Assessing Workers’ Compensation Schemes in an Incomplete Contracts Framework Arlene Wong...

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

Monopoly Hybrid

Unregulated

Competitive

QLD

Canada

Washington

NSW

SA

Victoria

Oregon

Colorado

SouthCarolina

Wisconsin Western Australia

TAS

ACT

NT

Texas

Germany

CentralSchemeCentral Scheme

Motivation

Aims

Claims management

Adequate compensation of injured workers

High quality of service to workers and employers

ManagedScheme

ManagedScheme

Partially RegulatedPartially Regulated

UnregulatedUnregulated

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


• Methodology




WC Insurance

Agent

Benefit B

Employers

Workers

Compensation R

G

Costs C

Approach

1. Theoretical Incomplete Contracts Model

• Social Optimum1) Central Scheme2) Monopoly Managed Scheme3) Oligopoly Managed Scheme4) Monopoly Private Scheme5) 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 & Mk

Mk chooses the level of investment.

1. Quality improving innovation

2. Cost-cutting innovation

Renegotiation of contract occurs.

Mk is remunerated.

Date 2

Source: Hart (1995)

Mk chooses the level of investment in:

1. Cost-cutting innovations

2. Quality improving innovations

Source: Hart (1995)B = B0 - b(e)B = B0 - b(e) + β(i)

C = C0 + e – c(e)

R = R0 + J(e)

C = C0 + e – c(e) + i

R = R0 + 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 & Mk

Mk chooses the level of investment.

1. Quality improving innovation

2. Cost-cutting innovation

Renegotiation of contract occurs.

Mk is remunerated.

Date 2

Source: Hart (1995)

Mk chooses the level of investment in:

1. Cost-cutting innovations

2. Quality improving innovations

i

$

MC

MR1MR2

i1i2

Managed Scheme

Relative bargaining payoffs

• Social Optimum

• Case 1: Central Scheme

• Case 2: Monopoly Managed Scheme

• Case 3: Oligopoly Managed Scheme

,

max e i

N e i

,

max ( ) ( ) ( ) ( ) ( )e i

N b e c e i R i J e e i

0 0,

1max [ { ( ) ( )} ( ) ]2 k k k k kM M M M Me i

N P C i R i c e e i

[ ( ) ( ) ( ) ( ) ( )]2 b e c e i R i J e

,

max [ ( ) ]e i

N c e e i 1 { ( ) ( )}2 i R i

kP

Modelling Competition

• Consumer utility model

• Probability of choosing insurer k

0 0( )k k kY S i

1

1

1

Pr max

( ) ( ) ( ) ( ) Pr ,...,

( ) ( ) ( )

k k j

k k nk n k

k

j k

P Y Y

i i i i

i if x F x dx

Two factors: Small σ and Large n

Relative bargaining payoffs

• Case 4: Monopoly Private Scheme

• Case 5: Oligopoly Private Scheme

( )VR i

0 0 0,

max [ ( ) ( ) ( ) ]k k k k k

V Vk k

V V V V Ve i

N P R C c e R i J e e i

0 0 0,

max [ ( ) ]V V

V V Ve i

N P R C c e e i ( )VJ e

kP

Two factors: Different remuneration and levels of competition

Agenda


• Methodology




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 Quality

Innovation (i)

Social Optimal


• Investment increases in n and decreases in σ

• Overinvestment: Small σ– Reduce n

• Underinvestment: Large σ– Increase n


High

Low

HighLow

Central Scheme

Managed Monopoly

Private Monopoly


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 Quality

Innovation (i)

Relative dominance of effects

High

Low

HighLow

Central Scheme

Managed Monopoly

Managed Oligopoly

Private Monopoly

Private Oligopoly


Level of Quality

Innovation (i)

Scheme Predictions

(e)

(i)

Central Scheme

Private Monopoly

Managed Monopoly

Managed Oligopoly

Private Oligopoly

Claims QualityCentral Low HighManaged Medium MediumPrivate High High

Predictions

Cost cutting dominates quality

improvements

Rank1 2

3Low

Central Private Managed

Agenda


• Methodology




Sources: *National Workers’ Compensation Statistics Database

4

6

8

10

12

14

16

18

20

1995 1996 1997 1998 1999 2000

ManagedPrivateCentral

Duration of Injury (weeks)* Total Scheme Costs**

**Australian Comparative Performance Monitoring Report

1.0

1.5

2.0

2.5

3.0

1998 1999 2000 2001 2002 2003 2004


%

Source: *Australian Comparative Performance Monitoring Report

Frequency Rate Asset to Liability Ratio

6

8

10

12

14

16

1998 1999 2000 2001 2002 2003 2004


40

60

80

100

120

140

160

1998 1999 2000 2001 2002 2003 2004


%

Quality of service

2.5

3.0

3.5

4.0

4.5

1999 2000 2001 2002 2003 2004 2005


Out of5.0

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

1 21

n

it k ikt i i itk

y X M P

Empirical Results

Mean Variable Aim

Central Private Managed

Frequency rate Lower 3 1 2

Total Costs Lower 1 2 3

AL Ratio Higher 1 2 3

Premium Rate Lower 1 2 3

Overall 1 2 3

Variance Variable Lower

Ranking

Similar across all schemes.

Agenda


• Methodology




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 eMk = eM

eVk = eV

* * *[ '( ) '( ) '( )]2 G G Gb e c e J e

* * *'( ) '( ) '( )op op opb e c e J e

* *'( ) '( )k kV Vc e J e

*'( )kMc e

eVk = eV eG

Backup

Quality Improvements is higher in schemes with less government control

1

iG i*op iM iMk

* *[ '( ) '( )]2 G Gi R i

* *1 [ '( ) '( )]2 M Mi R i

* * * ** * * *

0 0

'( ) '( ) ( ) ( )'[0]. '( ).[ ( ) ]

2 [0] 2k k k k

k k k k

M M M MM M M M

i R i i R iFi P C c e e i

F

* *'( ) '( )op opi R i

iV

iVk

Backup

Assessing Workers’ Compensation Schemes in an Incomplete Contracts Framework Arlene Wong...

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