Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Bumper returns rescue books at ACC

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ACC's 2010 report noted that for several decades healthcare costs have risen faster than inflation. Photo / Richard Robinson
ACC's 2010 report noted that for several decades healthcare costs have risen faster than inflation. Photo / Richard Robinson

Credit where it is due.

Over the past year or two there has been a remarkable turnaround in the finances of ACC.

For the year to June 2010 it reported a surplus of $2.5 billion, in stark contrast to the $4.8 billion deficit the previous year, when it recognised a blowout in its future liabilities. It is targeting a surplus of $1.2 billion in the current year.

Last year's surplus shrank ACC's unfunded liabilities by a fifth, to $10.3 billion from $12.8 billion in June 2009, and levies will not increase this year.

The unfunded liabilities are the extent to which the net present value of future obligations to people already injured exceeds ACC's reserves. Following a law change last year ACC now has until 2019 to move to a fully funded basis.

With the Government having decided in principle to open the work account to competition - subject to an electoral mandate in November - it is worth looking at what underpinned the turnaround and how sustainable those factors are.

Otherwise the conclusion is liable to be: If it ain't broke no more, don't fix it.

It turns out the biggest contribution to ACC's $2.5 billion surplus was $1.4 billion in investment income, $1 billion more than the year before.

ACC's fund managers are highly regarded and typically outperform their benchmarks, but clearly the biggest factor in last year's bumper return was the recovery in world financial markets after a particularly severe slump.

"We are doing better than I thought at the moment" ACC chairman John Judge told the finance and expenditure select committee last week,"but we can't take credit for external investment markets".

ACC's bottom line was also boosted by the fact that the $2.9 billion it paid out in rehabilitation costs and income compensation was nearly $500 million less than it had budgeted, and levied, for.

That reflects a drop of 5 per cent in the number of claims compared with the year before. Between 2005/06 and 2007/08 new claims had increased by an average 5 per cent a year. They flattened out in 2008/09 and have now declined.

Some of the decline may be cyclical. Apparently it is common for claims to workers' compensation schemes to fall during tough economic times, perhaps because of concerns about the state of the labour market generally.

But there may also be a potentially more durable effect at work: a perception that ACC is not as soft a touch as it was in the latter part of the previous Government's time - erring on the side of compassion, if you prefer, or taking the path of least resistance where there was a risk of sob stories in the media, if you do not.

The "stocktake" of the scheme, a review headed by a former ACC chairman David Caygill and released just before Christmas, concluded that of the $14.4 billion increase in ACC's liabilities between 2004 and 2009 $5.8 billion was due to unanticipated increases in claims costs that were almost all within the control of ACC management.

That was unacceptable and had it continued would have threatened the viability of the ACC scheme, it said.

The rest of the increase was either anticipated and budgeted for or outside the corporation's control like a change in accounting standards which required a substantial safety margin on top of the most likely estimate of future costs of claims.

The lion's share of that part of the blowout seen as within ACC's control related to rehabilitation costs.

ACC's 2010 financial condition report notes that for several decades healthcare-related costs have risen faster than general inflation.

Over the past two years there had been "improved clarity as to the causes of increases and more detailed analysis to support more robust assumptions".

Let's hope so. It is a truism that you can't manage what you don't monitor and measure in a timely way.

The stocktake report concluded that the current structure of the ACC scheme is "fatally flawed".

It called for competitive private delivery of accident insurance not only in the workplace but in the earners account (which covers injuries outside the workplace for employees and the self-employed) and in the motor vehicle account.

It claimed that this would improve rehabilitation rates, remove cross-subsidies and provide stronger incentives to invest in reducing accident rates.

Private sector insurers would have to set premiums to fully fund their liabilities "removing the potential for employers to be required to pay additional levies in respect to past unfunded liabilities" - something it regards as both inefficient and inequitable.

The stocktake report is confident private insurers would be able to achieve efficiency gains that would offset the additional costs they would face, like having to provide a return on equity, marketing and tax.

Officials, however, are not so sure about that.

"Employers could see a rise in the price of their insurance," ACC Minister Nick Smith said in a report to his Cabinet colleagues.

"Initial advice commissioned by officials indicated that cost savings of 20 to 26 per cent would need to be realised by private insurers for the price of insurance to be equivalent to today's price."

But Smith argues there is another reason for the introduction of competition, namely, the reduction of political risk.

So long as ACC is a state monopoly it is liable to yo-yo between periods of rigour and periods of laxity depending on the priorities and values of the Government of the day.

At this stage the Government is not prepared to go as far as the stock committee advocated.

It is only proposing to open up the work account to competition - though work will be done on whether the same might be done for the earners and motor vehicle accounts. And ACC would continue to provide workplace insurance cover, subject to rules to prevent it from cross-subsidising or otherwise competing unfairly.

The work account represents just 16 per cent of ACC's levy income and 13.3 per cent of its unfunded liabilities.

It would be more were it not for the Accredited Employers Programme which allows larger firms, accounting for about one employee in five, to take responsibility for managing their own claims ( and saving about 15 per cent in the process).

The Government plans to extend that scheme and remove some of the barriers to uptake.

And in the quest for more accurate pricing of risk it plans to introduce experience rating (for larger employers) and a no claims discount scheme (for smaller ones) to the work account.

Perhaps it should wait and see what gains those initiatives deliver before making changes to the scheme that are both more radical and more likely to be reversed upon a change of government, as happened last time.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

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