Appendix 4: Methodology, assumptions and uncertainty
Information provided by the MIIs
A.4.1 Information was provided by the MIIs and MDOs and their actuaries in relation to projected future payments for:
 ROC claims notified as at 30 June 2007; and
 ROC incurredbutnotreported (IBNR) claims as at 30 June 2007.
A.4.2 Table 9 below summarises the estimated accrued Scheme liabilities as at 30 June 2007. The Scheme liabilities are divided into those attributable to claims notified as at 30 June 2007 and those attributable to IBNR claims as at 30 June 2007. For simplicity, the liability for 200607 compliance costs payable in 200708 is not included.
Table 9: RunOff Cover Scheme liabilities related to medical incidents prior to 30 June 2007
Liabilities in relation to claims notified as at 30 June 2007  $6.8 million^{(a)} 
Liabilities in relation to IBNR claims as at 30 June 2007  $46.7 million^{(b)} 
Total Scheme liabilities related to medical incidents  $53.5 million 
(a) Including $0.4 million CHE.
(b) Including $3.0 million CHE.
A.4.3 The components of the Scheme liabilities in relation to prior medical incidents as at 30 June 2007 are reconciled to those as at 30 June 2006 in Table 10 below.
Table 10: Reconciliation of RunOff Cover Scheme liability components with previous report
(a) Numbers may not add due to rounding. The liability for 200607 compliance costs payable in 200708 is not included.
A.4.4 For the purpose of this report, the 30 June 2007 liability has been subjectively apportioned in the following way to give broad consistency with the results of our own model.
 $7 million in respect of practitioners eligible for the Scheme as at 1 July 2004.
 $46 million in respect of practitioners who were not eligible for the Scheme as at 1 July 2004.
A.4.5 The actual value of the Government obligation will not be known for a number of years but estimates will become more reliable with time.
A.4.6 Projected payments in relation to medical incidents occurring before 30 June 2007 were calculated based on estimates provided by actuaries of the MIIs.
Description of the model used to project the accrual of new RunOff Cover Scheme liabilities after 30 June 2007
A.4.7 The approach involved projecting the expected future ROC indemnity payments for each doctor who was practising as at 30 June 2007. Projection of indemnity payments entailed the projection of:
 incidents which will result in a claim;
 the delay involved in notification of claims;
 the cost of claims after allowing for the HCCS;
 the likelihood of eligibility for the Scheme at the time a claim is notified; and
 the delay involved in the payment of notified claims.
ROC claims
Components of claim cost
A.4.8 For the purposes of the model, a ROC claim includes any eligible claim notified and finalised at direct cost to the MII. Claim costs include all costs which are directly attributable to the claim. Indirect claims handling expenses (CHE) are dealt with separately.
A.4.9 Directly attributable claim costs include damages, plaintiff legal costs to the extent that they are awarded, and defence costs to the extent that they are directly attributable to the claim.
A.4.10 The Scheme pays 5 per cent of the direct cost of each eligible claim to cover CHE. Where an eligible claim is partly covered by the HCCS, the allowance for CHE paid under the Scheme is 5 per cent of the total claim cost, including the portion covered by the HCCS.
Assumptions
A.4.11 Claim experience has emerged in 200607 which was lighter than that we expected based on the assumptions in our 200506 report. A short period of emerging experience shouldn’t necessarily be relied on as a guarantee that underlying assumptions are inappropriate for such a longtail and uncertain line of insurance as medical indemnity. This is especially true in relation to the Scheme, due, for example, to the following factors:
 RunOff Cover Scheme claims are very longtail and model projections are particularly sensitive to assumptions.
 The Scheme is relatively immature.
 Systems to facilitate timely and accurate data transfer are still being developed.
 The Scheme commenced immediately after tort reforms were implemented, with the tort reforms being preceded by a period of abnormally high claim rates (‘claim spike’).
A.4.12 However, given the continuing low observed claims experience, we have made moderate changes to the assumptions for the purposes of this report:
 Retirement decrement assumptions have been changed.
 Doctors are assumed to winddown their risk exposure from age 60, at a rate above that reflected in the premiums paid under their claimsmade policies.
A.4.13 The remaining claim and demographic assumptions underlying the longterm Scheme projections have been left unchanged for the purpose of this review.
A.4.14 The sensitivity of the results to changes in retirement and winddown assumptions is illustrated at the end of this Appendix.
Claim frequency assumptions
A.4.15 Claim frequency and claim size assumptions were made in light of information provided by the actuaries of the MIIs.
