Brian Fallow: ACC hostage to a changing world

For the Government to wrap legitimate concerns about slippage in ACC's performance in a whole lot of shrill scaremongering and scapegoating is gratuitous.

Indeed it is downright irresponsible when talking about the scheme to use terms like "insolvent" and "going down the gurgler" - even if the context is counterfactual - because there are people who depend on it to keep body and soul together and will do for the rest of their days.

The Accident Compensation Corporation is one of the largest financial organisations in the country with revenues and outgoings running into billions of dollars. Its finances are correspondingly complex.

Its actuaries, PricewaterhouseCoopers, estimate its liabilities as at next June 30 will be $21.9 billion, which is $2.6 billion higher than they thought they would be back in June last year.

Its reserve assets by contrast are around $10 billion and like other investors it is not immune to what has been happening on financial markets worldwide.

Its record as a fund manager is impressive, however. It managed a $187 million gain - yes, gain - for the six months to December 2008 and over the past 16 years it has outperformed its market benchmark indices by an average of 1.5 percentage points a year.

Nevertheless, ACC Minister Nick Smith said last week that if it were an insurance company it would be insolvent.

It is not a commercial insurer, of course, and most of the gap between its assets and its liabilities arises from the fact that it is only part-way through a process of transition from a pay-as-you-go scheme to a fully funded one.

As the law stands the scheme has to be fully funded by 2014.

ACC's briefing to the incoming minister last year notes that upward pressure on levies would be reduced if the date were pushed back to 2019, or if it were allowed to continue indefinitely as a partly funded scheme, with only new injuries fully funded.

Labour ACC spokesman David Parker has a private member's bill in the ballot to push the date out to 2019 and Nick Smith has indicated he supports that approach too. That will help.

Most of the recent increase in the fund's liabilities, however, has nothing to do with the way ACC is run.

Rather it reflects the parlous state of the world economy and the resulting steep drop in the discount rate, the assumed interest rate used to put a net present value on the scheme's future obligations.

As soon as an injury occurs the lifetime costs of that injury accrue. Conceptually the exercise of annually revaluing the liabilities is simple enough. It is to answer the question: how much money would you need to set aside in a bank account to cover the lifetime costs arising from existing injuries and the coming year's projected injuries?

In practice it is very demanding task. The answer depends on all sorts of things, including how many injuries occur, how much it costs to treat them, how long people stay on ACC and what happens to wages growth.

A key variable is interest rates. The lower rates are the larger the notional lump sum needed to fund the required cash outgoings will be. And lately they have dropped with a thud.

In the actuaries' latest estimate the steep drop in interest rates, all along the yield curve but especially at the short end, has alone added $1.6 billion to the liability - more than half the overall increase.

Together with other changes in economic assumptions, including the outlook for economic growth and wage inflation, it accounts for 71 per cent of the latest "blowout" in liabilities the politicians are wringing their hands over.

Given the prodigious sum governments around the world are borrowing it is a racing certainty interest rates will climb - and the seesaw effect on the net present
value of ACC liabilities will be downward.

It is also specious to assume that the current level of interest rates will continue when projecting the outlook for levies in the earners' account and conclude that they would need to treble to 4 per cent of gross wages by 2014. "There go your tax cuts!"

But fluctuations in the discount rate are only part of the blowout story.

Blow that political froth away and there is still some honest-to-goodness beer beneath.

The briefing to the incoming minister highlights three troubling trends.

One is in the number of claims. In the 2007-08 year claims rose 4 per cent when the population grew only 1 per cent.

In the case of workplace accidents alone the number of claims per million hours worked has increased by 15.6 per cent over the past four years, and is now at the same rate as Australia (where the trend has been declining).

Secondly the proportion of claimants who return to work has been trending down, from 93 per cent in 2001 to 87 per cent six years later.

And the combined effect of more claims and high rates of inflation in the health industry have pushed ACC's overall cost of medical treatment up an arresting 55 per cent in the three years to June 2008.

The Department of Labour's most recent quarterly report card on ACC says: "The three-month rehabilitation rate, return-to-work rate and long-term claims pool are continuing to show negative results, indicating clients are staying on the scheme longer, thus increasing outstanding liabilities, particularly weekly compensation."

But the board, in a letter to the minister objecting to being muzzled, argues that most of the $9.2 billion increase in the scheme's reported liabilities over the past three years was beyond its control.

In addition to the effect of lower interest rates ($1.45 billion) there was a $2.45 billion increase in the reported liability because of a change in accounting standards which required a higher risk margin.

"The underlying situation is not worse, it is just reported differently," now-ousted chairman Ross Wilson wrote.

Another $200 million was the result of court rulings (about asbestos) and legislative changes to increase the scheme's coverage, on top of $600 million in Cabinet-approved policy decisions.

"Of the total only 20 per cent is able to be influenced by the board through operational programmes and interventions," he said.

"The previous Government wanted to increase ACC benefits take-up and coverage. Now the new Government wants greater cost control."

The shift in focus is fair enough.

But ACC is a civilised and cost-effective approach to dealing with the injured. Why undermine confidence in the scheme, unless you plan to undermine the scheme itself?