Australian Government, Australian Government Actuary

4. Financial management of the Run-Off Cover Scheme

4.1 Future liabilities of the Run-Off Cover Scheme

4.1.1 The estimation of the Commonwealth’s liabilities under the Run-Off Cover Scheme in future years is an inherently imprecise process. The operation of the Scheme is likely to be characterised by a small number of claims of highly variable size. It is not possible to predict the costs of the Scheme with a high level of confidence. For example, the presence of a single very large claim in any given year could have a substantial effect on the total amount of ROC indemnity payments for that year.

4.1.2 The liabilities of the Scheme could be measured in a number of ways. It is normal for insurance-type liabilities to be measured on either a ‘notified’ or an ‘occurrence’ basis. On a notified basis, new liabilities would accrue to the Scheme as new claims were notified. On an occurrence basis, new liabilities would accrue to the Scheme at the time of the occurrence of the medical incidents which were expected to give rise to medical indemnity claims which would attract a ROC indemnity payment.

4.1.3 Under the occurrence model, liabilities are recognised more quickly than under the notified model. The occurrence model is more consistent with the notion that the Scheme is ongoing. Accordingly, the occurrence model has been adopted for this report. The liabilities of the Scheme are therefore taken as the present value of future ROC indemnity payments (plus associated insurer claims handling expenses) which relate to medical incidents which occurred before the effective date of valuation.

Comment on experience during 2005-06

4.1.4 In any actuarial investigation it is appropriate to compare the emerging experience with that previously projected. This analysis informs the assumption setting process for the current investigation.

4.1.5 Based on input from industry actuaries, the previous report estimated the incurred-but-not-reported (IBNR) Run-Off Cover Scheme liability at 30 June 2005 as $28.9 million. Implied within that estimate was an expectation that approximately $5 million in new notifications would emerge during 2005-06. In fact, the most recent actuarial estimates suggest a total of less than $2 million in new notifications for 2005-06. There are a number of possible ways of responding to this emerging experience in the current investigation.

4.1.6 It is theoretically possible that the difference between expected notifications and actual experience relates only to lags in the system. This would be consistent with factors such as delays in identification of ROC claims and the legal profession taking some time to adjust to new tort arrangements. The response in this case would be to make no adjustment to the initial estimate.

4.1.7 On the other hand it could be argued that comparison between the actual notifications and the expected notifications is the only available tangible indicator of the reliability of the original estimate of $28.9 million and that therefore the implied estimates of future notifications should be revised down accordingly, leading to an adjusted estimate of around $8 million.

4.1.8 However, the implied estimate of $5 million for the 2005-06 notification year is highly uncertain. For example, actual experience is likely to be significantly driven by the presence or absence of even a single large claim. This means that the fact that actual experience has diverged substantially from what was expected does not of itself imply that the original estimate was unreasonable. Further, it suggests caution in adjusting estimates for the remaining notification years. An approach which allows differences to be recognised as the experience emerges has been adopted in this report, rather than one which replaces one set of subjective estimates with another. The original estimate has been adjusted only in respect of the experience during the 2005-06 notification year.

4.1.9 In relation to Scheme-eligible claims which had been notified at the time of the previous investigation (30 June 2005), actuarial estimates of the corresponding ROC indemnity payments had a present value then of $1.5 million. Since then, claim payments of $0.7 million have been made by MIIs/MDOs. All else being equal, this would suggest a residual figure at 30 June 2006 of less than $1 million. In fact, up to date actuarial estimates put the number at around $1.2 million. However the numbers are so small that it would be inappropriate to draw conclusions based on them.

4.1.10 In summary, we have made adjustments to the 2005 estimates provided by the industry actuaries only in respect of the implied 2005-06 notification year estimate and in respect of the development of claims that had been notified as at 30 June 2005. In both cases we have used the most recent information provided by industry actuaries directly.

