Designing Benefit Structures for Temporary Disability

By Richard A. Victor

December 1, 1989 Related Topics: Indemnity Benefits

Benefit structures are a primary concern of workers’ compensation policymakers. WCRI has completed a series of studies that examines the structure of temporary disability benefits in the United States and describes the structure in place and the outcomes achieved in twenty-four states. The objective is to help policymakers answer two key questions:

  • How well is a specific system meeting its goals?
  • How can that system be improved by changing its features?

This series of reports was started in 1985, was updated and revised in 1989, and is updated on an ongoing basis. Analysis continues using a computer model that calculates income replacement rates, the percentage of a disabled workers’ after-tax income loss that is replaced by workers’ compensation benefits. We also estimate the percentage of workers at each level of replacement rate. In constructing and implementing the model, we used benefit levels and tax rates in effect around the time of the studies. The model has been updated to analyze other states or the impact of proposed changes in benefit structures.

In a "typical" state, where the statute provides benefits of two-thirds of a worker’s pre-injury wages, all workers receive benefits that are more than two-thirds of their lost income. This is true because workers’ compensation benefits are tax-free. Moreover, replacement rates vary for workers with different incomes. This is true because the value of tax-free workers’ compensation benefits is greater for workers in higher tax brackets. In general, most workers in a typical state receive between 80 and 100 percent of their after-tax income.

Replacement Rates in a Typical State

The studies examine different design choices available to policymakers and how each affects levels of income replacement. Among the features examined are

  • maximum benefits
  • minimum benefits
  • gross versus spendable income as the benefit base
  • waiting and retroactive periods

These combine with a progressive income tax structure to provide widely varying levels of income replacement to workers within as well as across states.

As the table below shows, in 20 of the 24 states we studied, system features combine to provide a significant fraction of workers with unusually low (less than 80 percent) or unusually high (more than 100 percent) levels of income replacement. All of these states base benefits on a percentage of workers’ gross (before-tax) income, an approach that presents policymakers with a Hobson’s choice: Attempts to reduce the number of workers with low replacement rates increase the number of workers with high replacement rates, and vice versa.

Michigan bases benefits on a percentage of workers’ spendable (after-tax) income. As the table indicates, this approach yields a more equitable distribution of benefits — mitigating the Hobson’s choice.

The results have been published in two volumes. In addition, WCRI publishes regular analyses in special research briefs for newly added or updated states.

Workers with High or Low Replacement Rates, by State and Benefit Feature Responsibility

Designing Benefit Structures for Temporary Disability: A Guide for Policymakers. VOLUMES 1 & 2. Dr. Richard B. Victor and Charles A. Fleischman. December 1989. WC–89–4 / WC–89–4a.

Copyright: WCRI

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