I Research & Evaluation I1

The Privatisation of GI0 Australia: Success or Failure?

Anlhony Casey Department of Economics, University of New England

Brian Dollery Department of Economics, University of New England

The privatisation of G I 0 Australia took place amidst acrimonious public debate on the merits of selling this government trading enterprise. Yet the innovative methods employed in the privatisation process represented a landmark in contemporary Australian economic history. With the passage of time and the attendant pow of information, it is now possible to assess the outcome of the privatisation of GI0 Australia. Without considering the wider philosophical dimensions of privatisation, we conclude that from a tripartite perspective that the privatisation of G I 0 Australia should be regarded as successful.

The article is subdivided into four main parts. Section I provides a brief synopsis of the historical evolution of GIO; Section 2 details the actual privati-sation process. Section 3 analyses the impact of the privatisation in terms of its effects on the GIO, the wider insurance market in Australia, and the ‘net worth’ of the NSW government. The article ends with some brief concluding remarks in Section 4.

This article draws extensively on Casey’s (1995) Honours dissertation supervised by Dollery. The authors would like to thank two anonymous referees for helpful comments on an earlier draft of the article.

The NSW government’s Workers ’ Compensation Act 1926 compelled employers to insure against injuries sustained by their employees in the workplace, but ‘many private insurance companies indicated a refusal to cater for the business of workers’ compensation insurance so the govern- ment was under an obligation to provide a vehicle via which employers could obtain insurance to comply with the Act’ (Evatt Research Centre 1989: 204). This vehicle was given legal status by the Government Insurance Act 1927. The GI0 thus originally dealt solely with workers’ compensation and was a branch of NSW Treasury.

In 1942, the Act of 1927 was amended to establish the GI0 ‘as a body corporate with power to carry on the general business of insurance, encompassing any class of commercial insurance activities and any other business activity’ (Evatt Research Centre 1989: 204). The original body was a single-product producer in a non-competitive market with primarily social objectives. After 1942 GI0 closely resembles the organisation that entered the 1990s. The Government Insurance (Amendment) Act 1985 allowed the G I 0 to have subscribed capital and to pay dividends determined by the Treasury in consultation with the GI0 Board. The GI0 had then become a statutory body, free from Commonwealth income tax, sales tax and stamp duty, and under political control both through the appointment of the board of directors and the determination of dividends. It paid the equivalent of these government levies to the NSW government. In 1989, the Evatt Research Centre (1989: 207) observed that:

This pressure for privatisation should be rejected, both on the basis of financial considerations and also social grounds. It is perhaps not readily appreciated that apart from being a significant source of revenue to the New South Wales public sector, the GI0 plays an important ongoing social role in the community.

In 1989 a NSW government white paper (1989: 3- 4) identified six basic types of government organi- sation: government service (heavily subsidised monopolies, such as Treasury or Consumer Affairs); semi-commercial service (partly subsidised monopolies, such as the Broken Hill Water Board); commercial service (self-sufficient monopolies, such as the Sydney Water Board); commercial business (self-sufficient, semi-competitive bodies,

Auslmlinn Journal of Public Adniinistmtion . 5565‘): 18-25, September 1996

The Privatisation of GI0 Australia: Success or Failure? 19

such as the TAB); commercial enterprise (self- sufficient, fully competitive bodies, such as the GI0 and the State Bank). The last category was classified in the non-budget sector. The white paper (1989: 9), in discussing the justification for public ownership of such businesses, noted that ‘if the activity is profitable and the rate of return to government is greater than what could be generated from investing the proceeds of the sale of the business, then there is a financial justification for retaining the activity in the public sector’. At that stage the government exercised no input or output controls over G I 0 or other commercial enterprises; appointed a board possessing welfare, legal, financial and management skills to produce equitable and efficient results; allowed the board to elect the chief executive officer; required any costly ministerial directions to be recorded in the annual report; exempted the enterprise from borrowing controls, but set its debt level; and had to approve of the formation of subsidiaries or new ventures and, with the board, set annual performance targets (NSW Government 1989: 19-21).

