Workers' compensation: Determining a feasible payment structure in a regulatory environment

Abstract

Moral hazard complicates the design of an optimal benefit structure in a regulated social insurance program such as workers' compensation. We discuss the type of empirical information necessary to set optimal benefit levels in the presence of moral hazard. Since we present trends in indemnity and medical expenditures that indicate the presence of “claims rate moral hazard,” we develop and estimate a model of this type of moral hazard. We find evidence of moral hazard effects that are roughly consistent with those found elsewhere in the literature. We also present the first direct estimates of the impact of benefits on the output of the firm. We find that an increase in real benefits significantly decreases the output of the firm. This is consistent with notion that higher benefits induce more jobless spells and increase production costs using skilled labor. We close by illustrating how these estimates can be used to provide information on the feasible benefit schedule, given the presence of moral hazard.