Government Program Evaluation

Study guide: Exam 6C

Government Program Evaluation is the structured assessment of whether a government or insurance-industry program — a workers' compensation board, a public auto insurer, a residual market, a guaranty fund, an agricultural or disaster program — achieves its purpose at an acceptable cost and can go on doing so. Exam 6C names the criteria: solvency, efficiency, stability, viability and long-term prospects, and the effects of external factors.

\text{Funded ratio} = \frac{\text{Assets}}{\text{Liabilities for benefits incurred}}

\text{Expense ratio} = \frac{\text{Administrative expense}}{\text{Premium or assessment revenue}}

• Solvency — can the program pay what it already owes? The measures differ by program: the funded ratio for a workers' compensation board, capital against a legislated target for a public auto insurer, the fund balance against the PML for a catastrophe fund, post-event assessment capacity for PACICC. A program that is solvent only because it can tax or assess later should be described that way.
• Efficiency — how much of each premium dollar reaches claimants, and at what transaction cost (administration, litigation, disputes). It includes incentive efficiency: flat levies, subsidised premiums or benefits with no link to behaviour create Moral Hazard and Adverse Selection that raise the program's cost.
• Stability — are rates and benefits predictable? Large year-to-year swings in assessment rates, politically timed rate freezes followed by catch-up increases, or benefit schedules rewritten every few years (Automobile Insurance Reform) are all instability, whatever the average level.
• Viability and long-term prospects — is the funding model sustainable as exposure, demographics and costs change? The warning signs are a growing unfunded liability, falling voluntary participation (good risks leaving), a growing Residual Market, and a funding model that works only while the program is young.
• External factors — what outside the program moves its results: interest rates (the discount rate on long-tail liabilities), wage and medical Inflation, the economy (payroll or premium base, claim duration), climate (flood, crop and catastrophe frequency), court decisions widening coverage, and federal cost-sharing formulas.
• Evaluation also asks whether the program meets its objective and how it interacts with the Voluntary Private Insurance Market — the remaining parts of the Social Insurance framework. A good answer takes each criterion in turn, gives evidence for each, and ends with a recommendation.

Evaluating a Workers' Compensation Board A provincial workers' compensation board reports:

• assets \$12.6 billion; benefit liabilities \$14.0 billion, with a duration of 8 years;
• assessable payroll \$80 billion; average assessment rate \$1.85 per \$100 of payroll;
• administrative expense \$190 million;
• average rate changes over five years of +2\%, +14\%, -9\%, +11\%, -6\%;
• a funding policy of retiring any unfunded liability over 10 years at 5\%.

Evaluate the board against each criterion.

Answer Solvency. The board is 10\% underfunded:

\begin{align*}
\text{Funded ratio} &= \frac{12.6}{14.0} \\
&= 90\%
\end{align*}

Cost of the funding policy. Retiring the \$1.4 billion shortfall over 10 years at 5\%:

\begin{align*}
\text{Annual payment} &= \frac{\$1.4\text{B}}{a_{\overline{10}|0.05}} \\
&= \frac{\$1.4\text{B}}{7.7217} \\
&= \$181.3\text{M}
\end{align*}

That is \$0.23 per \$100 of payroll — a 12\% surcharge on the \$1.85 average rate.

Efficiency. Revenue is 0.0185 \times \$80\text{B} = \$1.48\text{B}, so the expense ratio is 190 / 1{,}480 = 12.8\%. The figure means little alone: ask what it buys (return-to-work programs lower claim duration) and compare cost per claim with similar boards.

Stability. Rate changes swinging between -9\% and +14\% are poor stability for employers who budget payroll costs. A rate-stabilisation policy — smoothing toward the funding target — would help.

External factors. With duration 8, a one-point fall in the discount rate raises liabilities by about 8\%, to \$15.1 billion. If the assets are mainly equities that do not respond:

\begin{align*}
\text{Funded ratio} &= \frac{12.6}{15.12} \\
&= 83.3\%
\end{align*}

A recession would also shrink payroll (the assessment base) while lengthening claim durations — both external, both unfavourable.

Viability. Viable: the funding policy is credible and the surcharge affordable. The weaknesses are the interest-rate mismatch and the rate volatility. Recommendation: match part of the liabilities with duration-matched bonds, and adopt a funding corridor that phases in surcharges and rebates rather than swinging rates each year.