Direct Effects: Employment Furloughs Now, Risk of Business Failures Later

The coronavirus (COVID-19) pandemic is causing layoffs of unprecedented rapidity and scale. In the space of a few weeks in March, some sectors of the economy shut down almost entirely as businesses furloughed all personnel except those essential to day-to-day operations.

For the week ending March 21, new claims for unemployment insurance came in at 3.3 million countrywide for the week ending March 21, almost five times the previous weekly record set in 1982. But that was only the beginning. In the next three weeks, the number of new US unemployment insurance claims were 6.9 million, 6.6 million, and 5.2 million. To give a sense of scale, 22 million new unemployment claims for the four weeks ending April 11 amounts to more than 40% of the total 52 million unemployment claims filed during 2008 and 2009, the first two years of the Great Recession. To be sure, layoffs happened at an unprecedented scale during March and may accelerate in April. But a recession’s economic impact depends on duration as well as intensity. During the Great Recession, unemployment stayed between 8% and 10% for more than three years, from February 2009 through August 2012, with a slow recovery thereafter.

While coronavirus-induced layoffs are severe and widespread, they are not uniform across all sectors of the economy. There is a broad divide between businesses that are public-facing or worksite-centric and businesses for which telecommuting is a viable temporary solution. With the exception of certain essential services, businesses that are public-facing or congregate employees on-site have furloughed workforces quickly and almost completely, either voluntarily or by public mandate. In contrast, businesses that can function via telecommuting have strived to keep employees on payroll while migrating them to working from home.

Since workers compensation insurance depends essentially on who is employed, the most direct effect of the coronavirus pandemic is via its impacts on employment. In the following brief survey, we group coronavirus-related effects into three categories: immediate employment losses, downstream employment losses and risks of business closure, and finally, employment surges directly related to the pandemic.

Immediate Employment Losses

Hospitality, Entertainment, Travel, and Retail. Restaurants, bars, hotels, theaters, sports and recreation, airlines, cruise lines, and a host of other businesses associated with hospitality, entertainment, and travel either were shut down by government mandate or saw their traffic drop close to zero. Retailers experienced the same phenomenon ̶ shopping malls, big-box and specialty stores all shut their doors. The US Labor Department reported that employers cut 701,000 jobs in March and that the unemployment rate jumped to 4.4%, up from 3.5% in February. The biggest cuts occurred in the leisure and hospitality sectors, especially food services, as shown in Figure 1.

Because the Labor Department’s employment data for March come from surveys conducted through mid-month when coronavirus closures were just getting started, they severely understate job losses for March as a whole. For comparison, unemployment claims at 10 million for the last two weeks in March are more than 10 times higher than job losses reported by the Labor Department through mid-month. As of March 22, restaurant workers alone lost 3 million jobs according to an estimate by the National Restaurant Association. The next jobs report, covering the period from mid-March to mid-April, is certain to show far larger employment losses.

How big are the labor sectors most severely impacted by the coronavirus pandemic? The Brookings Institution recently compiled a list of industries where employment is considered to be immediately at-risk from the coronavirus pandemic. Who are the Workers Already Impacted by the COVID-19 Recession? The Brookings Institution, April 3, 2020. Using our own version of such a list, we find that 31 million people, 24% of private nonfarm employment, worked in immediate-risk industries at the end of 2019 (see Figure 2). Around 12 million of these are restaurant and bar workers, followed by retailers, accommodation workers (hotel workers), and workers in transportation or entertainment-related industries. At-risk workers also include nearly 2 million employees in physician’s offices, dental clinics and health services such as physical therapy. Many of these establishments ̶ restaurants, bars, medical services (physician offices, medical clinics), and personal service enterprises (personal care, laundry services) ̶ are privately owned small businesses especially vulnerable to business interruptions for reasons we discuss in a separate section below.

Durable Goods. At the end of March, the Institute for Supply Management’s (ISM) index of new orders to manufacturers slid to 42.2, down from 49.8 the previous month and the lowest value for this index since March 2009. (Readings of less than 50 indicate shrinking business activity.) Industries reporting declines in new orders during March include petroleum products, transportation equipment, furniture, fabricated metal products, and machinery.

Cancelled and deferred orders are causing layoffs at manufacturers, distributors, and sellers of a wide range of products, including autos, aircraft, producer capital equipment, and discretionary big-ticket consumer goods like appliances.

