Strong results masked by interest rate impact on claims liability

ACC recorded a $570 million cash operating surplus in the 2018/19 Financial Year.

“The cash operating surplus demonstrates ACC’s robust funding structure that enables the scheme to withstand volatility, including falling interest rates,” ACC Board Chair Dame Paula says.

“It reflects the strong performance of the organisation during a year that has seen continued growth in claims, wide-ranging improvements in service delivery, and double digit investment returns.”

The outstanding performance of ACC’s investment fund made a strong contribution to the result. The fund achieved a 12.97 percent investment return, substantially outperforming comparable diversified funds. This added $5.1 billion to ACC’s assets and increased the fund’s size to $44 billion at the end of the financial year.

Part of the fund’s performance was attributable to the effect of falling interest rates – both globally and domestically. That lifted the value of ACC’s bond portfolio.

The trend of declining interest rates, which was beyond ACC’s control, also impacted the other side of ACC’s balance sheet through a significant revaluation of the Outstanding Claims Liability (OCL). That liability reflects the estimated present-day value of all claim costs for injuries that have already occurred. This increased the OCL by $10.8 billion to $53 billion.

Including the valuation influences, ACC’s annual result is an $8.7 billion accounting deficit.

“This is not a cash loss, and ACC continues to have more than enough funds to cover and support those who are injured in accidents”, Dame Paula says.

Because the OCL is the lifetime cost of supporting all existing injury claims 100 years into the future, it is highly sensitive to changes to long-term interest rates. A lower interest rate increases the OCL. The opposite is true when interest rates increase.

“Around the world, falling interest rates have impacted insurance companies and pension funds that have long-term liabilities like ACC,” Dame Paula says.  

“As the Scheme gets bigger, it becomes more sensitive to changing interest rate conditions. However, the long-term nature of our liabilities means we have time to manage this volatility.”

In 2009 the decline in interest rates caused by the Global Financial Crisis contributed to a substantial revaluation of ACC’s claims liability and a $4.8 billion deficit. However, a renewed increase in yields a few years later had the opposite impact.

“We learned from that experience the scheme is sustainable and able to be managed on a medium to long-term basis. Therefore, we can respond and reduce the asset liability gap over the coming years.”

Due to the long duration of its claims liability, ACC has limited ability to fully hedge against those effects. However, the successful defensive positioning of its bond portfolio has provided considerable offsetting valuation gains during the past financial year.  

Dame Paula said it was too early to say what implications the deficit would have for levies, and the ACC Board’s recommendations to the Government next year.

“In recommending levies, the ACC Board will have regard to the underlying costs of the scheme and the ability to respond to volatility – including falls in interest rates – over many years.”

Dame Paula said the increased valuation of the claims liability should not detract from ACC’s operational highlights for the year. Those included delivering multiple initiatives as part of the organisational transformation, making it easier for customers to engage with ACC and receive our services – including online.

This transformation included new systems to lodge and manage claims, advanced data analysis and a digital interface for business customers and clients - MyACC. We also have a new nationwide case management approach that focuses on the specific – and often changing – needs of an individual client.

“The investment we are making in transforming our people, processes, information and technology is all about ensuring we make ACC as efficient and effective as possible – as well as meeting the needs of New Zealanders.”

We also increased our investment in injury prevention programmes – from $69 million to $75 million – and strong partnerships allowed us to reach more than 700,000 New Zealanders with our injury prevention messages. For every dollar we invested, the future cost of injury claims reduced by $1.81 – the best return yet.

We also helped 55,000 injured clients return to work within 10 weeks, up from 52,000 in 2018.

Dame Paula said 2018/19 was a significant year for ACC which received a record two million claims, including support for those affected by the Christchurch terror attacks on 15 March.

“I want to thank Chief Executive Scott Pickering and the whole team for their leadership and hard work in ensuring the injured and families of those killed were well cared for and supported.”

This Financial Year also saw weekly compensation claims rise by 5.1 per cent while sensitive claims (sexual violence) rose by 25 per cent.  The cost of treatment and rehabilitation services increased 7.5%.