In an earlier 1988 report, the following were listed as the preferable methods of corporatisation (making a government trading enterprise (GTE) behave more like a publicly listed company): establish the minister responsible as the principal, analogous to shareholders; GTEs should be stripped of regulatory and policy advisory activities; board appointments should be on the basis of commercial expertise; boards of directors should seek to maximise the return on GTE assets, subject to regulation, and with performance-related reward and sanction schemes in place; boards should be given full discretion to hire and fire senior executives; formal contact between the ‘shareholding’ minister and board should be kept to a minimum; cross- subsidisation, captive government business, and favoured treatment should be replaced by com- petitive tendering (NSW Government 1988: 38-9).

In essence, these parameters determined the institutional and commercial environment within which the G I 0 operated immediately prior to privatisation. At least two direct consequences flowed from the 1988 report. First, the GI0 lost its workers’ compensation and third party insurance monopoly franchises, and its business arrange- ments with the government changed from an insurance risk business to a fee-for-service business (Walsh 1992). And second, whilst under public

ownership insurance policies were guaranteed by the NSW government; this would no longer be the case after privatisation.

Despite these efforts to induce independence into the operations of the GIO, evidence of continuing political influence and interference in GI0 and the insurance market remained. GIO’s managing director, Bill Jocelyn, for example, in the 1989 annual report complained about the erratic changes to motor accident injuries insurance. Assessing the profitability of automobile injury insurance, Jocelyn argued that ‘we believe that future Government interference will inevitably lead to losses and the withdrawal of insurers’ (GI0 1989: 6). Similarly, noting GI0 plans to expand into other states, Greiner, Premier of NSW at the time, is quoted as saying ‘We’re certainly not going to countenance a situation where those organisations continue to run their own race rather than having the money used where the taxpayers, where the people of NSW, want it used’ (Larriera et a l . 1991). He went on to stress objections to expanding into Western Australia and into offshore reinsurance, and threatened to extract a ‘surplus capital’ payment of dividends from G I 0 so that ‘appropriate dividends come back to the taxpayer because the money is better spent for you’ than in expansion outside NSW or Australia. Moreover, the Government Insurance Act itself required the GI0 to function as three separate businesses (General, Life and Funds Administration) and debarred the transfer of capital between them (NSW Government 1992: 10). This meant that the NSW legislature imposed limits on the structure and commercial activities of the GIO, which, in a privatised company, would normally be decided by private managers and the capital market.

In 1990 G I 0 changed its name to G I 0 Australia and set out its new terms of reference in a vision statement (GI0 Australia 1990: ii). Business proceeded apace. In the year before privatisation, GI0 Australia underwrote single premiums worth $461 million dollars; only six private insurers in the country scored higher (Mychasuk 1992). In total general insurance, only the NRMA, FAI, National Commercial Union and NZI ranked above GIO. In the life insurance market for single premiums it was seventh (with 3.9 per cent market share) and was eighth (3.7 per cent) in the annuity market (Boyd 1991). It had over $8 billion in total assets compared to 4.9

Casey and Dollery 20

billion four years earlier (GI0 Australia 1991: 8). It declared a net profit of $95 million, tax expenses of $92.6 million and dividends of $30 million. At this stage, GI0 management was eager to compete with private firms when ‘privatisation inevitably occurs’ (GI0 Australia 199 1 : 8).

The Government Insurance Office (Privatisation) Act 1991 directed the privatisation process. On 1 January 1992, GI0 Australia became GI0 Australia Holdings Ltd, changing the organisation from a statutory authority to an incor- porated company whose share capital was held by the NSW government (NSW Government 1992: 49). An extraordinary publicity campaign followed.