A.4.16 The overall claim frequency was assumed to be 5 per cent. That is, on average each ‘atrisk’ doctor was assumed to have a 5 per cent chance of being involved in a medical incident in the next year which will result in a future medical indemnity claim. This is unchanged from our previous review. Individual claim frequencies were adjusted based on premium as discussed below.
A.4.17 Practitioners with medical indemnity premiums of less than $1,500 were excluded from the analysis in order to ensure that only genuine ‘atrisk’ doctors were the focus of the investigation. The excluded group contained interns, trainees and hospital indemnified doctors in some of the data provided by the MIIs. In all about 58,000 practising doctors have some medical indemnity premium. After excluding those doctors with medical indemnity premiums of less than $1,500 we were left with 35,368 ‘atrisk’ doctors and we have set our claim frequency assumption at 5 per cent to be consistent with this.
Adjustment to individual claim frequencies based on premium
A.4.18 The likelihood of future notifications of ROC claims was projected according to the assumed ‘riskiness’ of each individual practitioner. The risk of medical indemnity claims posed by each practitioner was determined based on risk categorisation. Practitioners were categorised according to specialisation, age, gender and MII.
A.4.19 The average premium for each risk group was used as a proxy for the risk of medical indemnity claims. The claim frequency for each group was multiplied by the ratio of the premium for the group to the premium of the entire cohort of ‘atrisk’ doctors.
A.4.20 Although insurance premiums are broadly determined in line with claim risk, the premium of a group is at best an imprecise proxy for risk. For example, market and financial considerations affect premiums charged. However, given the data available, relative premiums have been assumed to be a reasonable means of categorising practitioners according to their risk of medical indemnity claims for the purposes of this model.
A.4.21 Insurance premiums tend to diminish for practitioners towards retirement age. This supports the suggestion that doctors tend to wind down their practice hours and possibly perform fewer risky medical procedures (for example, surgery) as they approach retirement. The possible reduction in risk towards retirement is apparent from the pattern of relative premiums for ‘atrisk’ male doctors shown in Figure 5 below. The pattern is less obvious for females, given the low proportion of females in the oldest cohorts. Note that age and gender were not available for some doctors.
Figure 5: Relative premiums by age for male doctors
Note: The graph includes all male practitioners with premiums of at least $1,500 from all MIIs.
A.4.22 The model adopted for the 200506 report did not impose an assumed pattern of ‘winding down of risky practice’ with age. Reduction in claim risk was accounted for in the model only to the extent that it is reflected in diminishing premiums. As part of our overall revision of the model, an additional adjustment has been made to individual claim frequencies based on an assumed winddown of risky practice at advanced ages.
Adjustment to individual claim frequencies based on assumed winddown of risky practice
A.4.23 The relative premiums of older doctors appear to indicate a reduction in risky practice as doctors approach retirement. Actuaries have also suggested that doctors winddown their risky practice approaching retirement. However, relative premiums may not capture the full extent of the reduction, since premiums are calculated on a claimsmade rather than claimsoccurring basis.
A.4.24 In this report, doctors are assumed to winddown their risk exposure from age 60, at a rate above that reflected in the premiums. Premium relativities are augmented with a winddown from age 60 according to the formula 0.933^{(age59)}, with a multiple of 100 per cent applied until age 60, 50 per cent at age 70 and 25 per cent at age 80.
A.4.25 This assumption is very subjective, and is not capable of objective validation. Nonetheless, it does not appear unreasonable in light of observed claim experience and discussions with actuaries. The model sensitivity to the relative claim frequency of doctors approaching retirement is illustrated at the end of this Appendix.
Claim size assumptions
A.4.26 Claim sizes were assumed to increase with the delay to notification, on the basis that claims which take longer to report tend to be bigger on average for example, cerebral palsy cases.
A.4.27 The assumed claim reporting pattern is shown in Table 11 below. Claim sizes presented in the table do not include allowance for inflation or superimposed inflation. Adjustment for inflation and superimposed inflation is discussed below.
A.4.28 The claim reporting pattern is based on the reporting patterns provided by the approved actuaries of two of the MIIs.
Table 11: Claim reporting and size pattern
Development year  Proportion of number of claims notified (per cent)  Gross average claim size ($’000)^{(a)} 

1  19.8  70 
2  20.3  80 
3  13.4  80 
4  18.8  100 
5  9.0  150 
6  5.4  150 
7  2.9  150 
8  2.4  150 
9  1.7  150 
10  1.8  150 
11  1.4  150 
12  1.1  150 
13  0.8  150 
14  0.4  400 
15  0.2  400 
16  0.1  400 
17  0.1  400 
18  0.1  400 
19  0.1  400 
20  0.2  400 
(a) Gross average claim sizes presented in the table are intended to be in 2007 dollars and do not include allowance for inflation and superimposed inflation.
