Appendix C
The Relationship Between Impairments and Earnings Losses in Multicondition Studies

John F. Burton, Jr., Seth Seabury, Michael McGeary, and Robert T. Reville


The purpose of this study is to provide assistance to the Institute of Medicine (IOM) Committee on Medical Evaluation of Veterans for Disability Compensation, and, in particular, to help address portions of the committee’s first task:

How well do the medical criteria in the VA Rating Schedule and VA rating regulations enable assessment and adjudication of the proper levels of disability to compensate both for the impact on quality of life and impairment in earnings capacity? Provide an analysis of the descriptions associated with each condition’s rating level that considers progression of severity of condition as it relates to quality-of-life impairment and impairment in average earnings capacity.

This study focuses on the aspect of task 1 concerned with the relationship between the medical criteria used to determine the level of disability and the impairment (or limitation) in earning capacity associated with that level of disability. More specifically, this study examines the relationship between impairments (the medical consequences of injuries or diseases) and the actual loss of earnings (the economic consequences of the impairments). We also discuss the intermediate consequences between impairments and actual earnings losses, such as the loss of earning capacity. The relationships will be examined with evidence from multicondition studies (that is, studies involving two or more medical conditions). The study will not examine the relationship between impairments (the medical consequences of injuries and diseases) and quality-of-life impairment (sometimes referred to as “noneconomic losses” or “nonwork disability”). The study will rely



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A 21st Century System for Evaluating Veterans for Disability Benefits Appendix C The Relationship Between Impairments and Earnings Losses in Multicondition Studies John F. Burton, Jr., Seth Seabury, Michael McGeary, and Robert T. Reville The purpose of this study is to provide assistance to the Institute of Medicine (IOM) Committee on Medical Evaluation of Veterans for Disability Compensation, and, in particular, to help address portions of the committee’s first task: How well do the medical criteria in the VA Rating Schedule and VA rating regulations enable assessment and adjudication of the proper levels of disability to compensate both for the impact on quality of life and impairment in earnings capacity? Provide an analysis of the descriptions associated with each condition’s rating level that considers progression of severity of condition as it relates to quality-of-life impairment and impairment in average earnings capacity. This study focuses on the aspect of task 1 concerned with the relationship between the medical criteria used to determine the level of disability and the impairment (or limitation) in earning capacity associated with that level of disability. More specifically, this study examines the relationship between impairments (the medical consequences of injuries or diseases) and the actual loss of earnings (the economic consequences of the impairments). We also discuss the intermediate consequences between impairments and actual earnings losses, such as the loss of earning capacity. The relationships will be examined with evidence from multicondition studies (that is, studies involving two or more medical conditions). The study will not examine the relationship between impairments (the medical consequences of injuries and diseases) and quality-of-life impairment (sometimes referred to as “noneconomic losses” or “nonwork disability”). The study will rely

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A 21st Century System for Evaluating Veterans for Disability Benefits FIGURE C-1 Three time periods in a workers’ compensation case where the injury has permanent consequences. on selected previous studies from workers’ compensation, on new data from the Californian workers’ compensation program, and on the 1971 Economic Validation of the [Veterans Administration] Rating Schedule (ECVARS) study. CONCEPTUAL FRAMEWORK1 Three Time Periods As shown in Figure C-1, three time periods are pertinent in compensating a worker with an injury serious enough to result in permanent disability benefits. The preinjury period is relevant because inter alia the employee’s average weekly wage is used to calculate the cash benefits after the worker is injured. The temporary disability period refers to the time from the onset of the injury or disease until the date of maximum medical improvement (MMI) has been reached; and the permanent disability period refers to the period following MMI. The distinction between the temporary and disability periods is important because workers’ compensation programs provide different types of cash benefits in the two periods. The permanent disability period is the crucial period for our study of the veterans disability compensation program because we are examining the benefits provided to veterans with permanent consequences of their injuries or diseases. 1 This section is based in part on Burton (2005).

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A 21st Century System for Evaluating Veterans for Disability Benefits The Permanent Consequences of an Injury or Disease The study will rely on the conceptual relationship shown in Figure C-2 because this provides a useful framework for presenting the evidence on the relationship between impairment ratings and earnings losses. Figure C-2 differs from the model of disability presented in Chapter 3 of this report in two ways. First, Figure C-2 is only concerned with work disability, while the report also considers losses in quality of life, which are defined as “the consequences of an injury or disease other than work disability.” Second, Figure C-2 divides both impairment and work disability into subcomponents in order to facilitate the analysis in this study. The concepts in Figure C-2 described below correspond to the operational measures currently used to determine the amount of cash benefits provided by workers’ compensation programs and to the outcome measure used in the research on disability programs examined in this study. IA. Medical impairment: Anatomical loss—The American Medical Association’s (AMA’s) Guides to the Evaluation of Permanent Impairment, Fifth Edition (Cocchiarella and Andersson, 2001, hereafter referred to as the Guides) provides impairment ratings for certain medical conditions based on the anatomical loss. For example, Table 17-32 at page 545 of the Guides indicates that amputation of the leg above the knee at the midthigh is rated at 90 percent of the loss of the leg and 36 percent impairment of the whole person. IB. Medical impairment: Functional loss—The Guides provides impairment ratings for certain medical conditions based on the extent of the functional loss. Example 16-78 at page 514 explains how to determine the rating for a person who sustained a Colles’ fracture of the right distal radius: “The factors to be rated are the loss of motion of the wrist and forearm rotation.” FIGURE C-2 The consequences of an injury or disease resulting in work disability.