The Privatisation Process The pre-privatisation publicity was accused of generating ‘retail euphoridhysteria’ (McCrann 1992), failing ‘to ignite a speculative frenzy’ (Ries 1992b) and being ‘one of the greatest marketing exercises in Australian financial history’ (McCrann 1992). Whichever it did achieve, the campaign certainly was unusual. For the first time the Australian Securities Commission waived regulations for privatisation prohibiting pre- prospectus promotion, so that ‘television viewers were treated to the spectacle of hordes of people stampeding to get their share’ and ‘newspapers carried a blunt message of greed’ (Frith 1992b). Rhetoric aside, the fact that the float only lasted 32 hours and attracted an $1 billion oversubscription indicated that the campaign was effective. Bryan Frith suggested that the ‘mums and dads’ were not just attracted by the advertisement campaign, but by the high, fully-franked dividends offered by GI0 and the prospect of the share price rising above the sale price (Frith 1992a).

Eventually 127,200 shareholders held 500 million GI0 shares after paying $2.40 per share. One hundred thousand of those had their applications met in full (GI0 Australia 1992: 6). The allocation of shares among applicants was biased in favour of small investors, customers and employees. Thirty-five per cent was allocated to the institutional offer, with the rest on public offer (NSW Government 1992: 60-1). Employees were offered concessions to the purchase of shares, to be held by a trustee, GI0 Guardians, but this offer was not extended to directors. The first day of trading on the Australian Stock Exchange, 23 July 1992, saw the shares initially traded at $2.68, reach a

peak of $2.78, before closing at $2.52 (Jackson 1992). The weeks and indeed months following showed disappointing results for the price of the share, but, initially at least, less than one per cent of shareholders had sold their shares in the first two weeks of trading (Frew 1992b).

Evaluating the Outcomes of Privatisation Numerous criteria could be invoked to evaluate the economic and social outcomes attendant upon the privatisation of GIO. We shall focus our attention on three of the most important dimensions of the privatisation of GIO: the effects on the operations of GI0 itself; the effects on the broader Australian insurance industry; and the effects of the privati- sation of GI0 on the ‘net worth’ of the NSW government.

The Effects on the GI0 Needless to add, the impact of privatisation on GI0 Australia was dramatic. A number of pertinent statistics are available. First, profitability fared far better than had been anticipated. The prospectus had predicted the maintenance of after-tax profits of around $100 million, which represented the average level of profitability for the previous five years (NSW Government 1992: 11). In fact, G I 0 performed much better despite the onset of Hurricane Andrew in 1993 which was ‘the largest catastrophe the world insurance market has experienced’ (GI0 Australia 1993: 7). Table 1 below shows the after-tax profits recorded by GI0 since 1986.

Table 1 Net Profit Statements of GI0 198694 ($ million)

1986 70.0 1987 80.7 1988 76.8 1989 81.0 1990 103.6 1991 95.0 1992 117.0 1993 103.1 1994 126.1

Sources: Evatt Research Centre 1989; G I 0 Annual Reports. 1989-94

The Privatisation of GI0 Australia: Success or Failure? 21

Second, the increase in net assets has been no less spectacular. The growth in asset values in 1994 dollars is shown in Figure 1 below. The effects of government legislative changes in the mid- 1980s, corporatisation in the late 1980s, and privatisation in 1992, all clearly evident.

Figure 1 Value of Net Assets of GI0 198694 ($ million)

Sources: Evatt Research Centre 1989; G I 0 Annual Reports, 1989-94

Third, shareholders have reason to be modestly pleased with dividends declared thus far: 14, 15 and 16 cents per share in 1992, 1993 and 1994 respectively, with plausible predictions of sustaining this over the foreseeable future (GI0 Australia 1994: 2).

