Inflation Is Hitting Consumer Prices Hard. Here’s Why Workers’ Comp Hasn’t Felt It — Yet

By: | August 21, 2023

Matt Zender is senior vice president and Workers’ Compensation Product Manager for AmTrust Financial Services, one of the top workers’ compensation carriers in the U.S. At AmTrust, he manages the WC Product line and strategy. He has been in the industry for over 25 years and is active in a number of committee and board positions of thought leaders and bureaus throughout the country, including CWCI, NCCI and NYCIRB.

For the past few years, inflation has impacted all of us as we shop for food at the local grocery store, eat at restaurants, fill our gas tanks, buy new cars and look for a new home.

The inflation rate, topping off at 8.5% a year ago, has not dramatically impacted workers’ compensation — yet. This is due to medical inflation staying at a lower rate than overall consumer inflation.

Why hasn’t medical inflation spiked as much as consumer inflation? How do these numbers impact workers’ compensation? And will it lead to changes in the final rates charged to policyholders?

The high consumer inflation numbers were the result of many factors, including an overheated economy due to COVID-19 stimulus money, post-COVID-19 recovery, supply chain issues and labor shortages. Higher energy costs are the largest category impacting the CPI, affecting the costs of vehicles, food and shelter. However, there have been positive signs, as we saw in the May 2023 Consumer Price Index (CPI) report, which showed that the inflation rate (4%) had cooled down to the lowest rate in two years.

How Does Inflation Impact Workers’ Compensation?

Inflation and other macroeconomic factors impact the insurance industry, perhaps no line more than workers’ compensation. While social inflation isn’t currently prevalent in the system, inflationary trends in wages and medical directly affect profitability in the line. Additionally, there are trend factors that can serve to amplify these effects, including frequency and medical and indemnity severity.

The COVID-19 pandemic saw very large payroll swings. In many respects, the easiest way to evaluate the trend lines is to focus on 2019 to 2022. For example, using U.S. Bureau of Labor statistics, 2022 saw a payroll increase of 9.9% over 2021. In this year-over-year view, wages (what folks are getting paid) went up 4.8%, while employment (how many folks are working) went up 4.9%. That is fairly balanced.

For comparison, when we look at 2019 to 2022, we see a payroll increase of 22.1%. However, this is mostly wage growth (20.1%) versus employment growth (1.6%). The employment growth view of 2022 versus 2019 demonstrates how tight the labor market is right now, with unemployment figures near all-time lows.

Medical Inflation’s Impact on Workers’ Compensation

Medical inflation in workers’ compensation has been relatively moderate for the past 10 years. Still, the food, shelter and energy inflation numbers of the past two years have raised concerns that medical inflation would rise at similar levels. Thankfully, medical inflation is usually more stable and moves more slowly, so the numbers did not increase when consumer inflation rose last year.

Medical inflation is split into services (including facilities and physician care) and commodities (including drug costs and medical equipment). The medical care services numbers carry a higher weight (at 80%) in the overall medical inflation numbers.

In the May 2023 CPI report, medical services inflation dropped to -0.1%, well below the overall average. A decrease in health insurance drove this number. Overall, the remaining medical services are at 2.2%. The physicians and related services’ inflation number dropped to 2.0%.

Removing health insurance, medical inflation is 2.6%. The main drivers of medical inflation are nursing home/invalid care and dental and inpatient hospital care.

The medical commodities inflation figure is 4.4%, led by nonprescription and medical equipment costs. Prescription drugs are the most significant portion of that total number at 3.1%. This number reflects a level of cost controls on pharmaceuticals present in health insurance and workers’ compensation.

Workers’ compensation state fee schedules are often tied to Medicare, which often lags behind the actual changes. Workers’ comp costs could go up after the CPI number drops. Currently, workers’ comp medical costs are running well below the medical CPI, but the commodities number is concerning.

Factors Driving Medical Claim Costs

According to an NCCI report, workers’ compensation paid costs increased by 1.5% annually between 2012 and 2019. Due to the COVID-19 pandemic, there was a dramatic drop in new workers’ comp claims. A drop in the denominator like this will often realize an increase in severity, as smaller claims don’t make their way into the system. Despite this, in 2021 medical cost per claim rose only 2%.

As with the medical inflation numbers, two factors drive changes in medical claim costs: the price of medical services and utilization, which measures the mix and number of services provided to an injured worker. Physicians, facilities, drugs and other services contribute to workers’ comp medical costs. Overall, drug costs are declining (mostly driven by opioid reforms), physician costs are up slightly and facility costs are rising in the workers’ compensation system.

The average physician paid cost per claim grew moderately from 2012 to 2021 at about 1.5% per year. Physician service prices increased, which was the primary driver of growth in costs across the U.S. Change in utilization was the principal contributor to shifts in costs of surgeries and physical medicine services; surgery use decreased, while physical medicine use increased.

During the first year of an injury, facility and physician costs make up the largest share of the treatments. These services diminish over the next few years as prescription drugs and physical medicine take over as potential treatments for the injured worker. Therefore, claims at different stages of the injured worker’s recovery will have different pricing.

Facilities were the most significant contributor to workers’ compensation medical cost changes. The changes in medical facility costs reflect the amount paid per visit and the number of visits per claim. The facility-paid cost per claim grew 3.3% annually, and hospital outpatient services were the most prominent contributor to the increase in facility costs.

While the number of inpatient visits decreased by 3% per year, the number of surgery visits to ambulatory surgical centers grew. Within each facility type, the amount paid on any individual visit can vary depending on the type of service performed during the visit — such as surgery, ER or imaging.

Guarding the Workers’ Compensation Market Against High Inflation

Unlike the generally untethered impact of inflation on items such as milk, the workers’ compensation industry does have some guards against runaway inflation, including:

  • Regulated fee schedules
  • Carrier-negotiated fee schedules
  • Contractual agreements with service providers
  • Settlement opportunities

Nonetheless, inflation is a key metric that deserves careful review. Inflation in wages should usually have a relatively linear impact on the premium, as payroll is the exposure base from a rating perspective. Changes in medical inflation, however, will be left for the individual carriers and bureaus to evaluate and determine the appropriate response. &