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A 21st Century System for Evaluating Veterans for Disability Benefits II. Limitations in activities of daily living—These are the limitations in the activities of daily living resulting from the impairment. These can be measured by some of the questions in the SF-36. (For example, Question 8 asks if the person’s health now limits bending, kneeling, or stooping.) IIIA. Work disability: Loss of earning capacity—This is the presumed loss of earning capacity resulting from the functional limitations. This can be measured by some of the questions in the SF-36. (For example, Question 13 asks if during the past four weeks the person cut down the amount of time spent on work or other activities as a result of his or her physical health.) The loss of earning capacity approach is used in a number of workers’ compensation programs for certain types of injuries. IIIB. Work disability: Actual loss of earnings—This is the actual loss of earnings resulting from the injury or disease and its consequences (e.g., impairment). The actual loss of earnings is measured by the difference between the worker’s actual earnings and the earnings the individual could have been expected to earn if he or she had not been injured (potential earnings) as shown in Figure C-3. In this example, prior to the date of injury, wages increased through time from A to B, reflecting the worker’s increasing productivity and other factors that caused wages to increase, such as inflation. At point B, the worker experiences a work-related injury that permanently reduces his or her earnings. Had the worker not been injured, his or her FIGURE C-3 Actual losses of earnings for a worker with a permanent disability.

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A 21st Century System for Evaluating Veterans for Disability Benefits earnings would have continued to grow along the line BC. The worker’s actual earnings in this example dropped from B to D and continued at this zero earnings level until point E, when the worker returned to work at wage level F. Thereafter, actual earnings grew along the line F to G. In this example, it is assumed the worker’s actual earnings never returned to the potential earnings (line BC) that he or she would have earned if the injury had not occurred. The worker’s “true” wage loss due to the injury is equal to his or her potential earnings after the date of injury (BC) minus the actual earnings after the date of injury (BDEFG). The calculation of potential earnings (line BC) is a crucial step in the analysis. Different researchers have used different methods to estimate potential earnings. We will describe these methods in connection with the research on the two workers’ compensation programs and the veterans disability compensation program examined in this study. The Causes of the Injury or Disease Both workers’ compensation programs and the veterans disability compensation program provide benefits only when specified causation requirements are satisfied. For workers’ compensation, the injury or disease must be work-related, which in most states requires several legal tests to be met.2 For veterans benefits, the injury or disease must be incurred or aggravated during active military service. We assume for this study that the injuries and diseases and the resulting impairment and disability meet the causation requirements of the programs we are examining. The distinction between causes and consequences of injuries and diseases is important. For example, work disability is a consequence of an injury or disease, but the cause may or may not be work-related. Indeed, one of our central inquiries is the relationship between injuries and diseases caused by military service and the consequences of those injuries and diseases on the loss of earnings (i.e., work disability). The Purpose of Cash Benefits A fundamental issue is which of the consequences of injuries and diseases shown in Figure C-2 provide the reasons or purpose of the cash benefits provided by workers’ compensation programs and by the veterans disability program. 2 Most workers’ compensation statutes require a worker to satisfy four legal tests: there must be (1) an injury (2) resulting from an accident that (3) arose out of employment and (4) in the course of employment (Willborn et al., 2007: 894-937).

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A 21st Century System for Evaluating Veterans for Disability Benefits Workers’ Compensation The possible reasons for workers’ compensation program cash benefits were examined by Burton: To the extent that the rationale for benefits is discernable … two schools of thought can be identified. One view considers lost wages due to the injury (work disability) as the sole justification for workers’ compensation benefits…. An alternative view of the rationale for benefits workers with permanent consequences of their injuries accepts work disability as the primary basis for benefits, but argues there is a secondary role for benefits paid for nonwork disability. Arguments for these “impairment benefits” indicate that the purpose is not only to compensate impairment per se but to also use permanent impairment as a convenient proxy for the functional limitations and nonwork disability that result from the impairment. A variant of this alternative view is to argue that nonwork disability merits compensation, and that the degree of permanent impairment serves as a proxy for the extent of nonwork disability. The dominant view probably is that the only permanent consequences that warrant benefits in a workers’ compensation program are medical care, rehabilitation, and work disability (Burton, 2005:80). The view that the only purpose of workers’ compensation cash benefits is to compensate for work disability is explicitly or implicitly adopted in almost all research on the program. Studies of the relationship between earnings losses and cash benefits, for example, use the entire amount of cash benefits to evaluate the performance of the system of cash benefits.3 We assume for this study that the sole purpose of cash benefits in workers’ compensation is to compensate for work disability and not for the other consequences shown in Figure C-2. Veterans Disability Compensation Program The statement of tasks for the IOM committee asks for an evaluation of VA’s Schedule for Rating Disabilities (Rating Schedule) and rating regulations for both quality-of-life impairment and impairment in average earning capacity. However, the sole purpose of the cash benefits specified by § 4.1 of the Code of Federal Regulations dealing with VA’s Rating Schedule is limited to work disability (as that term is used in this study): 3 Examples of studies of the relationship between earnings losses and cash benefits that use the entire amount of the cash benefits for the evaluation—thus implicitly or explicitly assuming that the sole purpose of the cash benefits is to compensate for work disability—are Berkowitz and Burton (1987) and Boden et al. (2005).