Fourth, although the internal or productive efficiency of organisations is notoriously hard to assess, available data suggest that the GI0 has performed well to date. Staff levels provide at least a partial view of developments within GIO, with data showing 2,500 personnel in 1989 (GI0 1989: 31). 3,170 in March 1992, 3,871 in March 1993, and 3,810 in March 1994. The big jump in employee numbers in 1993 probably re resents the

significant expansion was the $167 million takeover of the Victorian government’s State Insurance Office (SIO) (Adamson 1992). The SIO employed 980 people (classed as public servants), faced greater political interference, had much smaller total assets and was basically a general insurer, with virtually no life insurance or other financial products (Frew 1992a; Gill and Frew 1992; Ries 1992a). Mark Furness (1992) reported the SIO was estimated to be 350 to 400 people overstaffed. They were given every opportunity to stay within the Victorian public service by the Labor government and GIO.

interstate expansion of GI0 in 1992. P The most

There are also other indications that GI0 is becoming more productively efficient. The name GI0 is no longer associated with the government of the day. Accordingly, the network of retail branches has been rationalised without political constraints. The first of these was announced in Wollongong where motor vehicle, household and business insurance claims processing was transferred to the head office in Sydney (Simpson 1992). In 1994 there was continuing commitment to the ‘development of larger full service branches and away from smaller high street branches’ (Iliffe 1994: 2) to be concentrated in population growth areas. Many of these are interstate rather than in NSW, where there appears to be a burdensome number of branches.

Comparing recent movements in revenue with movements in profit is only illustrative of efficiency, bearing in mind the erratic behaviour of short-term insurance sector figures. Apart from the Hurricane Andrew year, Table 2 shows revenue increasing less than profits after privatisation, implying lower costs. Not too much weight should be placed on these data, since some types of insurance premiums are costs only in the medium to long term.

Table 2 Revenue and Profit Results 1991-94

Year Revenue Change Net Change $m % profit %

1991 1 396.6 -5 95 -9 1992 1423.3 +2 117 +23 1993 2 132.6 +50 103.1 -14 1994 1871.9 -14 126.1 +22

$m

Sources: GI0 Australia Annual Reports, 1991-94

Further indications that productive efficiency has been improved may be seen by the change in GIO’s own product-mix. A versatile and flexible range of general insurance and financial products shows it is marketing to meet market wants. Moreover, the expansion of GI0 into other states and abroad demonstrates the company’s enhanced ability to find markets and compete for them. This is surely a result of the GI0 feeling its way around markets unencumbered by the responsibilities of being a state-owned enterprise.

22 Casey and Dollery

The Effects on the Australian Insurance Industry The classic case against privatisation of a govern- ment enterprise operating in a competitive industry has been advanced by De Fraja (1990). In essence, De Fraja argues that privatising a relatively inefficient nationalised firm in a competitive industry will reduce overall industry efficiency. This will occur because a large public producer, setting lower than maximising prices and operating at a loss, imposes a competitive discipline on the rest of the industry’s producers, forcing them to be more efficient. This pressure is removed by privatisation. De Fraja’s (1990) argument may be summarised as follows: a public firm ordered to maximise social welfare will operate with low prices and some degree of organisational slack. There is a tax imposed on the product to cover the losses incurred by the public firm. Private firms remaining in the industry are forced to cut costs, improve efficiency and are reduced to zero profits. When the public firm is privatised, the tax will be dropped, the firm will pursue profit maximisation, increase its efficiency and reduce its output. The artificial discipline on the private firms will diminish because the public firm will decrease its market share, allowing the private firms higher output and positive profit. Unless the public firm is grossly inefficient, the short-run effects of increased efficiency in the privatised firm will therefore be eventually outweighed by the increased inefficiency of the private competitors.

These outcomes did not eventuate in the case of GI0 and the Australian insurance industry for several reasons. First, a great proportion of the pre-privatisation GI0 business was written in NSW and not in the broader Australian market. Second, there were no losses by a pre-privatised GIO, so no tax to fund it was ever imposed. It is hard to imagine that, even if there were losses, a tax on insurance and financial products within NSW would be feasible. GI0 was not so riddled with organisational slack as to render it unprofitable. De Fraja (1990: 13-10) anticipates this objection: his analysis still ‘applies to the case in which the objective of profit-maximisation is imposed upon a public firm, perhaps in view of its privatisation’. If there was damage to the insurance industry’s efficiency, if the de Fraja effect indeed occurred, it would have been when the public firm was given commercial objectives in 1942 and when

it was corporatised in the 1980s. Third, ‘the long run industry efficiency increases with privatisation if and only if the long run equilibrium pre- privatisation output of the public firm is lower than that of the private oligopolists’ (De Fraja 1990: 14). In this particular instance, GI0 pre- privatisation was significant but not dominant in a number of markets. It was dwarfed by AMP in life insurance (Boyd 1991) and overshadowed by NRh4A in general insurance (Mychasuk 1992).

