Understanding the Impact of Recessions on Workers’ Compensation

Workers and employers in the U.S. have endured 17 recessions during NCCI’s 100 years of operation. Recessions produce far-reaching consequences on the economy, and the extent of those impacts depends on the severity, length and nature of the economic downturn. While there are some similarities across recessions, each one has impacted the economy, workers and the workers’ compensation system in unique ways.

Employment, Industry Composition, Employee Tenure

During a recession, employment levels decline as businesses face economic challenges and reduce their workforce. The simplest impact on workers’ compensation is that with fewer workers, overall payroll decreases, leading to a reduction in workers’ comp premium.

NCCI’s research, conducted across several decades, has explored the relationship between injury frequency and fluctuations in employment.

There are two main channels by which this occurs.

First, as businesses reduce their workforces, the industry composition changes. For example, in the Great Recession, the construction and manufacturing industries suffered the largest percentage of employment losses. These industries have high injury rates per worker or per payroll.

Second, in a recession, businesses make fewer new hires and new workers on the job are typically the first to be let go. Short-tenured workers tend to have higher injury frequency than longer-tenured workers. Thus, as the proportion of short-tenured workers in the workforce diminishes, there is a reduction in overall injury frequency.

NCCI identified that the share of short-tenured workers is a crucial factor in driving injury frequency during recessions. A common misconception is that workers tend to file workers’ compensation claims at a higher rate during a recession. NCCI data indicates that the opposite is true, which can be partially explained by the changing mix of workers across industries and worker tenure.

When the economy starts recovering and companies expand hiring again, there are more new workers, and construction employment often booms. These factors put upward pressure on the frequency of claims during the period of economic recovery.

These patterns have been generally observed throughout previous economic downturns; however, there is no one-size-fits-all model when understanding the impact of a recession.

Shifting Workplace and Workforce

The COVID-19 pandemic led to significant shifts in the workplace and workforce. Many of these shifts were different than changes in previous recessions and tell a different story.

The biggest shifts relate to the nature of job loss and recovery from the COVID-19 recession. Job losses were larger than any downturn since the Great Depression and occurred in a very short time frame, primarily from February to April 2020. The Great Recession’s employment losses had occurred over two years – not two months. But the recovery was also much more rapid than in the Great Recession. These changes in the workforce were unprecedented.

Another key issue is that the pandemic-related recession was primarily a “services recession.” Because of pandemic-related shutdowns and quarantines, as well as voluntary changes to behavior, the largest job losses occurred in sectors that provide in-person services, especially leisure and hospitality.

This led to a dramatically different impact on the mix of workers in the economy and in workers’ compensation than in most downturns. The changing workforce composition led to a temporary spike in average worker wages because lost restaurant jobs averaged far lower wages than those remaining.

A Great Reshuffle began in the second half of 2020 as the economy reopened. Businesses posted record numbers of job openings, and many workers moved across jobs, occupations and sectors. This led to a spike in short-tenured workers in late 2020 and 2021, which put upward pressure on injury frequency. However, the impact was somewhat moderated because the injury differential between short-tenured and full-tenured workers is smaller for service sectors than for sectors such as construction and manufacturing.

There were other major changes to the workforce. Most notably, the pandemic led to a large-scale adoption of remote work. While there has since been a partial return to the office, there is no doubt that the share of remote work dramatically and permanently increased. This change led to a reduced number of injuries in office and clerical occupations where remote work is most prevalent. It also led to a temporary reduction in motor vehicle accidents and a rise in telemedicine.

Other changes to the workforce in the post-pandemic recovery, such as a relative decrease in labor force participation for those over age 65, can also impact the economy and workers’ compensation.

Today’s Economic Outlook

At midyear 2023, employment and wage growth remained above pre-pandemic averages. There has been substantial slowing in labor market growth since the fast recovery period in 2021 and early 2022, but economic indicators are more consistent with continued gradual cooling off than an imminent recession.

Both residential and nonresidential construction employment and spending are robust, and the manufacturing sector’s indicators are holding steady. These sectors, which are sensitive to changes in economic demand, play a crucial role in impacting workers’ comp premiums and losses.

Small businesses played an outsized role in catch-up employment recovery. Despite concerns about cutbacks due to tightening credit conditions, small businesses continue to steadily add jobs each month through the present writing.

One potential driver of slowing growth relates to household income and consumption patterns. Real household income has fallen below pre-pandemic trend due to higher inflation, but personal consumption has remained consistent with the pre-pandemic trend. To maintain this consumption, households have been spending down surplus savings accumulated early in the pandemic. This surplus is likely to run out late in the year, which will likely cause consumption to dip below the trend.

This potential slowdown in consumer spending would contribute to a deceleration in economic growth, but a slowdown is not necessarily indicative of a full-blown recession. Although the possibility of a contraction exists, it’s likely that employment and wage growth may level off, but without the disruption of significant job losses or payroll declines. NCCI’s recent “Quarterly Economics Briefing-Q2 2023” examines the current state of the economy in further detail.

Unique Moments in Time

Recessions have a multifaceted influence on workers’ compensation, impacting employment levels, payroll and injury frequency. Understanding the changes in workforce composition during economic downturns provides valuable insights into the dynamics at play.

During the last 100 years, we have experienced more than a dozen recessions, with each scenario impacting the economy differently.

There is one constant: There’s not one indicator or one formula that explains how an economic downturn will impact workers, employers and workers’ compensation. Each moment is unique, and while we can learn from experience, we must also remain vigilant and be prepared for the next economic challenge.

Executive Summary

In late July, the staff of the U.S. Federal Reserve was no longer forecasting a recession in 2023. But with talk about the prospect of a recession or soft landing still circulating, Carrier Management asked NCCI to describe how recessions typically influence workers’ compensation results.

Here, NCCI representatives focused on changes in three contributing factors: employment, industry composition and employee tenure. Beyond providing insights into how future recessions might impact the workers’ comp landscape, this look at past recessions reveals that commonly held assumptions about their impact on comp claims may not hold up under scrutiny.

This article originally was published in Insurance Journal’s affiliate Carrier Management.