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A 21st Century System for Evaluating Veterans for Disability Benefits The percentage ratings represent as far as can practicably be determined the average impairment in earning capacity resulting from such diseases and injuries and their residual conditions in civil occupations. We assume for the purposes of this study that the sole purpose of the cash benefits provided by the VA Rating Schedule and rating regulations is to compensate for work disability and not for the other consequences of injuries and disease shown in Figure C-2. The Operational Basis for Cash Benefits The generally accepted view is that the sole or dominant purpose of cash benefits in workers’ compensation and in the VA disability compensation program is to compensate for work disability. Ideally, the extent of work disability would be determined by measuring each worker’s actual loss of earnings. However, it is impractical and probably inappropriate to directly measure actual loss of earnings for each worker and to determine the amount of cash benefits based on the measure of actual wage loss.4 As a result, one of the other consequences shown in Figure C-2 is used as a proxy (or predictor) of actual loss of wages. There are several possible reasons why disability compensation programs use proxies, such as the extent of the applicant’s impairment, to provide benefits for which the purpose is actual loss of earnings. The first reason is administrative convenience: It is easier to conduct a medical examination of an applicant than to monitor the worker’s actual labor market experience over an extended period of time. The second reason is that linking benefits to actual loss of earnings may result in incentive effects for some beneficiaries, who may limit their extent of participation in the labor force if higher earnings result in reduced benefits. Despite these reasons for the use of proxies, one possible drawback is that they may not provide accurate estimates of the actual loss of earnings. We examine how well proxies predict the amount of actual wage loss in this study. One possible objection to using the amount of actual wage loss as the test of the accuracy of the predictions of the disability rating systems is that the stated purpose of the veterans disability compensation program is average impairment in earning capacity, not the average loss of actual earnings. However, there is no meaningful test of the accuracy of the current Rating Schedule if a comparison is made between (1) the ratings produced by application of the criteria for evaluating medical conditions in the Rating Schedule and (2) the average reduction in earning capacity, since in practice 4 The difficulties of using each worker’s own actual earnings as a basis for cash benefits is discussed by Berkowitz and Burton (1987).

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A 21st Century System for Evaluating Veterans for Disability Benefits they are the same thing. The only meaningful test is whether the ratings produced by the Rating Schedule (which are estimates of the loss of earning capacity) are closely related to the actual losses of earnings. THE 1987 STUDY OF THE WISCONSIN WORKERS’ COMPENSATION PROGRAM The Wisconsin Workers’ Compensation Program Berkowitz and Burton (1987) conducted a wage-loss study of Wisconsin, Florida, and California workers who were injured in 1968. The results for one of the two samples from Wisconsin are shown in Table C-1. The sample consists of male Wisconsin workers who received permanent partial disability (PPD) benefits without a legal contest. The system of cash benefits in Wisconsin relied on several distinctions found in most (although not all) state workers’ compensation programs.5 As shown in Figure C-1, three time periods were relevant for determining benefits for workers who received PPD benefits. During the temporary disability period, most Wisconsin workers in the study qualified for temporary total disability (TTD) benefits. In 1968, the TTD benefits were 66-and-two-thirds percent of the workers’ preinjury wages, subject to a maximum weekly benefit. Once the worker reached the date of MMI, the TTD benefits stopped and most workers with permanent disabilities qualified for permanent partial disability (PPD) benefits.6 Scheduled PPD benefits were paid to workers who had an injury included in a list (or schedule) of body parts included in the Wisconsin workers’ compensation statute. The statute also specified the number of weeks of PPD benefits associated with the total loss of each body part. The complete loss of an arm, for example, entitled a worker to 400 weeks of PPD benefits. A 50 percent loss of an arm meant the worker received 200 weeks of PPD benefits. Nonscheduled PPD benefits were paid to workers who had an injury not included in the list of body parts in the statute. The seriousness of the nonscheduled injury—typically a back condition—was rated “as the nature of the injury bears to one causing permanent total disability.” A 40 percent rating for the back was multiplied by 1,000 weeks to determine the duration of the PPD benefits. 5 An extended discussion of the various approaches to cash benefits in workers’ compensation programs is included in Burton (2005). 6 A limited number of Wisconsin workers qualified for permanent total disability (PTD) benefits. However, the number of PTD cases was so small that the workers were not included in the study.