The Effects on the NSW Government’s ‘Net Worth’ The fiscal effects of privatising a public enterprise seem simple. The sale of an asset provides the state with revenue. It may dispose of this money in any way, including the retirement of debt. If the enterprise is profitable, it forgoes the future stream of dividends returned by the firm; if it makes a loss, the state is no longer responsible for making up the deficit. The price is crucial in determining whether or not the privatisation will be ‘a success’ according to fiscal criteria. The government has to sell the asset at a price that will attract buyers, but it also desires a maximum windfall from the sale. The price will therefore be determined by the capital value of the business as well as political expediency. The state’s objectives may conflict, so optimal price-setting is bound to be frustrated by the simultaneous pursuit of such things as creating a widespread ownership of shares, reducing the public sector borrowing requirement, altering the balance of economic power, liberalising the market (a business will be less attractive if monopoly profits are to be reduced), appeasing interest groups and so on.

Quiggin (1994) has argued that privatisation often reduces the net worth of the public sector which has disposed of the asset. Quiggin advances two reasons why privatisation typically has this effect. First, the profitability of an enterprise can usually be expected to increase with changed ownership, which pushes up the potential sale price. But the price is depressed by the fact that, to ensure that no shares remain unsold, investors will require a premium on the price in excess of what can be reasonably subtracted for risk. These effects ensure that the policy will not be fiscally neutral (Quiggin 1994: 6-8). The existence of this equity premium implies that the rate of return on equity is more valuable to the government than its sale

The Privatisation of GI0 Australia: Success or Failure? 23

value and seems to create a case for government holding equity, not privatising, at least until the public debt becomes too expensive.

Second, Quiggin (1994) postulates that privatisation involves a ‘political calculus’ which favours the underpricing of privatised assets. The argument runs as follows: when privatisation is controversial, governments would rather sell an asset too cheaply than face the embarrassing political costs which would follow under- subscription of a float. The evidence cited to support this proposition is the extent of oversubscription of share offers both in Australia and the United Kingdom. A share price of less than the true market value allows their eventual purchasers to enjoy a windfall in the form of a large and immediate capital gain. Quite apart from the obvious objection that it is selective to posit government failure in pricing while maintaining faith that the state can realise close to a business’s true capital value under public ownership, i t is somewhat more plausible to assume politicians can price assets with greater accuracy than they can run a trading enterprise.

We can examine the empirical validity of Quiggin’s ( 1994) first hypothesis following the method he himself employed to analyse the part- privatisation of British Telecom.2 The G I 0 offer price was $2.40 for each of 500 million shares, implying a valuation of the entire firm at $1.2 billion. However, it is necessary to point out a peculiarity with this privatisation. As a state- owned organisation, the GI0 was exempt from Commonwealth income tax, the equivalent of which it paid to the state government, in addition to dividends. As a private company, this revenue would be lost to the state, going instead to the Commonwealth. As compensation, the NSW and Commonwealth governments agreed on a $430 million retirement of state debt held by the federal government, compared to a total of $257 million in payments made by the G I 0 in the five years to 1990-9 1 . Without this payment the privatisation would not have taken place: ‘with tax compo it makes it not a marginal decision’ (AAP 1992). Other taxes to be collected by the state would increase the additional benefits to $600 million (Thomas 1992). This effectively increases the saving on debt to NSW to $1.8 billion, on government figures. Walker took issue with the ‘so-called tax compensation’ and ‘moneys stripped

from the GI0 prior to the float’ because they did not come from investors (Walker 1992: 17). He also identified $71 billion in additional sale costs, not considered by the NSW government analysis. While the ‘tax compensation’ and other components of the $600 million are not revenue from selling the organisation, they can nevertheless be legitimately thought of as savings from privatisation, and so are properly part of these calculations as is the $71 million.

