Assessing Workers’ Compensation Schemes in an Incomplete Contracts Framework Arlene Wong University of New South Wales Supervisors: Dr. Kieron Meagher and Dr. Sachi Purcal

Purpose of Study A range of Workers’ Compensation schemes exist in Australia Our aim is to evaluate the different schemes in achieving its objectives –Incomplete contracts model –Empirical Study Consider the choice of scheme as a policy tool Extend the incomplete contracts literature to understand the effect of competition on incentives.

Central Scheme Managed Scheme Competitive State Fund Highly Regulated Partially Regulated MonopolyHybrid Unregulated Competitive QLD Canada Washington NSW SA Victoria Oregon Colorado South Carolina WisconsinWestern Australia TAS ACT NT Texas Germany Central Scheme Central Scheme Motivation Aims  Claims management  Adequate compensation of injured workers  High quality of service to workers and employers Managed Scheme Managed Scheme Partially Regulated Partially Regulated Unregulated

Agenda Key conclusions… details later Methodology Theoretical results Empirical Results Policy Implications

Key Conclusions Dispersion in performance of WC schemes in Australia. Partly explained by differences in incentives to cost cut and improve quality of service. –Schemes with lower government control have a greater incentive to cut costs, but also improve quality of service. Empirical evidence suggests pursuing a government run scheme is preferable.

Agenda Key conclusions… details later Methodology Theoretical results Empirical Results Policy Implications

WC Insurance Agent Benefit B Employers Workers Compensation R G Costs C

Approach 1. Theoretical Incomplete Contracts Model Social Optimum 1)Central Scheme 2)Monopoly Managed Scheme 3)Oligopoly Managed Scheme 4)Monopoly Private Scheme 5)Oligopoly Private Scheme 2. Empirical Investigation Hart, Shleifer, Vishny (1997)

What is an ‘incomplete contract’? A contract between a publisher and an author. Idea on twist in the plot – how much effort to put in?

Incomplete Contracts Framework Date 0 Date 1 Contract written between G & M k M k chooses the level of investment. 1.Quality improving innovation 2.Cost-cutting innovation Renegotiation of contract occurs. M k is remunerated. Date 2 Source: Hart (1995) M k chooses the level of investment in: 1.Cost-cutting innovations 2.Quality improving innovations Source: Hart (1995) B = B 0 - b(e) B = B 0 - b(e) + β(i) C = C 0 + e – c(e) R = R 0 + J(e) C = C 0 + e – c(e) + i R = R 0 + J(e) – R(i) Three Effects: Operating costs, Quality of service and Claim costs

Incomplete Contracts Framework Date 0 Date 1 Contract written between G & M k M k chooses the level of investment. 1.Quality improving innovation 2.Cost-cutting innovation Renegotiation of contract occurs. M k is remunerated. Date 2 Source: Hart (1995) M k chooses the level of investment in: 1.Cost-cutting innovations 2.Quality improving innovations i $ MC MR 1 MR 2 i1i1 i2i2 Managed Scheme

Relative bargaining payoffs Social Optimum Case 1: Central Scheme Case 2: Monopoly Managed Scheme Case 3: Oligopoly Managed Scheme

Modelling Competition Consumer utility model Probability of choosing insurer k Two factors: Small σ and Large n

Relative bargaining payoffs Case 4: Monopoly Private Scheme Case 5: Oligopoly Private Scheme Two factors: Different remuneration and levels of competition

Agenda Key conclusions… details later Methodology Theoretical results Empirical Results Policy Implications

Distortions Incomplete contracts. Privatised schemes do not consider quality. Competition can cause excessive investment.

Sub-optimal Investments High Low HighLow Central Scheme Managed Monopoly Private Monopoly Level of Cost-Cutting (e) Level of Quality Innovation (i) Social Optimal

Impact of Competition High Low HighLow Central Scheme Managed Monopoly Private Monopoly Level of Cost-Cutting (e) Level of Quality Innovation (i) Social Optimal

Impact of Competition Investment increases in n and decreases in σ Overinvestment: Small σ –Reduce n Underinvestment: Large σ –Increase n

Impact of Competition High Low HighLow Central Scheme Managed Monopoly Private Monopoly Level of Cost-Cutting (e) Level of Quality Innovation (i) Social Optimal

Impact of Competition High Low HighLow Central Scheme Managed Monopoly Private Monopoly Level of Cost-Cutting (e) Level of Quality Innovation (i) Social Optimal

In the end, it is a question of trade-offs High Low HighLow Central Scheme Managed Monopoly Managed Oligopoly Private Monopoly Private Oligopoly Level of Cost-Cutting (e) Level of Quality Innovation (i)

Relative dominance of effects High Low HighLow Central Scheme Managed Monopoly Managed Oligopoly Private Monopoly Private Oligopoly Level of Cost-Cutting (e) Level of Quality Innovation (i)

Scheme Predictions (e) (i) Central Scheme Private Monopoly Managed Monopoly Managed Oligopoly Private Oligopoly Cost cutting dominates quality improvements Rank Low Central Private Managed

Agenda Key conclusions… details later Methodology Theoretical results Empirical Results Policy Implications

Sources: * National Workers’ Compensation Statistics Database Duration of Injury (weeks)*Total Scheme Costs** ** Australian Comparative Performance Monitoring Report

Source: * Australian Comparative Performance Monitoring Report Frequency RateAsset to Liability Ratio

Quality of service

Empirical Modelling Indicators of claims management: –Frequency rate, claims costs, asset to liability ratio and average premium rates. Explanatory variables: –Proportion of male –Proportion of full-time workers –Proportion of workers over 55 –Unemployment rate –AWE

Empirical Results

Agenda Key conclusions… details later Methodology Theoretical results Empirical Results Policy Implications

There are differences in incentives across schemes –The ‘optimal’ WC scheme depends on the relative importance of the different investments. A government controlled scheme appears favorable in light of the aims of WC insurance. The choice of scheme is an effective policy tool to be considered. Competition between agents may move the incomplete contract outcome further away from the social optimum.

Questions and Comments Welcome

Cost cutting is higher in schemes with less government control 1 e * op e Mk = e M e Vk = e V e G Backup

Quality Improvements is higher in schemes with less government control 1 iGiG i * op i M i Mk i V i Vk Backup