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A 21st Century System for Evaluating Veterans for Disability Benefits TABLE C-1 Wisconsin Uncontested Permanent Partial Disability Cases for Men with 1968 Injuries     Percent Rating   Classification of Workers 1–2 3–5 6–10 11–15 16–50 51–100 Mean Ratings Total Panel A Weighted counts of workers and mean disability ratings 1 Workers ages 20–59 941.0 467.0 177.0 52.0 48.0   3.70 1,685.0 2 Workers ages 20–29 294.0 105.5 36.0 15.0 14.0   3.54 464.5 3 Workers ages 30–39 226.0 122.0 39.5 10.0 14.0   3.69 411.5 4 Workers ages 40–49 219.5 140.5 53.5 11.0 13.0   3.68 437.5 5 Workers ages 50–59 201.5 99.0 48.0 16.0 7.0   3.71 371.5 6 Upper extremities 785.0 192.0 82.0 20.0 20.0   2.80 1,099.0 7 Trunk cases 17.0 93.0 42.0 10.0 0.0   5.83 162.0 8 Lower extremities 120.0 150.0 34.0 9.0 4.0   3.76 317.0 9 All other cases 19.0 32.0 19.0 13.0 24.0   9.62 107.0 Panel B Mean potential earnings (1968–1973, in dollars)a 1 Workers ages 20–59 42,567 43,938 43,320 42,472 37,960     42,892 2 Workers ages 20–29 40,144 44,412 38,743 41,693 32,671     40,829 3 Workers ages 30–39 43,641 46,232 47,880 52,464 42,605     44,995 4 Workers ages 40–49 45,298 44,383 48,995 48,364 41,628     45,414 5 Workers ages 50–59 41,925 39,973 36,673 32,905 32,434     40,159 6 Upper extremities 42,740 44,084 41,644 39,699 35,516     42,706 7 Trunk cases 37,364 44,193 45,224 44,276       43,748 8 Lower extremities 42,497 43,123 43,355 37,036 37,720     42,670 9 All other cases 40,529 46,136 46,279 49,113 40,036     44,159

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A 21st Century System for Evaluating Veterans for Disability Benefits Panel C Mean earnings losses (1968–1973, in dollars)a 1 Workers ages 20–59 1,554 2,759 *4,292 * 7,483 *7,175     *2,519 2 Workers ages 20–29 1,714 1,890 1,337 6,627 8,757     *2,096 3 Workers ages 30–39 3,009 7,595 *6,399 *13,028 *9,611     *5,162 4 Workers ages 40–49 2,822 954 4,647 *4,131 4,241     2,520 5 Workers ages 50–59 −1,694 287 4,379 7,124 *4,586     117 6 Upper extremities 1,535 1,688 2,913 5,098 7,503     *1,838 7 Trunk cases 4,583 5,417 *3,395 8,916       5,022 8 Lower extremities 1,808 2,307 9,349 *11,740 1,984     3,137 9 All other cases −1,978 3,581 3,178 7,102 *7,766     *3,889 Panel D Standard deviation of mean earnings losses (1968–1973, in dollars)a 1 Workers ages 20–59 860 1,150 1,138 2,236 2,046     662 2 Workers ages 20–29 1,482 2,057 2,987 4,479 3,398     1,237 3 Workers ages 30–39 2,194 2,449 2,272 6,193 3,059     1,559 4 Workers ages 40–49 1,768 1,951 1,760 5,321 5,055     1,228 5 Workers ages 50–59 1,294 2,596 2,248 2,250 4,129     1,213 6 Upper extremities 875 1,952 1,726 2,754 2,328     809 7 Trunk cases 4,430 1,364 2,132 5,040       1,115 8 Lower extremities 1,639 1,160 2,351 8,283 4,188     935 9 All other cases 2,613 3,354 3,767 3,513 3,436     1,596

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A 21st Century System for Evaluating Veterans for Disability Benefits     Percent Rating   Classification of Workers 1–2 3–5 6–10 11–15 16–50 51–100 Mean Ratings Total Panel E Proportional earnings losses 1 Workers ages 20–59 0.036 0.063 0.099 0.176 0.189     0.059 2 Workers ages 20–29 0.043 0.043 0.035 0.159 0.268     0.051 3 Workers ages 30–39 0.069 0.164 0.134 0.248 0.226     0.115 4 Workers ages 40–49 0.062 0.021 0.095 0.085 0.102     0.055 5 Workers ages 50–59 −0.040 0.007 0.119 0.216 0.141     0.003 6 Upper extremities 0.036 0.038 0.070 0.128 0.211     0.043 7 Trunk cases 0.123 0.123 0.075 0.201       0.115 8 Lower extremities 0.043 0.053 0.216 0.317 0.053     0.074 9 All other cases −0.049 0.078 0.069 0.145 0.194     0.088 Panel F Mean benefits of legal fees (1968–1973, in dollars) 1 Workers ages 20–59 696 2,479 4,957 7,807 10,980     2,150 2 Workers ages 20–29 742 2,316 5,078 8,388 12,846     2,047 3 Workers ages 30–39 626 2,509 5,451 7,224 10,286     2,136 4 Workers ages 40–49 706 2,316 4,999 7,360 10,327     2,201 5 Workers ages 50–59 696 2,846 4,412 7,934 9,851     2,234 6 Upper extremities 593 2,057 4,503 6,716 11,641     1,453 7 Trunk cases 1,288 3,141 5,371 8,410       3,850 8 Lower extremities 1,261 2,636 5,803 10,254 13,537     2,809 9 All other cases 842 2,348 4,485 7,326 10,003     4,782

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A 21st Century System for Evaluating Veterans for Disability Benefits FIGURE C-18 Replacement rates (benefits as a percentage of earnings losses) for veterans with five types of injuries. FIGURE C-19 Replacement rates (benefits as a percentage of earnings losses) for veterans: averages for 10 types of injuries.

