2006, included several workers' comp reforms, such as a cap on eligibility for permanent partial disability awards at 500 weeks and an increase in the maximum award for which injured employees are eligible from $400 per month to $500 per month. This proposal is a scaled back version of a similar proposal he introduced in 2004 and again in 2005.

In addition to the permanent partial liability cap and the benefit increase, Gov. Pataki's reform plan also includes easier access to care and speedier handling of claims; a new system of tiered benefit levels for permanent partial disabilities based on severity of injury; a pharmaceutical fee schedule; and a pilot program under which carriers are encouraged to provide compensation and medical benefits to injured workers without the intervention of the state workers' comp board.

The measures proposed by Gov. Pataki, if implemented, would go a long way toward addressing the problems facing the New York workers' comp system. Gov. Pataki has projected that if the state adopts his tiered benefit approach, overall costs would be reduced by 15%. Under a tiered benefit plan, the level of benefits is tied directly to the severity of the disability, an approach that 37 other states have adopted. Furthermore, the measures designed to provide easier access to care and speedier claim handling, if adopted, could reduce the state's high administrative costs. In particular, if the pilot program were to be successful, and ultimately is expanded, minimizing the role of the state bureaucracy could lead to significant premium reductions for New York businesses.

Finally, the problem of rapidly rising drug prices is one that has affected most states--drug costs have increased by 15.7% nationally since 2001. If New York were to implement a pharmaceutical fee schedule, as 23 states already have done, this would help control drug costs. Gov. Pataki's proposed reforms would be a good first step toward taming New York's workers' comp system.

Like the California reform effort, Gov. Pataki's proposed reforms focus on cost-containment. However, given the high premiums New York employers must endure, legislators in Albany would be wise to learn from the experience of the "laboratory" in Harrisburg by focusing on alternative solutions to reducing costs in the system, such as creating incentives for safe workplaces. Combining California's cost-containment approach with Pennsylvania's employer-based incentives, the New York "laboratory" can fix its badly broken workers' comp system.

Key Points

* New York businesses pay 70% more than the national average for workers' comp premiums.

* Injured New York workers receive less in benefits than workers in neighboring Pennsylvania, even though Pennsylvania businesses also enjoy lower premiums.

* California, once known for having the highest premium rates and among the lowest benefits paid in the nation, has been able to vastly improve its system through a series of workers' comp reforms.

Contributor Felton Newell is a senior associate in the Reinsurance Practice Group at Milbank. He can be reached at [e-mail].

Workers' Compensation, Top Writers--2005

New York

AMB #          Companies                                   Market
                                                          Share (%)

04029          State Insurance Fund of New York             41.65
18540          American International Group Inc             17.76
00060          Liberty Mutual Insurance Cos.                 8.38
00048          Hartford Insurance Group                      4.69
18549          Zurich Financial Services NA Group            3.41

California

04028          State Compensation Insurance Fund of CA      42.12
18540          American International Group Inc              8.27
03020          Zenith National Insurance Group               5.26
18647          St. Paul Travelers Group                      4.05
00811          Berkshire Hathaway Insurance Group            3.59

Pennsylvania

18540          American International Group Inc              7.88
00060          Liberty Mutual Insurance Cos                  7.76
04283          Erie Insurance Group                          7.63
18436          PMA Capital Insurance Group                   6.28
00048          Hartford Insurance Group                      5.52

Source: A.M. Best Line Data