The net proceeds from the sale, then, was $1,729 million. In 1991, the G I 0 had a gross operating surplus of $125.3 million and an after- tax net profit of $95 million. This would imply that the effective rate of return forgone by the privatisation was 5.5 per cent as against a real bond rate of 5 per cent. Using present values with a 5 per cent bond rate, the stream of profits is worth (in perpetuity) $1,995 million as against the sale price of $1,729 million.

If an 8 per cent rate is used, then the income stream is worth $1,282.5 million. Thus whether or not there will be a net financial loss to the public sector depends crucially on assumptions about bond rates. The sale becomes beneficial at bond rates above 5.8139535 per cent, following the approach by Quiggin. Should we be using the last reported result of an insurance company? If we assume GIO’s net profits to be $100 million, the result predicted in the prospectus, and the average for the five years before privatisation, the range is $1,350-$2,100 million and the critical bond rate is 6.1 per cent. It is thus evident that the validity of Quiggin’s argument depends crucially on the magnitudes involved.

Second, the issue of underpricing is somewhat less complicated. Table 3 below shows the monthly share price and P/E ratio of GI0 Australia from October 1993 to November 1994 on the last day’s trading of each month. Also listed is the insurance sector average P/E ratio.

Over 1993-94, the share price had a low of $1.85 and a high of $3.60. The GIO’s P/E ratio seems to follow, but is less volatile than, the average of the sector. This is not so surprising since GI0 Australia was easily the largest listed insurance company. The point is the market, especially for insurance stock, is unpredictable in the short term. It is unreasonable to look at trading on day one and pronounce failure to get the price right. Although some shares might well

24 Casey and Dollery

have traded at $2.60 and higher on the day of the float, this would surely not have implied $500 million in total. Moreover. it is evident that with

Table 3 GI0 Monthly Share Price and P/E Ratio Oct. ’93-Nov. ’94

Month Price$ PIE Industrv ratio PIE

Oct 1993 3.20 15.8 17.9 Nov 3.01 14.9 17.0 Dec 3.42 16.9 18.9 Jan 1994 3.36 16.6 19.7 Feb 3.30 16.3 11.7 March 2.73 9.3 8.3 April 2.65 9.0 8.3 May 2.68 9.1 8.3 June 2.37 8.1 7.4 July 2.49 8.5 7.8 Aug 2.46 8.4 7.8 Sept 2.24 9.4 10.5 Oct 2.32 9.8 10.4 Nov 2.31 9.7 10.2

Source: Australian Stock Exchange 1994

the passage of time and greater certainty amongst the investment community on the likely performance of GI0 Australia, the G I 0 Australia P E ratio becomes more representative of that of the industry as a whole. Given the information shown in Table 3, it cannot be unambiguously concluded that underpricing was evident in the privatisation of GIO.

Concluding Remarks The present article has sought to evaluate the historic privatisation of GI0 by examining the effects of privatisation on the operations of the GI0 itself, on the broader Australian insurance market and on the ‘net worth’ of the NSW government. On the basis of limited information now available and in terms of these three dimensions, we have attempted to demonstrate that the privatisation of the G I 0 may indeed be regarded as successful. Without wishing to become embroiled in the larger ideological question of the desirability of privatisation p e t se, it seems to us that other prospective attempts at the privatisation of government enterprises would do well to take into consideration the technical features of the G I 0

privatisation process.

Endnotes 1 . Exact staff levels are not available before 1992.

Ms Marilyn Bradshaw of G I 0 suggested to the authors that data on staff levels were simply not kept in any systematic form prior to 1992. See Casey (1995) for a more complete analysis of this aspect of net worth.

2.

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The Privatisation of GI0 Australia: Success or Failure ? 25

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