A.4.29 Claims cost net of high cost claim indemnities is calculated assuming that the HCCS threshold will change such that a constant proportion of the gross average claim size will be met by the HCCS. Thus, for simplicity, the HCCS threshold is assumed to increase in line with claims inflation over time. The model effectively assumes that 24 per cent of the total discounted claims cost (in relation to future medical incidents) will be met by the HCCS and 27 per cent of the ROC discounted claims cost will be met by the HCCS.
A.4.30 The projected ROC claims cost is very sensitive to the proportion of claims which are assumed to be reported late. The longer the delay between the incident and the claim, the greater the likelihood that a practitioner will be eligible for the Scheme at the time the claim is notified. Thus, the majority of Scheme cost relates to the small proportion of claims which are notified very late. Therefore, a minor change in the assumed proportion of late reported claims can have a significant impact on the estimated ROC claims cost.
Probability of a claim falling under the RunOff Cover Scheme
A.4.31 The model involved projection of the proportion of the total accrual of liabilities which falls under the Scheme.
A.4.32 A practitioner can become eligible for the Scheme by reason of:
 retirement at 65 years and older;
 permanent disability;
 death;
 maternity;
 resignation; or
 satisfaction of other eligibility criteria specified in the regulations.
A.4.33 The probability of becoming eligible for the Scheme was estimated for each practitioner based on their age as at 30 June 2007 and their sex. Note that practitioners do not become eligible by means of resignation until three years have passed since cessation of practice.
A.4.34 The estimated likelihood of practitioners becoming eligible for the Scheme was overlaid on the projected claim notifications to give the projected ROC claim notifications for each practitioner. The expected notified claims cost was multiplied by the likelihood of eligibility in each future year, and summed across all practitioners to arrive at the expected cost of ROC claims notified in that year.
A.4.35 In other words, the total ROC claim notifications were calculated as the scalar product of the vector of claim notifications and the vector of probabilities of Scheme eligibility for each practising doctor in each future year.
A.4.36 It was assumed that on average practitioners who become eligible for the Scheme do so halfway through the financial year.
Demographic assumptions
A.4.37 The probabilities of death and disablement were assumed to be an increasing multiple of the probabilities of death in Australian Life Tables 200002 (ALT 200002). The probabilities of death were assumed to be 50 per cent of ALT 200002 until age 65 whereafter they were assumed to be 90 per cent of ALT 200002. The probabilities of permanent disability were assumed to be an increasing multiple of ALT 200002 from 20 to 40 per cent from age 25 to 64, and 0 from 64 onwards.
A.4.38 The assumed probabilities of maternity leave were derived assuming that female practitioners each have an average of 1.5 children between ages 28 and 43 and that they take one year of maternity leave for each child. The probabilities of alternative means of Scheme eligibility (particularly resignation and retirement) were inferred from the age distribution of practising doctors.
A.4.39 The probabilities of resignation were assumed to be 0.5 per cent between ages 39 and 51, increasing linearly to 1 per cent at age 56, increasing to 6 per cent at age 60, and increasing linearly to 10 per cent at age 64.
A.4.40 The probabilities of retirement up to age 85 have been revised slightly. In our previous reports we assumed retirement probabilities of 13 per cent between ages 65 and 70, increasing linearly to 41 per cent at age 84. In this report we have assumed retirement probabilities of 10 per cent at age 65 increasing linearly to 29 per cent at age 84. The probabilities of retirement were assumed to be 100 per cent for ages 85 and above, given the negligible effect on the results.
A.4.41 It is instructive to present the probabilities that a practising male doctor will be eligible for the Scheme in future years. The decrement assumptions are summarised in Table 12 in the form of assumed probabilities of being eligible for the Scheme at the end of each of the next 10 financial years for males.
Table 12: Assumed probabilities of eligibility for the RunOff Cover Scheme over the next 10 financial years for male doctors
A.4.42 The model is very sensitive to the assumed resignation and retirement decrements and the calibration of these decrements is very important. The model is somewhat less sensitive to death and permanent disability decrements since resignation and retirement are assumed to be more likely means of eligibility. The model is not particularly sensitive to maternity decrements as doctors on maternity leave are only eligible for the Scheme for the period of leave which is assumed to be one year.
