Steven Fanaroff was baffled. As CFO of privately held Magruder Holdings Inc., a well-known grocery store chain in Virginia, Maryland and Washington, D.C., he had watched the premiums on the company's workers compensation insurance jump in each year for the last several by 25%. The company had been maintaining a payroll of about 600, and it wasn't as if there were significantly more claims. The problem Fanaroff found was that the average medical bill for each claim seemed to be rising dramatically. "We discovered a cut finger costs more to treat if it occurs at work than if it occurred at home," says Fanaroff from his Rockville, Md., corporate headquarters.

Fanaroff is not alone in his discovery of how the system works. According to figures provided by Tillinghast Towers Perrin, the inflation in health care costs for workers comp has not only exceeded that for overall medical care–the gap between the two has been growing exponentially. For instance, in 1998-99, the growth in medical care costs for workers comp was not quite double the inflation in overall health care, but by 2000-01, the workers comp number was almost triple the growth in the nation's medical bill. (See chart on page 30.)

How can that be explained? In the mid-1990s, the answer seemed clear to everyone: Health costs under workers comp were climbing at a rapid clip because most had been exempted, by law, from managed care controls. One need only look at the growth in costs between 1993 and 1998, the years in which managed care produced the biggest cost savings for corporate plans, to see what the absence of managed care meant for workers comp. (See chart on page 31.) "With group health care–a traditional employee benefit–a physician or hospital typically receives a fixed fee per employee of, say, $200 a year," explains Robert Hartwig, chief economist at the New York-based Insurance Information Institute. "There is a strong incentive for the doctor to resist additional tests beyond what is necessary, otherwise his or her costs rise and profits diminish. If someone needs just a single X-ray as opposed to a CAT scan, for example, there's more money left over for profit."

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