The auto industry provides an interesting case study. Starting in mid-March, new car sales dropped abruptly as consumers put big-ticket purchases on hold. Light vehicle sales in March were 11.4 million at an annualized rate, down 35% from 17.5 million annualized in the same month last year. After five straight years of strong sales at over 17 million cars and light trucks per year, J.D. Power recently reduced its forecast 2020 run rate to between 12 and 15 million units, a 10% to 30% reduction from its pre-coronavirus forecast for the year. The new forecast assumes that light vehicle sales will rebound in August after losing between 1.6 to 2.4 million units in sales from March through July.

Automotive manufacturing plants and their suppliers across the country closed quickly in March, dropping new car production to close to zero. In addition to Michigan, auto manufacturers and parts suppliers are prominent in Indiana, Ohio, Kentucky, Tennessee, South Carolina, Georgia, Alabama, Mississippi, Texas, and California.

Although sales are down everywhere, whether auto dealerships stay open or are required to close varies by state. Vehicle maintenance and repairs are essential services, allowing dealer service centers to stay open; but showroom sales are not essential, and are subject to state discretion. At recent count, 24 states allow auto dealerships to remain open for direct sales, 23 states allow online sales only, and 3 states have banned auto sales entirely.

Online auto sales platforms run by dealerships have existed for over 15 years but have not been strongly embraced by dealers. Coronavirus is rapidly changing that attitude as dealerships scramble to replace lost in-store visits by going online, even in states where showrooms remain open. The coronavirus pandemic seems likely to accelerate a permanent transition from showroom to online sales for automobiles, a phenomenon already far more advanced in other branches of retail trade.

Contracting. Reports to date indicate that builders are still working on projects already begun, but that planned and new projects are at risk of cancellation. With prospective new home buyers either furloughed or facing economic uncertainty, expectations for new home sales for the rest of 2020 are severely reduced. At large homebuilders, land purchases are being deferred and new developments put on hold. Smaller builders are likely to see existing commitments cancelled or have project financing pulled back.

Supply chain issues are also important in contracting, though secondary to demand uncertainty. Some building components, like plumbing and electrical equipment, are sourced from China and Asia. Building inputs manufactured in the United States ̶ for example, doors and window assemblies, heating and cooling equipment, insulation and roofing materials ̶ are likely to be subject to production delays or logistic bottlenecks as the pandemic continues.

These observations suggest that employment in contracting is likely to be hit hard if the coronavirus pandemic lasts through spring and summer ̶ peak building season in most of the country. A survey by the Federal Reserve Bank of Minneapolis at the end of March found that half of responding contractors had experienced delays or cancellations of projects active or expected to start within 30 days; about two-thirds expressed uncertainty about projects scheduled after that. Thirty percent of respondents said that they have already laid off some of their construction workforce; roughly half said that they expect to have done so within the coming month. Construction Impact: How COVID-19 is Silencing the Shovels, Federal Reserve Bank of Minneapolis, March 27, 2020.

Oil and Refining. Global reduction in transportation demand, coupled with a price war between Saudi Arabia and Russia, have decimated oil prices and refining margins. The benchmark price for US crude oil fell close to $20 per barrel in March, well below the breakeven threshold for US shale producers. Production shutdowns have resulted in layoffs in exploration and production, oilfield services, and refining. States particularly impacted are Texas, Oklahoma, New Mexico, Louisiana, Colorado, and North Dakota.

Downstream Impacts Including Business Closures

For many businesses, employment impacts may be manageable for now but will intensify significantly if the coronavirus pandemic lasts too long. How long is too long depends on circumstances ̶ from a couple of months for some businesses to a few quarters for others. For small businesses with slim operating margins and limited working capital, a shutdown intended to be temporary may transition quickly into permanent closure via voluntary liquidation or bankruptcy. Defaults on leases, mortgages, and other commercial and consumer credit obligations creates financial stress for lenders. This increases lenders’ insolvency risk and reduces the availability of new credit to businesses and households, feeding back into increased defaults.

Small Businesses. Across all sectors of the economy, small enterprises have been hit hard by the coronavirus pandemic. Small businesses are especially at risk of temporary shutdowns turning into permanent closures for two reasons. First, small businesses typically depend on high traffic flow rates to break even, forcing them to close their doors quickly when business slows in order to stem losses. They also have limited cash buffers, which means that they cannot stay idled for long before going out of business.