A.4.43 Figure 6 below depicts the number of ‘atrisk’ practitioners projected to become eligible for the Scheme by various means during the 200708 financial year. Although doctors will become eligible for the Scheme during 200708 by way of cessation of practice (having ceased practice during 200405), the number below refers to doctors who will actually become eligible during 201011.
Figure 6: Projected entries of ‘atrisk’ practitioners to the RunOff Cover Scheme based on decrement assumptions
A.4.44 The number of ‘atrisk’ practitioners projected to enter the Scheme were substantially higher than the number provided by the insurers for 200405 to 200607 financial years (see Table 1).
A.4.45 It is possible that the information provided by the MIIs underrepresented the number of practitioners who became eligible for the Scheme during during 200405 to 200607 financial years by way of age retirement. Alternatively, the assumed retirement rates may be too high. The concept of retirement might be less clearcut for a private medical practitioner than for, say, a general workforce employee. This point will continue to require close scrutiny in future years, and also in the administration of the Scheme.
A.4.46 Where the date of birth or gender were not available for a practitioner, these were assigned randomly according to the age and gender distribution of ‘atrisk’ doctors.
Payment patterns, inflation and discounting
A.4.47 ROC indemnity payments in relation to medical incidents occurring after 30 June 2007 were projected assuming the payment pattern in Table 13 below.
A.4.48 This payment pattern has not changed from that adopted in last year’s report.
Table 13: Payment pattern assumed
Delay from notification to payment (years) 
Proportion of claim costs paid (per cent) 


1  3.15  
2  15.41  
3  20.10  
4  19.53  
5  10.07  
6  8.73  
7  6.78  
8  5.45  
9  4.02  
10+  6.74 
Economic assumptions
A.4.49 Medical indemnity claim costs tend to increase at a faster rate than general inflation. Claim payments were projected to increase in line with wage inflation plus superimposed claim cost inflation.
 Wage inflation was assumed to be 4 per cent per annum. This is not inconsistent with general expectations of wage growth.
 Superimposed inflation was assumed to be 2.5 per cent per annum. Superimposed inflation refers to the tendency for medical indemnity claim amounts to increase at rates faster than general inflation. Bursts of superimposed inflation have been observed in the past. Despite this, superimposed inflation is typically allowed for with a constant assumption. For this exercise, an allowance of between 2 per cent and 5 per cent per annum might be reasonable. We have adopted an assumption towards the lower end of this range, having regard to the potential impact of the various tort reforms that have taken place over the last few years.
A.4.50 Claim payments were discounted at a rate of 6 per cent per annum. This is the same rate as was assumed last year. The chosen rate remains broadly consistent with the yield on Commonwealth bonds at 30 June 2007. Moreover, it provides consistency with the rate adopted in a number of similar contexts and therefore is suitable from a whole of government perspective.
Data summarising the cohort of ‘atrisk’ doctors
A.4.51 Table 14 summarises the age distribution of the cohort of ‘atrisk’ practitioners, with the total premium representing a proxy for risk of medical indemnity claims for each age group. Note that age and gender were not available for some doctors.
Table 14: Cohort of ‘atrisk’ doctors
Age at 30 June 2007  Number 'atrisk'  Total premium ($’000)  Proportion males 

<30  55  264  65 
3034  1,114  5,164  56 
3539  3,851  31,257  64 
4044  5,408  52,208  65 
4549  6,283  59,031  69 
5054  6,083  53,769  71 
5559  4,984  45,555  79 
6064  3,834  37,959  84 
6569  2,148  19,300  88 
7074  934  5,872  91 
7579  456  2,268  93 
8084  188  755  93 
85  30  114  93 
Total  35,368 

73 
(a) Numbers may not add due to rounding.
Projection of future RunOff Cover Scheme costs
A.4.52 Table 15 below summarises the next 10 years’ ROC indemnity payments which were aggregated to derive the projected Scheme costs in future years. The payments projected during 200708 include $2.5 million in amounts paid but not yet recovered by insurers as at 30 June 2007.