4.1.11 In relation to the Scheme accrual for 2005-06,5 we have made three adjustments to the estimate provided in the previous report. The first was in respect of a technical error which has been discovered in the valuation program. The second results from a changed interest rate assumption. The third relates to a slightly modified assumed payment pattern. The combined effect of these adjustments was around 1 per cent of the estimate. There is insufficient information available in relation to the emerging experience at this time to make any other credible adjustments.

4.1.12 More generally, as a result of this, the main demographic and experience assumptions remain largely as they were for the previous investigation. Apart from modifying the valuation programs to correct the technical error referred to above, no changes have been made. The current projections are based, however, on the latest available data regarding the insured medical workforce.

4.1.13 Appendix 4 sets out the main assumptions and describes the methodology that was used to estimate the liabilities. Appendix 5 looks at the effect of the High Cost Claims Scheme.

Projected ROC indemnity payments

4.1.14 This section sets out projections of ROC indemnity payments for the next 10 financial years. For the reasons described above, the projections should be regarded as indicative only. The data issues referred to earlier in this report also contribute to the uncertainty. The underlying assumptions and methodology are described in Appendix 4, with the calculations summarised in Table 14. Table 3 below sets out the projections, which are illustrated in Figure 5. The Scheme is not expected to become mature in a cashflow sense for many years. The payments projected below are in nominal dollars and have not been discounted to current dollar values.

4.1.15 The projected payment for 2006-07 assumes that all ROC indemnity payments which are ‘due’ at 30 June 2006 (that is which relate to claim payments already made by MIIs/MDOs) will be made during 2006-07. More generally, other ROC indemnity payments are assumed to be made at the same time as the corresponding claim payment. The estimate for 2006-07 is reasonably close to the estimate presented in our 2004-05 report, before the inclusion of the indirect costs associated with handling claims, referred to as indirect claims handling expenses (CHE)6 (see 4.2.8 below), which is new in this current report. This is because changes made in response to the emerging experience were largely offsetting.

Table 3: Projected ROC indemnity payments plus CHE

Year ending 30 June Projected ROC indemnity payments plus CHE
2007 1,681
2008 1,962
2009 3,502
2010 4,632
2011 6,068
2012 8,378
2013 11,041
2014 13,644
2015 15,852
2016 18,169

(a) These projected payments do not include administration amounts payable under the ROC Claims and Administration Protocol.

Figure 5: Projected ROC indemnity payments plus CHE

Figure 5 (column chart): Projected ROC indemnity payments plus CHE

4.2 Notional Account

4.2.1 The Scheme must be managed over a long time frame. As discussed previously, ROC indemnity payments are likely to be ‘lumpy’ in nature and immature in size for some years. ROC support payments will be received well in advance of ROC indemnity payments. As a result of the payment timing mismatch and the expected volatility in the ROC indemnity payment pattern, it is appropriate to have a system which enables proper tracking of the financial flows over time. Accordingly, a Run-Off Cover Scheme notional account (the Notional Account) is maintained.

4.2.2 It is important to appreciate that the Notional Account is not an official Government account. Rather, it is a device established for the sole purpose of facilitating equity between practitioners and other taxpayers.

4.2.3 The Notional Account is credited with:

  • ROC support payments; and
  • notional interest.

4.2.4 Notional interest is credited to the Notional Account to ensure that practitioners derive the proper benefit of the time value of money since ROC support payments are received by Medicare Australia well in advance of any ROC indemnity payments being made by Medicare Australia. Notional interest is applied at the short-term bond rate for consistency with section 34ZS of the Medical Indemnity Act which requires interest at the short-term bond rate to be applied to the total run-off cover credit balances of individual practitioners.

4.2.5 On establishment of the Scheme, the Government announced that it would fund the opening liability that was attributable to practitioners who were already eligible for cover under the Scheme at the time of its commencement. Accordingly, this obligation represents an asset of the Notional Account.

