Fears of a recession emerged recently as long-term interest rates dropped below short-term interest rates leading to a so-called inverted yield curve.

This is Nebraska Workers’ Compensation Watch not CNBC, so I’m not going to play Mario Bartirehmo and go into the why and how of the inverted yield curve or make economic forecasts. (Blogger Joe Paduda wrote a good post about how a recession could impact workers’ comp. if you want to read about that sort of thing.)

Instead I will write about how workers’ compensation policy makers and regulators should respond to the threat of a recession and lower long-term interest rates.

The importance of state regulation

Workers’ compensation is first and foremost a form of insurance. Insurance is regulated at the state level. (You can read about the why of that here) In Nebraska, workers’ compensation insurance is regulated by the Department of Insurance and the Nebraska Workers’ Compensation Court. State regulators and lawmakers need to be doing two things to protect injured workers in any future recessions.

Preserve Guaranty funds – Guaranty funds pay out for claims from insolvent insurers. In Nebraska insurance companies need to pay into a guaranty fund. Insurance companies are financial institutions who make their money by collecting premiums and investing those premiums. In a recession, those investments can go bad. If bad investments lead to insolvency, a guaranty company can pay out claims from an insolvent insurer. Even if the economy doesn’t tip into a recession, low interest rates can lead to bad investment decisions and create problems for financial institutions like insurance companies.

The problem with guaranty funds is that politicians like to use them to balance state budgets instead of cutting programs or  raise taxes. A quick Google search reveals that such bi-partisan paragons of fiscal responsibility such as  Montana Governor (and Democratic Presidential Candidate) Steve Bullock and former New Jersey Governor (and former GOP presidential candidate) Chris Christie raided guaranty funds to balance state budgets. Cutting a workers’ compensation guaranty fund is essentially cutting benefits if the fund can’t pay legitimate workers’ compensation claims.

Strict scrutiny for self-insureds: Nebraska allows companies to self-insure for workers’ compensation. NWCC Rules 70-76 spell out the rules for self-insurance. The rules require yearly approval of for self-insurance and only a small number of employers are self-insured. I am not aware of a guaranty fund for self-insureds in Nebraska. Nebraska Workers’ Compensation Court rules requires a showing of financial responsibility in order to self-insure which should give workers’ some reassurance. But in the worst case scenario an injured worker would become a creditor in a bankruptcy proceeding if a self-insured went bankrupt.

The challenge of high deductible insurance – Financially unstable companies tend to have high deductible insurance for workers’ compensation. Those companies are more vulnerable to bankruptcy. In those cases, as Iowa law firm Gilloon, Wright and Haeml points out on their blog, insurance companies may want to delay payment until the bankruptcy is settled. Injured workers should retain counsel to preserve their rights in that situation.

Settlement value and interest rates

Last year I wrote how Nebraska’s mandated 5 percent discount rate lead to the undervaluing of permanent total disability claims. Long-term interest rates are good measure about the safe return on a long-term investment. The higher those rates the less an insurance company needs to put aside in order to meet their obligation to pay out an award of permanent total disability. The lower the rate of return the more they need to set aside to meet that obligation.

Traditionally the Nebraska workers’ compensation court would approve the settlement of litigated permanent total disability claims for 80 percent of the present value of the claim. In the last few years, the court has not been willing to follow the 80 percent rule. I suspect the difference between long-term interest rates and the mandated 5 percent discount rate is part of the reason that the court won’t follow that custom.

In the wake of low interest rates, the United Kingdom lowered their settlement discount rate. I believe jurisdictions in the United States need to follow suit. Long term interest rates have reached a historic low and are even negative in many countries. A 5 percent discount rate doesn’t make sense in these economic conditions.