A 2016 study of nearly 600,000 small businesses reported median cash inflows of $381 per day against median daily outflows of $374, and a median cash buffer of 27 operating days (the number of days of cash outflows sustainable from cash balances in the absence of inflows). The study found that restaurants have bigger average daily cash flows than other small businesses but equally thin margins – $968 in per day against $957 out – and hold an average cash buffer of 16 days, less than three weeks. Another more recent national survey of small businesses came to similar conclusions, finding that nearly half would need to rely on owners’ personal funds in response to a two-month revenue loss, and 17% would either close or liquidate. Cash is King: Flows, Balances, and Buffer Days: Evidence from 600,000 Small Businesses, JPMorgan Chase Institute, September 2016. Small Business Credit Survey: 2020 Report on Employer Firms, co-authored by Federal Reserve Banks, April 2020.

Small businesses account for a large share of employment. One quarter of the US workforce is at establishments with fewer than 50 employees, and a half is at establishments with fewer than 500 employees (Figure 3). The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted in mid-March contains provisions for financial support to small businesses of 500 or fewer employees, including $10 billion in immediate assistance loans through the Small Business Association (SBA Loan Program) and the much bigger $350 billion Paycheck Protection Program (PPP). The PPP provides federally guaranteed loans to small businesses (and some large businesses like restaurant and hotel chains) in exchange for their commitment to maintain employment.

To date, rollouts of both the SBA Loan Program and the PPP have experienced difficulties. Common complaints from applicants involve long review times and seemingly arbitrary decisions to approve or deny. PPP loans are offered through the private banking system, and banks have been much quicker to approve loan applicants to existing customers, for whom they already have required documentation, than to first-time clients.

Both the SBA Loan Program and the PPP are likely to get increased funding above their existing limits in future stimulus packages, which may also include additional measures to support small businesses. How effective these measures will be in sustaining small businesses through the coronavirus pandemic remains to be seen.

Defaults and Credit Spirals. When businesses are idled, they stop payments on loans and leases. When workers are furloughed, they stop payments on consumer loans, mortgages, and rent. Households and businesses are already failing to make current payments on mortgages, loans, and leases. For credit providers (including banks, commercial lenders, and financing subsidiaries of manufacturers like GM Financial) and lessors (including equipment, commercial real estate, and apartments), the wave of coronavirus-induced payment defaults immediately hits liquidity and reserves. Some credit providers and lessors, especially those with concentrated portfolio risk and high financial leverage, will face financial distress and risk of failure if the pandemic continues for several quarters.

Financial distress at credit providers can lead to a credit crisis via a self-reinforcing feedback loop: credit and lease defaults by businesses and households run down credit reserves, lower credit reserves and heightened default risk make it harder for other businesses and households to extend or renew loan and lease obligations, which accelerates defaults at other businesses and households. From mid-2008 to mid-2009 during the Great Recession, the United States experienced a credit crisis following this pattern as commercial and retail lending markets froze up and defaults on credit, mortgage, and lease obligations skyrocketed. A lesson from the Great Recession is that if a wave of temporary business shutdowns escalates into a credit crisis, then the risk of failure and permanent closure is substantially increased, not only for lenders and lessors, but also for the businesses and households they serve.

So far, government support for lenders has come primarily from the Federal Reserve via its commitment to buy essentially unlimited quantities of securities, including corporate and municipal debt, and to backstop short-term credit markets. More direct forms of government relief may also be necessary: for example, creating a federally backed credit line to mortgage servicers contractually obligated to make payments on mortgages for which the CARES Act has granted forbearance.

Demand Surges Due to Coronavirus

A few businesses are seeing demand surges directly related the coronavirus pandemic and are adding workers. However, new hires in these businesses are likely to be temporary and their numbers are dwarfed by employment losses elsewhere.

Groceries, Medical Supplies, and Home Delivery. Demand for groceries and medical supplies skyrocketed during March as anxious consumers built up stockpiles, often resulting in local shortages. Some new hires staff stores and warehouse networks, others fill the burgeoning demand for direct delivery services. For the most part, new hires at employee-based companies like Kroger, Walgreens, Walmart, and Amazon are likely to be temporary, not permanent. And the demand spike for home delivery services extends to app-based mediators, like DoorDash and Grubhub, that coordinate delivery services from independent contractors not covered by workers compensation.

The hiring surge in warehousing suggests that an uptick in injury frequency is likely in this sector during 2020. Warehousing constitutes a potential exception to our general view that injury frequency is likely to decline in most sectors of the economy. In the Fourth Quarter 2019 issue of the Quarterly Economics Briefing, we observed that the Transportation and Warehousing sector experienced 5% employment growth in 2018 and has a much higher injury rate than closely related sectors such as Wholesale and Retail Trade. A sharp influx of inexperienced and short-tenured workers into warehousing may temporarily push injury rates in that sector even higher.