4.2.6 The Notional Account is charged with:

  • ROC indemnity payments; and
  • payments made under the ROC Claims and Administration Protocol.

4.2.7 The Run-Off Cover Scheme ‘operates after’ the High Cost Claims Scheme (HCCS). The HCCS meets 50 per cent of the excess above $300,000 of the cost of individual large claims. For example, for a claim which costs $1 million, the HCCS will pick up:

50 per cent × ($1,000,000 - $300,000) = $350,000

4.2.8 The Run-Off Cover Scheme will also pay an amount to a MII or MDO to cover the indirect costs associated with handling claims, referred to as indirect claims handling expenses (CHE). The Scheme pays 5 per cent of the cost of each claim to cover CHE. Table 4 below describes how an eligible $1 million claim would be funded. The total amount paid of $1,050,000 includes claim costs of $1 million and CHE of $50,000.

Table 4: Funding sources for a $1 million claim which is eligible for the Run-Off Cover Scheme

Funding source Amount
HCCS $350,000
ROC indemnity payment (direct claim costs) $650,000
Run-Off Cover Scheme CHE (5 per cent × $1 million) $50,000
Run-Off Cover Scheme (Total) $700,000

4.2.9 Appendix 3 provides more detail on claim amounts eligible under the Run-Off Cover Scheme.

4.2.10 As noted earlier, the Medical Indemnity Act provides for payment of a practitioner’s total run-off cover credit, should the Scheme ever be wound up without alternative arrangements being put in place. Thus, in this event, a large part of the accumulated ROC support payment balance would become a liability of the Scheme. At the same time, since the Scheme liabilities are being measured on an occurrence basis, some of the liabilities of the Scheme would be released, partially offsetting this impact. However, for the purpose of this report, the Scheme has been assumed to be ongoing and the whole amount of the accumulated ROC support payments has been taken to be available to meet relevant ROC indemnity payments.

4.2.11 The liability estimates given in this report are central estimates. In broad terms, this means that they are intended to be equally likely to be too high or too low. In particular, it is not intended that the liability estimates contain any margin for risk or prudence. Funding considerations for the Scheme are not the same as for private sector insurance arrangements. The objective here is to manage the funding over the long term. Since substantial volatility in the liability estimates is likely from time to time, periods of surplus and periods of deficit in the Notional Account might be expected. However, given the long funding time horizon that is appropriate for the Scheme, a short-term deficit in the Notional Account is not a cause for concern. As a result of this, there is no strong reason to maintain a risk margin in the liability estimates.

4.2.12 Table 5 below sets out the cashflow statement of the Notional Account for 2005-06.

Table 5: Cashflow statement of the Notional Account 2005-06

ROC support payments (received 31 December 2005) 9,634
ROC support payments (received 30 June 2006) 15,203
Notional interest 1,010
ROC indemnity payments 0
Administration cost payments to MIIs (including implementation fees and 2004-05 and 2005-06 compliance costs) 4,654
Net cashflow 21,192

4.2.13 Table 6 below sets out the balance sheet of the Notional Account as at 30 June 2006.

Table 6: Balance sheet of the Notional Account as at 30 June 2006

Cash as at 1 July 2005 13,998
ROC support payments (receivable 31 December 2006) 9,845(a)
Net cashflow 21,192
Government commitment to fund opening liability 8,000(b)
Total 53,035
Paid by MIIs but not yet recovered from Medicare Australia 709(c)
Notified to MIIs but not yet paid by them 2,596(d)
Incurred but not yet notified to MIIs 39,411(e)
Claims handling expenses 2,910(f)
Total 45,626

(a) AMIL payment received 31 December 2006 discounted to 30 June 2006.
(b) Discussed in paragraph 4.2.17.
(c) Based on estimates provided in relation claims/incidents notified to MIIs and MDOs by 30 June 2006.
(d) Based mainly on estimates provided by industry actuaries.
(e) Based on estimates provided by industry actuaries and models developed within this office.
(f) Based on 5 per cent of ‘grossed up’ ROC indemnity payments (to allow for the impact of the HCCS).