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A 21st Century System for Evaluating Veterans for Disability Benefits gram. However, the decision about what constitutes adequate benefits is not part of the charge for the IOM committee for whom this report is being prepared. We therefore will not discuss that topic other than to note that the contributions of veterans to the security of the United States provides a special justification for adequate benefits. Replacement Rates and Equity for Veterans with Disabilities Vertical Equity for Benefits The data in Figures C-17 through C-19 can also be used to examine the vertical equity of benefits for veterans with disabilities. Vertical equity requires that the same proportion of lost wages should be replaced for veterans at all disability ratings, which would require the lines for an injury to be flat in these figures. In this instance, there is fairly good vertical equity for the benefits for the five conditions included in Figure C-18, with the obvious exception of the spike in the replacement rate for veterans with scars rated at 50 percent. There is less vertical equity for the five conditions shown in Figure C-17. For the average of the 10 types of injuries, shown in Figure C-17, the replacement rates vary between roughly 55 and 85 percent for all the rating categories, except the 50 percent rating category, which indicates there is reasonable degree of vertical equity for the benefits in the veterans disability benefit program. Inter-Injury Horizontal Equity for Benefits Inter-injury horizontal equity for benefits requires that the replacement rates for veterans with the same disability ratings and different types of injuries should be the same or similar. The results in Figures C-17 and C-18 suggest there are significant differences among the types of injuries concerning the relationships between benefits and lost earnings. Observations on the Veterans Disability Compensation Program We again note it is important to distinguish between the ability of the disability rating system to accurately predict earnings losses (discussed in entries 3 through 5 below) and the ability of the benefit system to match benefits to earnings losses (discussed in entries 6 and 7). The former is of particular relevance to this study because the IOM committee has been asked to assess the accuracy of the disability ratings produced by the Rating Schedule.

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A 21st Century System for Evaluating Veterans for Disability Benefits We have analyzed data on veterans with 10 medical conditions, which constitute a small portion of veterans who received disability benefits during the year covered by the ECVARS study. At the most aggregate level—the average for the 10 medical conditions—the disability rating system for veterans does a fairly poor job of providing vertical equity. As shown in Figure C-16, the earnings losses decline with higher ratings for several levels of severity. In addition, the earnings losses are consistently less than the ratings levels. When the veterans are separated into the 10 injury types, the rating system appears to do a better job of providing vertical equity. In general, as shown in Figures C-14 and C-15, earnings losses increase as ratings increase, although there are exceptions. Of interest is that earnings losses are less than the disability ratings for almost all entries in the figures. There are serious problems with the rating system for veterans with disabilities in terms of inter-injury horizontal equity. As shown in Figures C-14 and C-15, there are significant differences among the 10 types of medical conditions in the relationships between disability ratings and lost earnings. The veterans disability system does a reasonably good job of providing vertical equity for benefits. Vertical equity for benefits is better at the aggregate level (Figure C-16) than at the level of individual medical conditions (Figures C-17 and C-18). Finally, the benefit system for veterans with disabilities has serious problems with inter-injury horizontal equity. As shown in Figures C-14 and C-19, there were significant differences among the types of medical conditions in the relationships between benefits and lost earnings. CONCLUSIONS Purpose of This Study The primary purpose of this study is to provide a framework for examining the relationship between disability ratings and earnings losses in order to help the IOM committee formulate a response to the first task assigned to the committee. We use that framework to examine three different programs that provide cash benefits to persons with disabilities. We realize that the three programs—the Wisconsin and California workers’ compensation programs and the veterans disability compensation program—are quite

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A 21st Century System for Evaluating Veterans for Disability Benefits different in many aspects. However, the three programs all have a common goal—compensating persons with earnings losses resulting from injuries or diseases—and a common procedure—using a proxy or proxies for actual earnings losses as the basis for predicting earnings losses rather than relying on direct measurement of each person’s actual earnings losses. Our study provides a useful framework and several empirical findings important for our understanding of VA’s Rating Schedule and other disability rating systems. However, we did not have access to current data concerning the earnings losses for veterans who are receiving benefits from the compensation program. A study being conducted by the Center for Naval Analyses (CNA) should provide data that can be used in connection with our framework to revise the Rating Schedule and related rating regulations. Use of the Equity Criteria We used several variants of equity criteria to assess the performance of the three programs. Vertical equity requires that actual wage losses increase in proportion to increases in disability ratings. At the aggregate level (the entire sample of workers or veterans), we concluded that the Wisconsin rating system did an excellent job, the California rating system did a moderately good job, and the VA rating system did a fairly poor job using the vertical equity criterion. When the samples were disaggregated by type of injury (or medical condition), Wisconsin did not do as well as at the aggregate level, California did a moderately good job (similar to the performance at the aggregate level), and the VA rating system did reasonably well (and better than at the aggregate level). Overall, we conclude that the three ratings did a reasonably good job on the vertical equity criterion. Inter-injury horizontal equity requires that workers or veterans with similar disability ratings but different types of injuries should experience similar earnings losses. We concluded there were serious inter-injury equity problems in the ratings systems used by the Wisconsin and California workers’ compensation programs, as well as the veterans disability compensation program. Each of the programs systematically treated some injuries or medical conditions different from other injuries in terms of the extent of earnings losses associated with similar disability ratings. Intra-injury horizontal equity requires that workers or veterans with the same injuries or medical conditions and the same ratings should experience similar earnings losses. We only have data for the Wisconsin workers’ compensation program to apply this criterion, and we found serious equity problems. Our overall conclusion is that the three programs do a reasonably good job on vertical equity—especially at the aggregate level—but that there are serious horizontal equity problems in each of the programs. As a result, we