“Falling interest rates are outside of our control and alongside growing claims and cost pressures, made it difficult to meet our performance targets, but we remain focused on what we can control – improving prevention, rehabilitation, customer experience and outcomes, and relative investment performance.”

We have an animation explaining the interest rate effect on the 2019 results

Animation explaining the interest rate effect on the 2019 annual report results

For ACC media inquiries: 021 998165 or media@acc.co.nz

Questions & Answers

1. What is the cause of the $8.7 billion deficit?

In short: the sharp fall in interest rates and the impact on the value of future costs of claims that have occurred.

The deficit is not a cash loss but a change in the accounting valuation of ACC’s Outstanding Claims Liability (OCL). This is the expected lifetime cost of supporting all claims already made and extends out 100 years to 2119.

It is not a reflection of what ACC has spent and received in revenue during the year; rather it is a revaluation of the future cost of claims on our books.

A sharp decline in interest rates – in particular, the Single Effective Discount Rate used to value the OCL – has had a significant effect on the solvency of ACC’s accounts and our OCL.

Because the OCL is future-focused, it is highly sensitive to external economic factors, such as changes to long-term interest rates. Interest rates have fallen to historical lows in the past couple of years, and put simply, a lower interest rate increases the OCL as we expect to earn less income on the dollars we have today, meaning we need more money today to pay for future costs. The opposite is true is interest rates go up.

For example, if you need $100 in a year’s time and the interest rate was 10%, you would need about $90 today. If the interest rate changed to 1%, you would need about $99 today. The lower the interest rate, the more money you need today to fund future costs.

As the ACC investment fund and OCL grow, the impact of interest rate changes has become more significant.

In the 2018/19 Financial Year, the interest rate ACC uses to value the OCL dropped by about 1%. It is important to note that changes in interest rates and the impact on ACC’s OCL are outside of ACC’s control.

Even a better than budget performance by ACC’s Investment team and the work we are doing in injury prevention could not offset the substantial impact of a fall in interest rates.

ACC did in fact forecast a deficit for this year and we shared that publicly in our 2018/19 Service Agreement. However, we did not – and could not – predict the sharp decline in interest rates.

2. Given the size of the deficit, will levies have to rise sharply to ensure the Scheme can meet its obligations?

New Zealanders should rest assured that, despite the large reported deficit, the Scheme continues to fund and support those who get injured, to invest to prevent injuries and to deliver investment returns that mean levy payers pay less than they otherwise would.

The Scheme is more than able to meet the costs of claims. On a cash basis, we made a surplus during the 2018/19 year and invested that money, c$500m, to help pay for the future costs of existing claims and to earn further investment returns.

Levies are currently assessed every two years and any levy rate changes are smoothed over 10 years. Many factors are considered when assessing levies and these factors can move around such as interest rates and inflation. The large deficit relates to costs which are on average at least 20 years away. We will need to wait until next year to understand all the factors and what has changed. Levies are set by the Government. The ACC Board just makes recommendations, with the next due in 2020.

That said we do expect in the medium term that levies will need to increase, reflecting things like medical inflation, weekly compensation claim growth (driven by a strong economy), legislative and pay rate impacts, and under-funding in the Accounts.

3. ACC is ‘fully funded’ and has investments of $44 billion. Is that the best approach?

ACC operates according to a ‘full funding’ model, which is determined by the Government. ACC’s role is to manage the Scheme within the parameters set by legislation and to cover the full lifetime cost of accidents that happen today.

The benefits of the full funding approach are:

• avoids ‘intergenerational’ transfer of debt (this generation pays for its injury-related costs, doesn’t pass them on to future generations)
• provides good value to levy payers, since we don’t need to collect the full value of claims costs we eventually pay out (set aside funds for future costs and grow them by investing them)
  • For example: the returns we have earned from the Investment Fund (more than 10% average annual return for the past 27 years) means levies are less than they would otherwise be.