4.2.14 The Notional Account at 30 June 2006 has disclosed an estimated surplus of around $7 million. Note that full credit has been taken in the assets of the Notional Account for ROC support payments due to be received from AMIL on 31 December 2006. Generally, the estimated surplus position should be regarded as highly uncertain.

4.2.15 The estimated liability of the Scheme at 30 June 2006 is based on a blend of estimates provided by industry actuaries and estimates derived from models developed within this office. It is highly uncertain and is likely to remain so for a number of years. Appendix 4 provides a high level reconciliation of the liability estimate as at 30 June 2005 with the current estimate.

4.2.16 The liability to make ROC indemnity payments will be partly funded by the Government. As noted above, the Government will fund the costs of claims made by those practitioners who were eligible for cover at the commencement of the Scheme. It is not possible to estimate this component of the liability with any precision. However, for the purpose of this report, the overall liability (about $46 million) has been assumed to be split in the following way to give broad consistency with the results of our own model.

  • $8 million in respect of practitioners eligible for the Scheme as at 1 July 2004; and
  • $38 million in respect of practitioners who were not eligible for the Scheme as at 1 July 2004.

4.2.17 The estimate in respect of practitioners who were eligible at start-up has been revised slightly from the previous report, broadly in line with the approach described in paragraph 4.1.10. The actual value of the Government obligation will not be known for a number of years. Estimates will become more reliable with time. The apportionment of the liability is very subjective. However, we regard the approach taken as satisfactory for the current purpose.

4.2.18 As actual experience unfolds and ROC indemnity payments are made, it will be necessary to attribute these payments accurately to either the opening liability (Government funded) or the new liability (practitioner funded) in order to preserve the integrity of the Notional Account. Indeed, the 2004-05 report foreshadowed that, at future reviews, separate accounting of the Government funded and practitioner funded components of the Scheme might be appropriate. Again at this review, both components have been combined to give an overall picture of the Scheme.

4.2.19 Finally, it is appropriate to provide a benchmark projection of the liabilities of the Scheme. Table 7 below sets out estimates of the liabilities of the Notional Account at the end of each of the next five financial years. The purpose is to illustrate the short-term development of the Scheme. There is very substantial uncertainty in these estimates. The numbers shown are in nominal dollars and have not been discounted to give values in today’s terms. The numbers in the table below differ in nature from those provided in the previous report. In particular they have been adjusted to include an allowance for indirect claims handling expenses (CHE).

Table 7: Projected balance sheet liabilities of the Notional Account

Year ending 30 June Liability ($’000)(a) New accrual ($’000)(a) Interest cost ($’000) Payments ($’000)(a)
2006 45,626 - - -
2007 65,402 17,708 3,750 1,681
2008 87,296 18,859 4,997 1,962
2009 110,217 20,085 6,338 3,502
2010 134,733 21,391 7,758 4,632
2011 160,715 22,781 9,269 6,068

(a) ROC indemnity payments plus CHE.

4.3 Actuarial management

4.3.1 It is appropriate that the Scheme be subject to ongoing actuarial management.

4.3.2 Regular review of the costs and notional assets of the Scheme will allow the ROC support payment rate to be adjusted from time to time, if necessary. Consideration of that rate is beyond the scope of this report. This report has described a framework for the valuation of Scheme liabilities and established the Notional Account. It is intended that the valuation and accounting framework be applied at each future annual review of the Scheme.

Signature of Peter Martin, Australian Government Actuary

Peter Martin FIAA
Australian Government Actuary

1 March 2007

5 Under the occurrence model, the Scheme accrual for 2005-06 refers to the present value of future ROC indemnity payments that are attributable to medical incidents which occur during 2005-06.

6 CHE are separate from administration costs. Administration costs refer to the costs of administering the Scheme and have not been included in the projected Scheme payments.

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