Health Care. The coronavirus pandemic has clearly produced a demand surge for medical services and supplies directly related to treatment of the disease. However, increased demand for the services of medical care providers, including doctors, nurses, and medical staff, has not resulted in a hiring wave, but rather local shortages due to the unavailability of qualified personnel. The shortage of medical personnel is likely to worsen as care providers exposed to the virus get sick themselves. Increased demand for medical supplies has encountered capacity limits and bottlenecks preventing a rapid ramp-up of production and hiring. To date, increased output of medical supplies and equipment, especially at large corporations, has meant retooling existing production capacity more than new hiring.

Indirect Effects: Variables and Ratios Critical to Loss Exposure

The coronavirus pandemic is likely to have several indirect impacts on workers compensation as well. Indirect effects relate to relationships ̶ like injury frequency, injury severity, and the ratio of premium to payroll. These relationships are stable during ordinary times but are likely to behave differently during the coronavirus pandemic. Indirect impacts may take longer to be noticeable than the direct employment impacts, but they are no less important.

Is Coronavirus Covered Under Workers Compensation?

Compensability is one of first questions that comes to mind for workers compensation; it is also one of the most complex to answer. The standard paradigm for workers compensation involves musculoskeletal injuries incurred in the workplace. Circumstances under which diagnoses of an infectious disease such as coronavirus may also be covered as a workplace injury are less clear and likely to be interpreted differently in different states.

A key consideration is the degree to which a worker’s occupation creates an increased risk of coronavirus infection compared to the general public. Front-line health care workers in direct contact with coronavirus patients presumably face a heightened risk of infection, while workers telecommuting from home may arguably face no greater coronavirus risk than they would if they were not working. But between these two stylized examples, many other occupations present nuanced considerations for which clear precedents are lacking.

While clearly important to assessing the economic impact of coronavirus on workers compensation, a discussion of issues related to compensability is beyond the scope of this article.

Effects on Severity and Frequency

Severity of Active Claims. Diversion of medical resources to fight coronavirus reduces their availability for workers compensation. For active claims, return to work can be expected to take longer because of deferred treatment and because some jobs will remain furloughed even after the claimant’s disability period. Elective treatments involving hospital or outpatient facilities diverted to coronavirus are likely to be postponed until hospital capacity is no longer stressed.

To some extent, these impacts may be limited to facilities that can be diverted to treat coronavirus patients — for example, hospitals and inpatient facilities with beds— and hence may be limited to severe injuries that require hospitalization. But what about less severe workplace injuries that do not involve major surgery or other inpatient medical treatment?

For many workers compensation claims, such as sprains and strains, the course of medical treatment involves evaluation and management, prescription drugs, and physical therapy. Coronavirus may also impact the availability of medical treatment for these claims, but for different reasons than claims involving hospital or inpatient treatments. Doctor’s offices and physical therapy clinics need a minimum number of patient visits per day to break even and most depend on payers other than workers compensation. As other patients cancel non-essential appointments, providers are forced to reduce staff or close temporarily. Ironically, at the same time as the coronavirus pandemic creates excess demand at hospitals and inpatient facilities limiting their availability to workers compensation, it also reduces demand for medical services at non-hospital venues with the same result.

Deferral of hospital treatments and physical therapy means longer claim duration, which translates into higher indemnity payments and probably more medical expenditure overall. Both effects translate into higher severity for active workers compensation claims. In addition, a claimant cannot return to work after medical treatment if work is furloughed, which also increases indemnity severity for active workers compensation claims.

Deferral Versus Acceleration of New Claims. The coronavirus pandemic may affect the frequency of new claims differently at businesses experiencing temporary layoffs versus businesses at risk of closing permanently.

During the pandemic, workers who expect their employers to stay in business may choose to defer reporting of workplace injuries that are nonacute and for which treatment can be postponed ̶ for example, cumulative strains or degenerative conditions. Reasons to “work through” an injury rather than report it immediately include expected delays for treatments such as elective surgery, the need for at least one wage earner to be fully employed if other household members are out of work, and uncertainty about having a job when one is ready to return to work. See Recession, Fear of Job Loss, and Return to Work, Workers Compensation Research Institute, April 2010. This paper finds that fear of job loss by injured workers is correlated with quicker return to work. An extension of this logic suggests that fear of job loss on return to work may also motivate workers to defer filling a workers compensation claim. Deferred claim reporting is likely to manifest as reduced injury frequency during 2020 followed by a frequency uptick when the pandemic passes.