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A 21st Century System for Evaluating Veterans for Disability Benefits conclude that the various factors in Figure C-1 (such as medical impairment or loss of earning capacity) currently used by various workers’ compensation programs and VA do a reasonably good job in serving as proxies for actual wage loss. Distinguishing Between the Purpose of Benefits and the Operational Basis for Benefits We distinguish between the purpose of benefits and the operational basis for benefits. The purpose of the two workers’ compensation programs we examined and the current purpose of the veterans disability compensation program is to compensate for work disability (loss of earnings). However, all three programs use proxies (or predictors) for losses of earnings as the operational basis for benefits. For example, the amount of benefits is determined for some medical conditions by rating the severity of the permanent impairment (a medical concept) because the severity of the impairment is assumed to be a good predictor of the loss of earnings resulting from the impairment. The Use of Proxies to Predict Earnings Losses We conclude that the various factors in Figure C-1 (such as medical impairment or loss of earning capacity) currently used by various workers’ compensation programs and VA do a reasonably good job in serving as proxies for actual wage loss. If the factors in Figure C-1 can be used as rough proxies for actual wage loss, what can be done to improve the match between the proxies and the actual wage loss? We have several observations and suggestions. One issue we have considered is whether the disability rating systems would do a better job of predicting actual wage loss if they placed less emphasis on impairment as the proxy for wage loss and more emphasis on functional limitations and loss of earning capacity as proxies. That is, should we be “shifting to the right” in the factors in Figure C-1 to find better proxies for actual wage loss? The answer—based on the comparison of Wisconsin and California results—is no! Wisconsin at the time the data shown in Table C-2 were collected relied strictly on assessments of medical impairment to determine the amount of PPD benefits, while California relied on a variety of the consequences shown in Figure C-2 as proxies for work disability. Wisconsin did a better job in terms of vertical equity than California and a comparable job in terms of horizontal equity. We therefore tentatively conclude based on the workers’ compensation data that there is no reason to incorporate consequences of injuries and disease other than medical impairment in order to improve the accuracy of the predictions of

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A 21st Century System for Evaluating Veterans for Disability Benefits actual earnings losses. We want to make clear that this tentative conclusion needs to be carefully examined in subsequent research, especially in studies of the veterans disability compensation program. The forthcoming data from CNA, for example, should be studied to compare the ability to predict earnings losses for (1) medical conditions for which the ratings are based on permanent impairment with (2) medical conditions for which ratings are based on limitations in the activities of daily living or other “intermediate” concepts in Figure C-2. One policy change recommended by RAND for California workers’ compensation was to periodically assess the actual earnings losses associated with workplace injuries and to determine if there were systematic overestimates or underestimates of the earnings losses associated with the disability ratings for both the system as a whole and for particular injuries or medical conditions. This information could then be used to recalibrate the rating system.22 A similar procedure could be adopted for the VA disability compensation program. For example, if mental disorders were found to have greater earnings losses than would be expected based on the disability ratings, the rating system could be revised. This could be done either by changing the rating system directly (so that a given level of mental impairment would now be rated at 40 percent rather than 20 percent) or indirectly by producing a set of “modifiers” (so that the medical impairment ratings for mental impairments would be multiplied by two to produce a “disability rating” used for determining the amount of benefits). This policy change could help improve the vertical equity and the inter-injury horizontal equity for the ratings in the veterans disability program. Intra-Injury Horizontal Equity and Outliers The preceding discussion essentially pertains to the virtues and deficiencies in the rating system for disabilities in two workers’ compensation programs and in the veterans disability program using the criteria of vertical equity and inter-injury horizontal equity, and to some possible policies to deal with the deficiencies. Another topic we want to examine is intra-injury horizontal equity for ratings, which requires that workers or veterans with the same disability rating and same type of injury or medical condition should experience the same or similar levels of earnings losses. The evidence from Wisconsin in Panels C and D of Table C-2, as summarized in Figure C-5, suggest that lack of intra-injury equity is a pervasive phenomenon. 22 The implications of periodically recalibrating the rating schedule based on empirical studies of actual wage loss is discussed in Reville et al. (2005).

