COVID-19, PEOs, and the Workers’ Comp Market

In late December, I wrote an article on coming workers’ compensation (WC) trends for the broader WC market as well as the PEO WC market. At the time, I thought to myself that my approach was reasonably conservative and that it would have to take something completely out of left field for my prognostications to be materially off.

Prognostications? Meet COVID-19.

(My weekly work routine? Also meet COVID-19.)

Entering week two in my new make-shift home office, I’ve been getting emails and texts from clients who are thinking about the future and, like me, wondering how this will all play itself out in the WC industry. Specifically:

• How will a COVID-19-driven recession impact WC costs?
• How may a COVID-19-driven recession impact the broader WC market versus the PEO WC market?
• What similarities does a COVID-19-driven recession have with past recessions?

Let’s take a look.

Impact of Recession on Broader WC Market Costs – Frequency

When analyzing WC costs, it’s common to separate the analysis into frequency and severity components, as often it can provide additional insights that looking at the combined whole doesn’t provide.

In this case, history has shown us that frequency tends to decrease in times of recession. Recall that frequency is the ratio of the number of claims relative to an exposure base, such as payroll.  As such, frequency could theoretically increase if payroll declines at a faster rate than the number of claims. But the general thought is that claims decline faster than payroll during a recession largely because of last-in-first-out employment changes. That is, less tenured, less experienced workers are typically the first to get laid off during a recession. On average, these workers have higher propensity to have a WC claim than the average worker, who presumably has more tenure and more experience. In fact, a 2008 analysis by NCCI’s then-Chief Economist, Harry Shuford, showed that those less experienced workers were 46% more likely to have a WC claim.

The declining trend isn’t all one-sided.   There are unique drivers during a recession that may force frequency up. For example, workers may fear unemployment or the risk of their employer having to close up shop.  This fear may lead the employee to file a WC claim to earn higher and longer-lasting wage in lieu of going on unemployment.

It is also important to note that pre-coronavirus frequency trends were already downward, driven largely by greater use of technology and improvements in, and emphasis on, worker safety conditions. Thus, the impact of a recession will likely continue the downward frequency trend.

Impact of Recession on Broader WC Market Costs – Severity

While the impact on WC frequency during a recession has ample precedent, the impact on WC severity is less clear.

Indemnity costs may increase in recessionary times as workers file claims to avoid unemployment and may stay on WC disability for longer due to the better wage and lack of work replacement. And for these claimants to continue receiving indemnity payments, they will need to incur additional medical expense through more treatments or doctor visits.

Adding to the uncertainty is the impact of wage which statutorily impacts indemnity costs. Because wages may decrease or not increase during recessionary periods, indemnity costs will move in the same direction.

Overall, WC costs are likely to benefit from lower frequency, but this will be partially, or even completely, offset by changes in severity.

Different Impacts on Broader WC Market vs PEO WC Market

While many of the above trends and drivers are likely to mirror themselves in the PEO WC market, there are some key differences that may result in a materially different outcome.

PEOs primarily serve small and medium-sized businesses (SMBs) which are disproportionately impacted relative to larger firms during a recession^[1], whether driven by reduced cash flow, a tightening credit environment, or decreased/disappearing demand.

Industry data from the 2008 recession also reveals other ways in which PEOs may be impacted:

• Revenue growth slowed and even decreased as much as 5% through a combination of clients decreasing in size and fewer clients in total
• Client retention decreased 4 pts on average from peak to trough