Conversely, workers who anticipate that their employer is likely to close permanently may accelerate reporting of nonacute injuries for fear of losing workers compensation benefits from their present job. The rationales for deferred versus accelerated claim reporting underscore the importance of worker expectations as to whether a pending furlough or layoff is likely to be temporary or to turn into permanent job loss.

Because the scenarios for delayed versus accelerated claim reporting work in opposite directions, the net effect on new claim frequency will depend on their relative magnitudes.

The situation is complicated by the expansion of unemployment insurance benefits under the CARES Act. Federally funded benefit enhancements to state-run unemployment insurance programs include an increase in cash payments, extended duration of benefits, and relaxed eligibility requirements. The CARES Act enhancements make unemployment insurance a much more attractive option for furloughed or laid-off workers now than at pre-existing benefit levels under state programs. For low wage workers especially, CARES-enhanced unemployment insurance offers better wage replacement than their full indemnity benefit under workers compensation. Because the two insurance systems are mutually exclusive – generally, a new workers compensation claim precludes a claim for unemployment insurance – workers must choose between one type of claim or the other. The CARE Act enhancements increase the likelihood that laid-off workers eligible for both types of insurance will opt to file claims for unemployment relief rather than for workers compensation, especially in cases involving minor injuries.

Short-Tenured Workers. Previous NCCI research surveyed in the Third Quarter 2019 issue of the Quarterly Economics Briefing stresses the idea that the employment share of short-tenured workers typically drops during the early stages of a recession and rises later during recovery, since these are the first workers to be laid off and the last to be rehired. It is well established that short-tenured workers have higher injury frequency than longer-tenured workers; therefore a recession-linked layoff and rehiring cycle focused on short-tenured workers will tend to drive down injury frequency going into a recession and to push it back up when the economy recovers. However, given the scale and rapidity of layoffs during the coronavirus pandemic, with entire workforces furloughed, we think that the impact of worker tenure on injury frequency is likely to be minimal.

To be clear, we do think that the frequency of reported workplace injuries may fluctuate during and after the coronavirus pandemic. However, frequency effects are more likely to come through delayed or accelerated injury reporting rather than variations in average worker tenure. A potential exception is warehousing, where the coronavirus-induced demand surge means that new hires are coming mostly from other occupations.

Motor Vehicle Accidents. A striking effect of coronavirus business shutdowns and stay-at-home initiatives is a sharp reduction in motor vehicle traffic. From coast to coast, major US cities including New York, Houston, Los Angeles, and Seattle report minimal traffic congestion even during rush hours. Many businesses have furloughed their salesforces entirely and severely curtailed other customer visits seen as nonessential. Less work-related driving means a lower expected frequency of motor vehicle accidents among workers in professional services and clerical occupational groups. In addition, furloughed workers and employees working from home are no longer commuting. Reduced commuting is the main driver of low traffic congestion in cities across the country. Because traffic congestion is a major contributor to motor vehicle accidents, accident frequency in commercial trucking is likely to go down for as long as other drivers stay off the roads.

Will Workers Compensation Premium Fall More Than Employment in Policy Year 2020?

We think that workers compensation premium is likely to fall by more than employment during Policy Year 2020, but for somewhat different reasons than during the Great Recession.

From 2008 to 2011 during the Great Recession, two main factors contributed to a disproportionate drop in premium relative to employment. First, employment fell more sharply in contracting and manufacturing, both sectors with high injury frequency and severity, than in other sectors. When the employment share for industries with high premium rates per employee goes down, average premium overall falls faster than employment. Second, layoffs across all businesses were more severe at small firms than at large firms. Because small firms typically elect first-dollar workers compensation coverage, whereas larger firms are more likely to have policies with deductibles, a greater share of layoffs at small firms translates into workers compensation premium falling faster than employment overall.

To date, layoffs from coronavirus have not been specially concentrated in contracting and manufacturing. The businesses hardest hit, like leisure and retail, do not have exceptionally high premium rates per employee. However, making up for that is the fact that small businesses have been hit exceptionally hard. Consequently, while both channels – industry composition and firm size – were active during the Great Recession, the latter channel is likely to dominate due to the speed and magnitude of layoffs in the coronavirus pandemic. In short, we think that workers compensation premium is likely to fall more than employment during the coronavirus pandemic. But whether the gap will be more or less than that during the Great Recession is hard to predict at this time.