Thursday, August 2nd, 2012

WorkCover Update 2012 – The Year Of The Dragon, Where There Is Smoke There Is Fire!

The Scheme financial results for the six months to December 31, 2011 were announced at the end of March and despite strong positive cash flow the Scheme delivered a $0.222 billion operating loss, the unfunded liability rose from $0.952 billion to $1.174 billion and the funding ratio decreased from 65% to 62%.

Despite this disappointing result the average premium rate has been held at 2.75%.

Against this background the New Employer Payment Scheme came into operation on 1 July 2012 and decisions are expected to be made before the end of the year in relation to the makeup of the Scheme’s claims management and legal panel.

It is widely believed that at least one and possibly two new claims agents will be introduced to manage claims alongside the incumbent EML.

What will these changes mean to the State’s employers?

  • Small employers (those who pay less than $20,000.00 to WorkCover or with a payroll less than $300,000.00) will not experience any change and will pay according to the current industry classification system.
  • Medium and large employers paying more than $20,000.00 in premiums or $300,000.00 in remuneration will be experience rated. WorkCover asserts that these employers which together make up 9% of the total number of employers are responsible for approximately 75% of claim costs each year.

Experience rating represents a move from the industry rate to a customised rate for each employer affected and it is designed to penalise employers whose claim costs are worse than the industry rate.

Premiums are designed to cover:

  • claim costs (both current and future);
  • WorkCover operating costs; and
  • the unfunded liability

which together make up WorkCover’s funding costs.

An individual employer’s base premium will be calculated at the start of the premium year on the basis of an initial estimate of remuneration and again in hindsight at the end of the year when actual remuneration is known. That base premium is adjusted up or down (known as ‘experience rating’) by a complex calculation based on WorkCover’s estimate of the total cost of any claims that the employer has had in the previous 2 years compared to the industry average.

WorkCover expects that initial claims estimates will be low but will get closer to accuracy over two to three years. It is not known why WorkCover expects the initial claims estimates to be low but some actuaries expect the opposite to be the case. What can be said with certainty is that employers with long term expensive claims will be disadvantaged by the changes and will likely find that premiums will be up to 25% more than the previous years’ rate and that will compound over subsequent years. WorkCover expects that approximately 1/3 of employers will experience a premium increase.

WorkCover asserts that experience rating is intended to be cost neutral. If the new system does prove to be cost neutral it begs the question just how we can see improvement in the funding position?

A compelling case could be made for the conclusion that over 20 years WorkCover hasn’t charged enough for premiums and the Scheme has been spiralling down.

A linear trend exists which illustrates the steady decline in Scheme funding in nearly 20 years. That trend will likely continue as investment returns continue to deteriorate in the current economic climate which increasingly looks to be the new normal.

In an article in SA Business Journal dated 10 July 2012 WorkCover SA Chief Executive Rob Thomson is quoted as saying that the new Experience Rating System was “one piece of the puzzle (and) hopefully, this change together with other changes that have been made, will actually result in the levy rate being reduced at some point. I would hope that’s within the next couple of years”

Against the background of that statement it is interesting to look at what has been happening to the NSW Scheme which has deteriorated at an alarming rate despite the reform of the premium system led by Rob Thomson up until his departure from NSW in 2009.

In the years 2006 to 2008 the NSW Scheme was fully funded but we now know that result was achieved by windfall investments prior to the global financial crisis and not through any structural changes in the Scheme.

In October 2011 the NSW Finance & Services Minister was reported as saying that he was “very concerned” about the Scheme’s $1.583 billion deficit.

A few weeks later in early November 2011 the deficit was acknowledged to be $2.36 billion.

In February 2012 the Chairman of NSW WorkCover, Greg McCarthy, resigned citing “continued frustration” at being “constantly ignored” when warning successive ministers about the structural problems in the Scheme. At that time he predicted that the Scheme would be in a $4 billion deficit by the time the December 2011 evaluation was finished and he warned of a blowout to $5 billion by June 2012.

