Australian Government, Australian Government Actuary

Report on the costs of the Australian Government’s
Run-Off Cover Scheme for medical indemnity insurers

4. Financial management of the ROC Scheme

4.1 Future liabilities of the ROC Scheme

4.1.1 The estimation of the Commonwealth’s liabilities under the ROC Scheme in future years is an inherently imprecise process. The operation of the ROC 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 This section sets out projections of ROC indemnity payments for the next 10 financial years. For the reasons given above, the projections should be regarded as indicative rather than definitive. In addition, the data problems referred to earlier in this report add to the uncertainty. The underlying assumptions and methodology are described in Appendixá4, with the calculations summarised in Table 13. Table 3 below sets out the projections, which are illustrated in Figure 5. The ROC 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.

Table 3: Projected ROC indemnity payments

Year ending 30 June Projected ROC indemnity payments
$’000*
2006 500
2007 1,306
2008 2,261
2009 2,992
2010 3,754
2011 4,644
2012 5,692
2013 7,087
2014 8,628
2015 10,039

* These projected payments do not include amounts payable under the ROC Claims and Administration Protocol.

Figure 5: Projected ROC indemnity payments

Figure 5: Projected ROC indemnity payments

4.2 Notional Account

4.2.1 As noted above, it will take a number of years before the ROC Scheme matures and the payment patterns stabilise. Accordingly, this section of the report establishes a financial reporting framework and mechanism to ensure that the financial integrity of the ROC Scheme is maintained.

4.2.2 The ROC 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, this section establishes a ROC Scheme notional account (the Notional Account).

4.2.3 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 doctors and taxpayers.

4.2.4 The Notional Account is credited with:

  • ROC support payments; and
  • notional interest.

Notional interest is credited to the Notional Account to ensure that doctors derive the proper benefit of the time value of money since ROC support payments are made well in advance of ROC indemnity payments. 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 run-off cover credit balances of individual doctors.

4.2.5 On establishment of the ROC Scheme, the Government announced that it would fund the opening liability that was attributable to doctors 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 ROC Scheme ‘operates after’ the High Cost Claims Scheme (HCCS). The HCCS meets 50áperácent of the excess above $300,000 of the cost of individual large claims. For example, for a claim which costs $1ámillion, the HCCS will pick up:

50áperácent Î ($1,000,000 - $300,000) = $350,000

4.2.8 The ROC Scheme will also pay an amount to a MII or MDO to cover the indirect costs associated with handling claims. For the purposes of this report, it has been assumed that the ROC Scheme pays 5áperácent of the cost of each claim to cover indirect claims handling costs. The HCCS does not pay for indirect claims handling costs. 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 $1ámillion and indirect claims handling expenses of $50,000.

Table 4: Funding sources for a $1 million claim which is eligible for the ROC Scheme

Funding source Amount
HCCS $350,000
ROC Scheme (direct claim costs) $650,000
ROC Scheme indirect claims handling expenses
(5áperácent Î $1 million)
$50,000
ROC Scheme (Total) $700,000

4.2.9 Appendix 3 provides more detail on claim amounts eligible under the ROC Scheme.

4.2.10 The liabilities of the ROC 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 ROC Scheme as new claims were notified. On an occurrence basis, new liabilities would accrue to the ROC 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.

4.2.11 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 ROC Scheme is ongoing. Accordingly, the occurrence model has been adopted for this report. The liabilities of the ROC Scheme are therefore taken as the present value of future ROC indemnity payments which relate to medical incidents which occurred before the balance date.

4.2.12 As noted earlier, subdivision E of Part 2 of the Medical Indemnity Act provides for repayment of ROC credit balance, should the ROC Scheme ever be wound up without alternative arrangements being put in place. Thus, should the ROC Scheme be wound up without alternative arrangements being put in place, a large part of the accumulated ROC support payment balance would become a liability of the ROC scheme. At the same time, since the ROC 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 ROC 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 ROC indemnity payments.

4.2.13 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 ROC 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.

4.2.14 Appendix 4 sets out the main assumptions and describes the methodology that was used to estimate the liabilities.

4.2.15 Table 5 below sets out the cashflow statement of the Notional Account
for 2004-05.

Table 5: Cashflow statement of the Notional Account

  $’000
Income  
ROC support payments (received 30 June 2005) 13,998
Notional interest 0
Expenses  
ROC indemnity payments 0
Administration cost payments to MIIs 0
Net cashflow 13,998

2004-05

4.2.16 Table 6 below sets out the balance sheet of the Notional Account as at 30áJune 2005.

Table 6: Balance sheet of the Notional Account as at 30 June 2005

  $’000
Assets
Net cashflow 13,9985
ROC support payments (receivable 31 December 2005) 9,3896
Government commitment to fund opening liability 9,0007
Total 32,387
Liabilities  
ROC indemnity payments related to medical incidents prior to
30áJune 2005
30,3258
Claims handling expenses 2,0499
Total 32,37410

4.2.17 The Notional Account at 30 June 2005 is effectively in balance. However, no allowance has been made for accrued administrative cost liability which has accrued under the ROC Claims and Administration Protocol in the balance sheet since the amounts involved are subject to ongoing negotiation. Moreover, the balance sheet estimates are subject to high levels of uncertainty.

4.2.18 The estimated liability of the ROC Scheme at 30 June 2005 is based directly on estimates provided by industry actuaries. 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 ($30.325 million) has been assumed to be split in the following way to give broad consistency with the results of our own model.

  • $9 million in respect of doctors eligible for the ROC Scheme as at 1áJulyá2004.
  • $9 million in respect of doctors who became eligible for the ROC Scheme during the 2004-05 financial year.
  • $12 million in respect of practising doctors who were not eligible for the ROC Scheme as at 30 June 2005.

4.2.19 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.

4.2.20 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 (doctor funded). Indeed, at future reviews, separate accounting of the Government funded and doctor funded components of the ROC Scheme is likely to be appropriate. Both components have been combined at this first review to give an overall picture of the scheme.

4.2.21 Finally, it is appropriate to provide a benchmark projection of the liabilities of the ROC 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.

Table 7: Projected balance sheet liabilities of the Notional Account

Year ending 30 June Liability ($'000) New accrual ($'000) Interest cost ($'000) Payments ($'000)
2005 30,325 - - -
2006 46,025 14,623 1,577 500
2007 62,686 15,574 2,393 1,306
2008 80,271 16,586 3,260 2,261
2009 99,117 17,664 4,174 2,992
2010 119,329 18,812 5,154 3,754

4.3 Actuarial management

4.3.1 It is appropriate that the ROC 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. This report has described a framework for the valuation of ROC 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 ROC Scheme.

Peter Martin FIAA
Australian Government Actuary

14 February 2006


5 Received 30 June 2005.

6 AMIL payment received 31 December 2005 discounted to 30 June 2005.

7 Discussed in paragraph 4.2.17.

8 Based on estimates provided by industry actuaries.

9 Based on 5áperácent of ‘grossed up’ ROC indemnity payments (to allow for the impact of the HCCS).

10 Does not include an amount for administrative support payable under the ROC Claims and Administration Protocol.

Next: Appendix 1: ROC support payments
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