The history of so-called second injury funds demonstrates, among other things, how unintended consequences can thwart even the best intentions of workers' compensation policymakers.
The July 1, 2007, closure by New York state to new claims against its SIF, often referred to as the Special Disability Fund or the 15-8 Fund in reference to its section in the controlling statute, illustrates this phenomenon and highlights the financial and administrative issues common to most states looking to close their SIFs.
Despite being a relatively small component of a state's overall workers' comp system, the declining number of active SIFs is of interest to many workers' comp risk management professionals, such as actuaries, underwriters, reinsurers, claims managers and insurance industry executives.
The SIF story in New York should also capture the attention of public-policy decision-makers across the country, at least some of whom may face similar choices and outcomes down the road.
Most states started SIFs near the end of World War II as well-intentioned programs aimed at addressing two related needs. First, the intent was to ensure that employers did not discriminate against veterans returning from war with serious wounds, the effects of which could be compounded by a subsequent on-the-job injury.
Second, the program aimed to alleviate employers of the burden (owing to the financial structure of most workers' comp programs) of accommodating a workforce with expensive "first injury" claims--war wounds in this case--not previously considered part of the employers' costs for workers' comp.
New York's SDF, however, predates that relatively late effort. It is one of 14 funds around the country that were set up a generation earlier to address the rare but oft-cited "pure" second injury dilemma. It was formed so that an employer wouldn't bear the cost of a permanent total disability incurred by an employee who had a permanent partial disability received working for a prior employer.
In fact, from its inception in 1916 until 1943, the New York SDF paid benefits only for the loss of a second limb or eye, rare events by any measure. By the end of World War II, however, the SDF began to expand claims coverage beyond two limbs or two eyes, to include "first injuries" that might not be work-related. The expansion included such things as arthritic conditions, obesity or diabetes--conditions not classified as injuries to begin with.
Each state that enacted an SIF created unique rules. In New York, the second injury must be caused by both the prior permanent physical impairment and the subsequent injury. It must be materially and substantially greater than the disability that would have resulted from the subsequent injury alone.
Some people call this relationship between conditions and injuries "linkage." In New York, two unrelated injuries or an unrelated injury and medical condition wouldn't pass the test for coverage.
In fact, the prior permanent physical impairment must also have "hindered" the claimant's employment, a provision thought to be unique to New York. The expansion of the definition of first injuries to include soft-tissue medical problems, which are often neither obvious nor acknowledged by workers, made it difficult to meet another requirement of the law--that employers have knowledge of an employee's first injuries.
Inevitably, the ambiguity over what constituted "employer knowledge" gave rise to extensive litigation. However, one thing became clear. When employer knowledge is held to a high standard of proof, second injury funds have low claim-acceptance rates.
Such was the case in New York until 1987, when the state removed the requirement for employer knowledge of first injuries. Since then, the scope of the SDF has greatly expanded and with it, the number of claims submitted.
From 1945 to 1987, the average annual number of claims submitted was less than 500. Since 1990, the SDF has averaged approximately 4,000 submitted claims annually. As of January 2007, there were 214,500 pending claims.
In an effort to moderate the steeply rising annual payout of the SDF, New York enacted legislation in 1996. The law extended the waiting period during which the SDF does not reimburse the employer/insurer for benefits paid, from two years to five from the accident date.
However, the measure clogged the operation of the SDF. When the waiting period was two years, employers and insurers usually filed claims as quickly as possible in the hope of avoiding expensive medical treatment, such as surgery, which frequently occurs more than two years after injury.
With the change to a five-year waiting period, the financial incentive for early establishment of claims evaporated, and the entire claims-management process slowed down. Work on pending claims grew to fill the time allotted for it; some claims can take up to 10 years to get established. Meanwhile, New York's annual disbursements are the largest of any SIF in the United States. They grew from $244 million in 1996, when the waiting period was extended, to nearly $500 million 10 years later.
One consequence of the legislation that closed the New York SDF to claims for accidents on or after July 1, 2007, is undeniable and inevitable: The clock started ticking on a three-year period for submitting all the documents necessary to establish a claim.
When July 1, 2010, rolls around, all filings will have been processed, and the universe of SDF claims will finally be known. Equally important, the status of all SDF claims, open or closed, will also be known, and relatively soon. Under the new law, requests on claims established before July 1, 2010, must be filed within one year after the expense has been paid, or by the date of the new law, whichever is greater.
When all the submissions have been totaled and tabulated, the universe of SDF claims will embody the central paradox that came to dominate SIFs in New York and elsewhere: Why were New York's workers' comp costs among the highest in the nation despite weekly maximum benefits that ranked among the lowest? A simple equation developed from an analysis of "nonscheduled permanent partial disability" claims in New York can help answer the question.
Although the number of claims is declining and the maximum weekly benefit is very low, the life duration of these claims kept New York's workers' comp costs very high. In recent years, NS PPD claims made up less than 10 percent of all submissions but represented more than 75 percent of total indemnity costs. Why?
In New York, as in most other states, soft-tissue injuries of the back, neck or shoulders, often not obvious or acknowledged by the affected employee, dominate NS PPD awards. Moreover, medical benefits for work-related injuries are payable for up to the life of the claimant. That life span will probably encompass the full spectrum of medical services. That extends from testing, surgery and physical training early in the claims process to the pain treatments and, in some cases, attended care that dominate treatment costs for claims open more than a few years.
Would New York employers and insurers have been as tolerant of the cost associated with these lifetime payout claims had many of them not disappeared into the SDF? States such as Florida, Kentucky and West Virginia made lifetime payout claims readily available in a setting where they disappeared into a SIF.
In Florida and Kentucky, the SIF was closed to new claims, and law changes reduced the future number of lifetime awards. In the case of West Virginia, the entire exclusive state fund was shut down because of its deteriorating financial condition; private insurance will begin there in 2008. The tolerance for a high frequency of lifetime awards in active SIF states is a clear historical lesson and an obvious departure from the original intent of SIF mechanisms.
SIFs like the SDF in New York worked well when they were narrowly defined by a few specific injuries, required employer knowledge of first injuries and addressed a small universe of potential claims.
Over the years, however, they've grown like some jerry-built Victorian mansion, adding rooms and extensions with little attention to the underlying architecture of the workers' comp system or the true costs of growth--thus, the dwindling number of states still operating some version of an SIF.
The trend toward closure of the funds by state authorities reinforces the impression that SIFs have become too costly to operate, both politically and financially.
ROBERT K. BRISCOE and ROBERT J. MEYER, FCAS, are actuaries with Milliman.
November 1, 2007
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