The state Department of Labor and Industries (L&I) says major rate hikes may be needed to replenish the state fund.

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The man in the yellow shirt, blue overalls and hard hat uses both hands to guide a sheet of steel toward a band saw, his left pinkie sporting a black medical bandage.

The bandage covers what’s left of Ile Ifopo’s little finger, which was smashed between two heavy steel bars last December. He ignored the injury until March, when he went to see a doctor, who amputated the fingertip.

Now, instead of staying at home for weeks and collecting partial pay from the state workers’ compensation system, the 67-year-old steel cutter is assigned to light duty and gets his full paycheck.

“I love my work,” he says, breaking into a big smile. “If I stay home, I’ll get old very fast.”

The state subsidizes the arrangement under the Stay At Work program, part of a legislative package passed in 2011 with the goal of saving the state $1.1 billion over four years and heading off huge increases in workers’ compensation insurance premiums for businesses.

Despite the reforms, officials at the Department of Labor and Industries (L&I) say major rate hikes may be needed to replenish the state fund — and those increases could last for a decade.

L&I officials recently offered scenarios with base rate increases between 7.8 percent and 28.6 percent next year. The department won’t propose a final base rate until September. (A company’s record of workplace injuries also affects its premiums.)

Milt Vine, owner of Seattle Bindery, a family business with about 20 employees, said a rate hike of more than 20 percent would be “an unmitigated disaster.” Even 7.8 percent could hurt job growth, he said.

“To the extent you raise the cost base of small businesses that are already struggling in tough economic times, it’s just making it that harder to survive,” Vine said.

The 2011 reforms reduced the state fund’s liabilities by about $380 million, according to L&I’s outside actuary, Deloitte Consulting.

But the actuary also said the state fund’s surplus needs a boost in case liabilities turn out to be higher than expected. Like banks, insurers need to maintain sufficient capital to cover unexpected losses.

Washington’s surplus level is significantly lower than at most other workers’ comp funds or insurance carriers, the actuary wrote.

Surplus tapped out

Blame the Great Recession for the rate hikes needed to replenish the fund’s surplus, state officials say. The economic crisis hurt the fund in three ways:

• The fund recorded more than $400 million in investment losses during the recession. Insurers rely on investment income to balance losses from insurance operations.

• Job losses, especially in the construction industry, meant that premiums dipped. The poor jobs recovery has also made it more difficult for injured workers to find new jobs, so they stay on disability longer and the cost is higher.

• To shield businesses from huge rate hikes, state officials spent down the surplus, which fell from a peak of about $2.1 billion in 2007 to $621 million as of March 31.

Now the surplus stands at 5 percent of liabilities, leaving almost no cushion for unexpected losses. Other states’ workers’ comp funds maintain a much higher ratio: Oregon’s ratio is 26 percent, while Ohio’s is 28 percent.

To get the surplus to somewhere between 9 percent and 19 percent of liabilities will require between $470 million and $1.75 billion in new insurance premiums, officials say.

Besides the Great Recession, there’s an even bigger shadow influencing the discussion about future rates — a staggering $7 billion in liabilities the state fund has racked up for total permanent disability pensions.

Washington’s rate of pension claims per 100,000 workers is the highest in the nation. Last year, it granted 1,272 pensions, down from 1,769 in 2009. Still, for a worker who’s received lost wages for a year, the odds of a pension ultimately being awarded are 1 in 5, up from about 1 in 10 a decade ago, L&I reports.

Liabilities for pensions, which account for close to half of the system’s benefit costs, are mushrooming because the state can no longer count on relatively high interest and investment income.

Using a lower “discount rate” to project earnings means the state has to put more money in the fund: between $772 million and $2.2 billion to cover the shortfall, depending on how pessimistic the state’s outlook is on future investment yields.

L&I has developed two dozen scenarios to raise the money, but those are still just for discussion, officials say. Next month actuaries will give the state one key figure: the rate needed for the fund to break even, based on wage and medical inflation and the cost of next year’s expected claims.