Table 15: Calculation of projected ROC indemnity payments
Medical incidents pre 1 July 2007  

Year ending 30 June  Notified as at 30/6/2007 ($’m)  IBNR as at 30/6/2007 ($’m)  Total ($’m)  Medical incidents post 30/6/2007 Total ($’m) 
Grand total ($’m) 
2008  3.6  0.3  3.9  0.0  3.9 
2009  1.0  0.8  1.9  0.0  1.9 
2010  0.8  1.5  2.3  0.2  2.4 
2011  0.6  2.1  2.7  0.5  3.2 
2012  0.4  2.6  3.0  1.2  4.2 
2013  0.3  2.8  3.1  2.3  5.4 
2014  0.1  3.0  3.1  3.8  6.9 
2015  0.2  3.3  3.4  5.6  9.1 
2016  0.2  3.5  3.7  7.6  11.3 
2017  0.2  3.8  4.0  9.7  13.7 
Note: The costs of notified and IBNR claims do not always sum to the total cost of medical incidents pre 1 July 2007 due to rounding.
Uncertainty in relation to liability projections
A.4.53 The projected ROC indemnity payments summarised in Table 15 are subject to uncertainty which relates to:
 data in relation to the claiming behaviour of eligible practitioners;
 substantial random variation associated with medical incidents and the notification of claims from year to year;
 calibration of the model claim size and claim frequency assumptions to the underlying claim process (medical indemnity liabilities are characterised by few claims associated with large random variation such that a wide range of results can be obtained with equal statistical validity);
 the extent to which doctors approaching retirement might cut down on their practice hours and possibly engage in less ‘risky’ practice (for example, less surgery);
 sensitivity of the model to the proportion of latereported claims;
 sensitivity of the model to the decrement assumptions;
 the possibility that not all Scheme eligible claims have been identified and that recoveries will be more diligently pursued later in the claim process; and
 recent tort reforms in a number of jurisdictions with the possible effect of ‘bringing forward’ claims and distorting recent claim experience.
A.4.54 The information provided by the actuaries of the MIIs and MDOs relied on broadly similar valuation models. The range of assumptions adopted by industry actuaries reflects the substantial uncertainty involved in estimating liabilities of the Scheme.
A.4.55 It must be emphasised that different results can be obtained from different yet equally plausible models and assumptions. Again, this is a common issue with liabilities of this nature.
A.4.56 An estimate of the projected accrual of ROC liabilities during the 200708 financial year was provided by each of the actuaries of the MIIs; these summed to $7.7 million (including CHE). Estimates of Scheme accrual varied substantially amongst the actuaries, from less than 2 per cent to more than 8 per cent of total estimated claims cost (Scheme accrual plus nonScheme accrual). Moreover, after taking into account differences between actuaries of their estimates of total claims costs, the estimated average accruing ROC Scheme cost per ‘atrisk’ doctor varied from about $55 to almost $600. This extreme variation in estimates provided to us by industry actuaries highlights the difficulty in projecting Scheme costs with confidence.
A.4.57 The estimates of 200708 ROC Scheme accrual provided by industry actuaries can be compared to estimates based on our model (including CHE) of:
 $18.9 million published in last year’s report (roughly 9 per cent of the estimated accruing claims cost for 200708); and
 $14.5 million published in this year’s report (roughly 7 per cent of the estimated accruing claims cost for 200809).
Model sensitivity to the retirement decrements and the relative claim frequency of doctors approaching retirement
A.4.58 The projection of ROC indemnity payments is particularly sensitive to the retirement decrements assumed in the model; and the relative claim frequency of doctors as they approach retirement.
A.4.59 By way of illustration, three different sets of retirement decrements were applied:
 13 per cent between ages 65 and 70, increasing linearly to 41 per cent at age 84;
 10 per cent at age 65 increasing linearly to 29 per cent at age 84; and
 10 per cent between ages 65 and 84.
A.4.60 In addition, the relative claim frequency of older doctors was adjusted using three different approaches:
 Premium relativities only: no further adjustment, with reduction in claim risk only modelled to the extent that it is reflected in diminishing premiums.
 65+ winddown: relative wind down from age 65 according to formula 0.933^{(age64) }with, a multiple of 100 per cent applied until age 65, 50 per cent at age 75 and 25 per cent at age 85.
 60+ winddown: relative wind down from age 60 according to formula 0.933^{(age59) }with, a multiple of 100 per cent applied until age 60, 50 per cent at age 70 and 25 per cent at age 80.
A.4.61 The winddown adjustments are applied before calculation of premium relativities, such that the overall claim frequency assumption of 5 per cent is retained.
A.4.62 The results of this sensitivity analysis are shown in Table 16, in terms of the estimated cost of incidents including CHE and number of retirements for 200708. Note that the results of the approach adopted in this report have been highlighted.
Table 16: Model sensitivity to retirement decrements and winddown assumptions
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