Definition
Workers' compensation (WC) moral hazard refers to behavioral responses to WC insurance that increase costs beyond what would occur if workers and employers fully internalized risk. Two distinct forms are identified: ex ante moral hazard (reduced accident prevention because insurance covers the financial consequences) and ex post moral hazard (false or exaggerated claims, including reporting off-the-job injuries as work-related). Because WC insures workers against wage loss from workplace injury, it lowers the private cost of an accident and can raise both the incidence and the reported severity or type of injuries.
Key Ideas
- Ex ante moral hazard: The worker's incentive to exercise care diminishes with WC benefit levels. Higher benefits → lower marginal cost of an accident → reduced preventive effort → more true injuries.
- Ex post moral hazard: Workers may file claims for accidents that never occurred, report injuries as more severe than they are, or attribute off-job injuries to the workplace. Since hard-to-diagnose injuries (back disorders, soft-tissue injuries) are intrinsically more difficult to verify, ex post moral hazard is concentrated in that category.
- Employer-side: Experience-rating partially internalizes costs by linking premiums to firm claim experience. When experience-rating is strengthened, ex ante moral hazard on the employer side decreases (firms invest more in safety).
- The composition test: If WC benefits raise the proportion of hard-to-diagnose injuries relative to easy-to-diagnose ones, this specifically implicates ex post moral hazard — a compositional shift impossible from prevention effects alone. Bolduc et al. (2002) operationalize this test using Quebec construction data.
- UI-WC substitution: In seasonal industries, WC may serve as a substitute for unemployment insurance (UI), amplifying ex post moral hazard in winter (lay-off seasons). Fortin and Lanoie (1992) documented this substitution channel in Quebec.
How It Works
The Three-Alternative Model (Bolduc et al. 2002)
The worker faces three options each period: (1) report a difficult-to-diagnose injury (true or false); (2) report an easy-to-diagnose injury; (3) report no injury. The WC wage replacement ratio affects all three options through two channels simultaneously:
- Ex ante: Higher WC benefits → less prevention effort → higher probability of true injury of either type.
- Ex post: Higher WC benefits → higher payoff from false/exaggerated reporting → disproportionate increase in difficult-to-diagnose claims (where false claims are harder to detect).
The combined prediction: WC benefit elasticity is larger for difficult-to-diagnose than for easy-to-diagnose injuries. Bolduc et al. confirm this across all specifications and both subperiods:
| Period |
Difficult-to-diagnose (multinomial probit [MNP] panel) |
Easy-to-diagnose (MNP panel) |
| 1977–78 |
4.01 |
2.17 |
| 1979–86 |
2.62 |
2.20 |
Experience Rating and Moral Hazard Attenuation
The 1979 Quebec reform introduced firm-level experience rating. The post-1979 drop in elasticities (from ~4.0 to ~2.6 for difficult-to-diagnose) is consistent with employers investing more in workplace safety when premiums reflect their own claim history, reducing the ex ante channel.
Physician Choice as an Amplifier
Quebec (unlike most North American WC systems) permits workers to select their own physician to certify the injury. This amplifies ex post moral hazard: workers can choose physicians willing to certify questionable claims, making the verification problem more severe.
Why It Matters
- Optimal insurance design: In the presence of ex post moral hazard, standard partial-coverage solutions (which address ex ante moral hazard) are suboptimal. Crocker and Morgan (1998) show efficient contracts should provide overinsurance for small losses and underinsurance for severe injuries, reversing standard moral-hazard logic.
- Auditing policy: Since ex post moral hazard is most severe for hard-to-diagnose injuries, claims in that category (back injuries, bursitis, spinal disorders) warrant more intensive auditing. Mookherjee and Png (1989) formalize the costly-state-verification framework for this.
- Program substitution: If UI benefit cuts push seasonal workers toward WC, the ex post moral hazard channel activates even without any change in WC generosity — highlighting the importance of cross-program interactions in disability policy design.
- Fiscal consequences: WC moral hazard inflates both program costs and disability insurance (DI) enrollment (via the occupational injury pathway). See Workers' Compensation and DI for the downstream DI effects.
Open Questions
- How much of the WC elasticity reflects ex ante vs. ex post moral hazard? The composition test establishes the presence of ex post effects but cannot cleanly decompose the total.
- Does experience-rating eliminate or merely reduce moral hazard? Quebec's post-1979 elasticities remained substantial.
- Do Monday-effect patterns (Smith 1989) or seasonal seasonality in hard-to-diagnose claims replicate in other industries and jurisdictions?
- How does the physician choice feature of Quebec WC interact with the frequency and composition of claims compared to systems where employers designate physicians?
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