Efforts to rein in costs

Gov. Chris Gregoire presided over deal-making on workers comp between business and labor interests in the spring of 2011. While the reforms resulted in an immediate drop in costs, it will take years to see if they produce the expected savings.

Two key reforms — both inspired by Oregon’s system — are taking longer than initially forecast to gain traction: Stay At Work and voluntary “structured settlements.”

Employers and business leaders endorse Stay At Work.

“I’ve been in HR for over 30 years. To me this has been one of the most effective state programs I’ve ever seen,” said Dave Salzberg, director of human resources at Kirkland-based Postal Express, a delivery service with about 400 employees. “If a company doesn’t take advantage of it, they’re basically missing the boat.”

Bill Smith, who manages Stay At Work for L&I, said more than 800 employers participate in the program, which covers half an injured worker’s wages for about three months or $10,000, whichever is less. Stay At Work subsidies don’t count against the employers for rate setting.

“Costs are down, morale is better, the worker is less likely to become disabled,” Smith said. “Everyone wins.”

Stay At Work was expected to save the state about $16 million in its first year and $32 million annually after that, according to projections given to lawmakers. Those estimates were predicated on the state disbursing about $12.5 million in subsidies to employers in the first year.

But so far Stay At Work has spent only $5 million.

L&I officials say they still expect the predicted savings over the long run, and that claims managers are making progress in returning injured workers to jobs sooner.

“We’ve made a huge effort to work incoming claims and resolve them more quickly,” said Kim Contris, an L&I spokeswoman.

There were similarly grand hopes for the structured settlements initiative, which pays a fixed amount over several years for long-term injuries instead of providing a lifetime pension.

L&I geared up to handle 3,000 requests, while a state board that gives final approval for the settlements was expected to receive about 1,350 this year.

But as of June, L&I had received about 300 settlement applications, and the board had received less than 30 proposed deals, state officials say.

Contris said L&I believes injured workers are still unfamiliar with the structured-settlement concept. “We believe there are people who will step forward as time goes on,” she said.

Other changes aim to slow the growth of medical costs — an area in which Washington state has done better than most states — and save $218 million over four years.

Starting in January, injured workers will be required to go to a network of doctors and other providers approved by the state for ongoing care. Doctors who don’t follow treatment guidelines can be dropped from the network.

And starting in 2013, L&I will expand statewide its Centers for Occupational Health and Education (COHE), which focus on safely returning workers to their jobs in the first 90 days after an injury.

The centers, which were piloted in Renton, coordinate with doctors to assess regularly what a worker can do, talk with employers about light-duty tasks, and follow up with workers to ensure they don’t miss doctor’s appointments.

“When you’re home, sitting on the couch, lying in bed, your whole body gets weaker and weaker,” said Jaime Nephew, a physical therapist at the COHE in Renton. “That’s why people have trouble going back to work after a long-term injury.”

Workers have a stake

On a recent morning at Seaport Steel, steel-cutter Ile Ifopo was shuttled to and from a clinic connected to COHE by human-resources manager Fern Shumway, and then was back at the warehouse, on light duty. Over the years, she said, she’s brought down injury claims at the Seattle firm from more than 40 a year to less than 10.

“When you get disconnected from the workplace, you don’t feel you’re part of the team anymore,” Shumway said. “It can lead to depression.”

Ifopo, who was sitting in a lawn chair chatting with two co-workers during a break, said he hoped to be done soon with physical therapy to regain flexibility in his pinkie finger.

Even workers who stay healthy have something at stake in the workers’ comp system: Washington state is the only one where workers cover a significant portion of the premiums — about a quarter of the cost.

That means the system’s expenses and each workplace’s injury rate ultimately affect workers’ paychecks, too. Shumway said she tells her staff: “You just had a pay decrease when your co-worker got hurt.”

Sanjay Bhatt: 206-464-3103 or