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A 21st Century System for Evaluating Veterans for Disability Benefits We are skeptical that any disability rating system—no matter how refined—can accurately predict the actual earnings losses resulting from medical conditions for substantial numbers of workers or veterans. Most systems can accommodate those cases in which the earnings losses are much less than is predicted based on the disability rating. The challenge is to deal with the other type of “outliers”—the worker or veteran who has earnings losses far in excess of the amount predicted based on the person’s disability rating. There are four possible responses to this challenge. First, the disability program can assert that in a system of social insurance (or social justice), outliers should be ignored in order to reduce administrative costs and to avoid excessive costs to the system. This is the approach used in most workers’ compensation programs for the vast majority of workers with permanent disabilities. Second, the disability program can treat every worker or veteran as an individual and determine benefits based on his or her own labor market experience. This comes close to the “wage-loss” approach (which bases the benefits solely or primarily on the worker’s own labor market experience) that has been tried in several workers’ compensation programs and generally rejected as unworkable or too expensive. The “wage-loss” approach foregoes the use of proxies as the basis for benefits, which have generally been incorporated into disability compensation systems because of administrative convenience and to avoid the incentive effects that occur if higher earnings result in reduced benefits. Third, the disability program may be able to identify variables that increase the accuracy of the rating system but that do not cause inappropriate incentives for beneficiaries. For example, if after controlling for the type and severity of injury, the addition of age to the disability rating system increases the accuracy of the predictions of loss of actual earnings, intra-injury horizontal equity will be improved. However, whether there are such variables that improve the accuracy of the rating system is an empirical question where logic is probably a poor guide.23 Fourth, the disability program can use the disability rating system to determine the amount of benefits for the majority of beneficiaries, but provide a safety valve for “outliers” who have earnings losses far in excess of the amount of losses predicted by the rating system. This approach is used 23 The age adjustments in the California workers’ compensation program are discussed by Reville et al. (2005). The baseline age is 39; individuals receive higher permanent partial disability ratings if they are older than age 39, and lower ratings if they are younger than age 39. The adjustments are presumably based on an assumption that older persons find it more difficult to adapt to permanent disabilities than do younger persons with equally severe impairments. However, when workers were placed into four age categories, the youngest workers (ages 18–29) had the highest proportional earnings losses in the three years after their injuries.

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A 21st Century System for Evaluating Veterans for Disability Benefits in some workers’ compensation programs in which workers with relatively low “impairment ratings” can receive additional benefits either because they are reclassified from PPD to permanent total disability (using the “odd lot” doctrine24) or because they are workers in a state with hybrid benefits (where workers who exhaust their benefits based on the rating schedule qualify for additional benefits because they have continuing wage losses due to their workplace injuries25). The counterpart to this provision of additional benefits for extraordinary wage loss in some workers’ compensation programs is the veterans disability compensation program provision of “individual unemployability” (IU) benefits, which serve as the program’s safety valve for those veterans who have much greater earnings losses than the disability rating system predicts. Without endorsing the specific aspects of the IU benefits in the veterans disability compensation program, we endorse the general concept of a special benefit for those veterans who are outliers in terms of their actual earnings losses compared with their expected earnings losses. The reason is that the best of all possible disability rating systems will seriously underpredict the earnings losses of some disabled persons. The Difference Between Rating Systems and Benefit Systems We have distinguished between the rating systems for permanent disability and the benefits systems for permanent disability. The former measures the seriousness of an injury or disease in terms of the consequences, such as permanent impairment, limitations in activities of daily living, and loss of earning capacity. The latter uses the disability rating, perhaps in connection with other information, such as the disabled person’s age or education, to determine the amount of disability benefits. We have focused on disability rating systems because that is the domain of the IOM committee. We have provided criteria for evaluating the rating system—horizontal and vertical equity. We have also briefly discussed benefits systems, and provided criteria for evaluating such systems—horizontal equity, vertical equity, and adequacy. While we have concluded that the disability rating systems for the two workers’ compensation programs and the veterans disability compensation program do a reasonably good job of providing equity, we have not attempted to make any judgment about the adequacy of the veterans disability benefits. 24 The “odd lot” doctrine is discussed by Larson and Larson (2006). 25 The hybrid approach to permanent partial disability benefits is discussed by Burton (2005). States that recently used or currently use the hybrid approach for permanent partial disability benefits include Connecticut, Texas, and Florida. Section 15(3)(v) of the New York workers’ compensation law also utilizes the hybrid approach for a limited number of permanent partial disability cases.