In April 2012 the NSW government announced a review of the Scheme because it was in deficit by $4.1 billion and the government warned that without reform premiums were predicted to rise by about 28%.

A parliamentary enquiry reported in mid June 2012 and amongst the 28 recommendations to overhaul the Scheme it called for the introduction of a “Victorian style step-down of benefits to 95% pre injury earnings in the first 13 weeks, to 80% from 14 weeks onwards replacing the current system of 100% payout for 26 weeks” as reported in InDaily News on 14/6/12.

Legislation was passed on 22/6/12 introducing the step-downs as well as restrictions upon journey claims with the amendments modelled on the current law in South Australia and capping weekly benefits at five years unless the claimant is assessed as having a 30% whole person impairment.

Interestingly, while Rob Thomson was General Manager of the Workers Compensation Division of WorkCover NSW a ban was imposed on the payment of a lump sum to commute weekly payments of income maintenance. That ban is now considered to have contributed to rising claim durations and increased pressure on common law, both of which are prime drivers of the blow out in liabilities. The NSW ban was formally lifted by statutory amendment last month.

In the SA Scheme the legislation allows for the payment of a lump sum to redeem weekly payments of income maintenance and medical and like expenses but WorkCover SA have effectively imposed an administrative ban upon such payments.

It will be interesting to see if SA follows the NSW lead and lifts the administrative ban so that judicious use of redemptions is mandated as a useful method of controlling claim durations in appropriate circumstances.

What can we take out of the New South Wales experience?

Firstly, investment income camouflaged the structural deficits in the NSW Scheme in the period 2006 to 2008. Those structural deficits have seen the Scheme deteriorate at an alarming rate despite “the reform of the premium system in the period 2005 to 2009”.

Secondly, a $175 million loss in the SA Scheme’s investment portfolio in the six months to December 2011 does not bode well for an improved scheme funding ratio when the end of financial year results are publicised in the annual report later this year.

When announcing the financial results for the six months to 31 December 2011 WorkCover SA Chairman Philip Bentley made the point that:

“It is important to remember the long term nature of the Scheme and that it is not designed to adjust automatically to the sorts of changes we are currently experiencing in global financial markets. We are yet to see the full impact of the 2008 legislative reforms, in part as a result of a staggered implementation”.

The problem as I see it is that investment income will likely remain subdued and, “the sorts of changes we are currently experiencing in global financial markets” are part of the new normal.

In previous reports I have expressed scepticism that we will ever see, “the full impact of the 2008 legislative reforms”.

The most recent data available makes it clear that income maintenance claims which remain active beyond two years post injury are still high and so the “tail” still exists and the impact of the 2008 legislative amendments designed to remove all but the most seriously injured claimants from the Scheme remains muted. The ill conceived administrative ban on redemptions will likely extend claim durations as it did in NSW and help to maintain the numbers in the “tail”.

The deterioration in investment returns coupled with the failure of the 2008 legislative amendments to have any significant impact make it almost certain that the erosion of the viability of the Scheme will continue.

Hopefully we will not see such a rapid decline as that which occurred in New South Wales but if we do the government will be placed in a catch 22 situation. Further decreasing the benefits of injured workers will not be enough to retrieve the situation and raising the premium rate will be politically unacceptable.

I think that anyone predicting that the average levy rate will fall “within the next couple of years” is being very hopeful indeed!

The uncertainty which remains in the Scheme will continue to make it attractive for large employers to seriously consider the viability of self-insurance. 

Self-insurance remains the ultimate form of experience rating and provides the only true method of controlling risk, costs and claims administration.

To read John Walsh's (Managing Partner, Donaldson Walsh Lawyers) full July Update and the August, March & May 2011 Special Reports on the WorkCover Scheme please visit http://www.donaldsonwalsh.com.au.

To contact John directly please visit his profile page at http://www.donaldsonwalsh.com.au/our-people/john-walsh

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