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A 21st Century System for Evaluating Veterans for Disability Benefits Methodological Limitations There are several methodological issues that sophisticated examinations of disability ratings systems must consider, and that are beyond the scope of the current study. We will briefly comment on two of them. First, there is a question concerning the proper level of aggregation for examining the relationship between disability ratings and loss of earnings. In our tables, we have divided the mean (or median) earnings losses for all workers in a cell (defined by medical condition and age) by the mean (or median) earnings losses for all workers in the cell. Thus, in Table C-1, we divided the mean earnings losses for workers with upper extremity injuries rated 1–2 percent in Panel C ($1,535) by the mean potential earnings for those workers shown in Panel B ($42,740) to produce the proportional earnings losses shown in Panel E (0.036 or 3.6 percent). An alternative approach would be to calculate the proportional earnings losses for individual workers by using each worker’s earnings losses and potential earnings. The approach we used may be affected by a few outliers, that is, by workers whose experience was much different than most workers in the cell. Using the distribution of proportional earnings losses for individual workers might show, for example, that the rating system accurately predicted the earnings losses for the vast majority of workers in the cell. We did not use this alternative procedure to assess the equity of the rating systems we examined because the necessary data were unavailable for the Wisconsin workers’ compensation program and the veterans disability compensation program. We suggest that subsequent examinations of disability rating systems consider this alternative approach. Second, there is a difficult methodological problem caused by the possible comingling of disability ratings and earnings losses, as discussed by Greenberg and Rosenheck (2007). This can occur for two reasons. In some disability systems, such as the Disability Insurance (DI) component of the Social Security program, eligibility for the benefits depends on demonstrating an inability to engage in gainful activity. If DI benefits increase, some workers may limit the amount of time they work in order to qualify for benefits. If there were no DI program (or if the DI benefits were lower) the workers would have higher earnings. Thus, the disability benefits system induces higher earnings losses than would have occurred in the absence of the system. The permanent partial disability benefits provided by most workers’ compensation programs and the veterans disability compensation program do not in general link eligibility for the cash benefits to a demonstration of earnings losses and, consequently, the possible inducement to reduce

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A 21st Century System for Evaluating Veterans for Disability Benefits earnings in order to qualify for benefits is muted.26 There is, however, another possible effect on earnings resulting from the cash benefits provided by these programs. The benefits received by injured workers and injured veterans increase their wealth, and the wealth effect (as it is termed by economists) may induce the beneficiaries to reduce their supply of labor. Thus, a higher disability rating may lead to higher disability benefits and, in turn, to lower earnings than would have occurred if there were no disability benefits system, with the result that part of the lower earnings associated with higher ratings may be due to the inducements provided by the disability benefits system. Ideally, an empirical study of the relationship between disability benefits and earnings losses would separate the effects of the severity of the consequence of the injury from the effects of the benefits provided by the disability benefits system.27 We do not think these methodological issues detract from the primary conclusions of the current study. REFERENCES Berkowitz, M., and J. F. Burton, Jr. 1987. Permanent disability benefits in workers’ compensation. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Boden, L. I., R. T. Reville, and J. Biddle. 2005. The adequacy of workers compensation benefits. In Workplace injuries and diseases: Prevention and compensation: Essays in honor of Terry Thomason, edited by K. Roberts, J. F. Burton, Jr., and M. M. Bodah. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Pp. 37–68. Burton, J. F., Jr. 2005. Permanent partial disability benefits. In Workplace injuries and diseases: Prevention and compensation: Essays in honor of Terry Thomason, edited by K. Roberts, J. F. Burton, Jr., and M. M. Bodah. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research, Pp. 69–116. Cocchiarella, L., G. B. J. Andersson. 2001. Guides to the evaluation of permanent impairment, Fifth Edition. Chicago, IL: American Medical Association. Greenberg, G. A., and R. A. Rosenheck. 2007. Compensation of veterans with psychiatric or substance abuse disorders and employment and earnings. Military Medicine 172:162–168. Hunt, H. A. 2004. Adequacy of earnings replacement in workers compensation programs. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Larson, A., and L. K. Larson. 2006. Larson’s workers’ compensation, desk edition. Newark, NJ: LexisNexis. Musgrave, R. A. 1959. The theory of public finance. New York: McGraw-Hill. The National Commission (National Commission on State Workmen’s Compensation Laws). 1972. The report of the National Commission on State Workmen’s Compensation Laws. Washington, DC: Government Printing Office. 26 One exception is individual unemployability benefits, which require the veteran to demonstrate lack of significant earnings. 27 Greenberg and Rosenheck (2007) examine the determinant of employment and earnings of veterans, and attempt to separate the effects of the severity of the injury from the effects of benefits from the veterans disability compensation program and from other programs.

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A 21st Century System for Evaluating Veterans for Disability Benefits Peterson, M. A., R. T. Reville, R. K. Stern, and P. S. Barth. 2001. Compensating permanent workplace injuries: A study of California’s system. Santa Monica, CA: RAND Corporation. Reville, R. T. 1999. The impact of a disabling workplace injury on earnings and labor participation. In The creation and analysis of linked employer-employee data, contributions to economic analysis, edited by J. C. Haltiwanger, J. I. Lane, J. R. Spletzer, J. J. M. Theeuwes, and K. R. Troske. New York: Elsevier Science, North-Holland. Pp. 147–173. Reville, R. T., J. Bhattacharya, and L. Sager. 2001. New methods and data sources for measuring the economic consequences of workplace injuries. American Journal of Industrial Medicine 40:452–463. Reville, R. T., S. A. Seabury, F. W. Neuhauser, J. F. Burton, Jr., and M. D. Greenberg. 2005. An evaluation of California’s permanent disability rating system. Santa Monica, CA: RAND Institute for Civil Justice. Willborn, S. L., S. J. Schwab, J. F. Burton, Jr., and G. L. L. Lester. 2007. Employment law: Cases and material, Fourth Edition. Newark, NJ: LexisNexis.