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 Scheme in future years is inherently imprecise. 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 (including associated insurer claims handling expenses) which relate to medical incidents which occurred before the effective date of valuation.

Comment on experience during 2014-15

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. In relation to Scheme-eligible claims which had been notified at the time of the previous review (30 June 2014) but not yet paid, actuarial estimates of the corresponding ROC indemnity payments had a present value then of $9.0 million. In 2014-15, claim payments of about $4.7 million were made by MIIs/MDOs relating to these claims (based on industry data). All else being equal, this would suggest a residual figure at 30 June 2015 of about $4.3 million in today’s dollars. Up to date actuarial estimates put this number at around $6.8 million (excluding 2014-15 notifications),8 which is around $2.5 million higher than expected. This is consistent with an upward revision of similar magnitude in the industry actuaries’ liability estimates in relation to claims that have been previously notified. Such revisions can be expected as actual claim costs eventuate over time. However, industry actuaries have taken a generally less cautious view of future liabilities. Thus, industry projections of future notifications have generally decreased when compared with the corresponding projections last year.

4.1.6. Based on input from industry actuaries and some judgement, the previous report estimated the incurred-but-not-reported (IBNR) Run-Off Cover Scheme liability at 30 June 2014 as $49.2 million. Implied within that estimate was an expectation that approximately $4.1 million in new notifications would emerge during 2014-15, $4.5 million during 2015-16, $4.8 million during 2016-17 and $5.2 million during
2017-18. The most recent actuarial estimates predict about $2.4 million of notifications for 2014-15, $3.0 million for 2015-16, $3.2 million for 2016-17 and $3.4 million for 2017-18. The significant downward revisions highlight the difficulty in undertaking reliable projections in this context.

Changes to model and assumptions

4.1.7. We investigated the recent eligibility experience. Last year, our model projected lower numbers of new entrants for 2013-14, and the difference was driven by an unexpected increase in the number of overseas doctors ceasing practice. The eligibility experience for 2014-15 shows that the numbers of new entrants have fallen back to long term historical levels. During 2014-15, our model projected slightly higher numbers of new entrants than the numbers reported by industry. However, there is substantial variability in the reporting of eligible practitioners among the insurers. Furthermore, the data can vary significantly between months of reporting, which undermines the reliability of the data. Accordingly, we have decided to leave our new entrant assumptions unchanged.

4.1.8. We modelled obstetricians and non-obstetricians separately last year to enhance the process of projecting liabilities arising from incidents that will occur during the first projection year. We have retained this approach this year.

4.1.9. We have not changed the way in which we have estimated the IBNR liability. For this review we have again based our IBNR estimate on industry actuarial estimates of future notified cost. We have used our claim reporting assumptions to split the estimates of future notified cost between past and future medical incidents. We have again added a margin to the base IBNR estimate in order to bring it broadly into line with our estimate of new accrual. We have retained the margin of 20 per cent. We remain satisfied that the approach is not unreasonable.

4.1.10. 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 (HCCS).

Projected Run-Off Cover indemnity payments

4.1.11. This section sets out projections of ROC indemnity payments for the next ten 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 16. Table 5 below sets out the projections, which are illustrated in Figure 4. The Scheme is not expected to become mature in a cashflow sense for a number of years. The payments projected below are in nominal dollars and have not been discounted to current dollar values.

4.1.12. The payment figure for 2015-16 is a blend of actual payments to the end of December 2015 and projected payments. Generally, ROC indemnity payments are assumed to be made at the same time as the corresponding claim payment. The estimates include indirect costs associated with handling claims, referred to as indirect claims handling expenses (CHE) (see paragraph 4.2.8).

Table 5: Projected Run-Off Cover indemnity payments (including CHE)
Year ending 30 June Projected ROC indemnity payments plus CHE $’000(a)
2016 2,528
2017 3,417
2018 4,332
2019 5,319
2020 6,336
2021 7,627
2022 9,133
2023 10,828
2024 12,601
2025 14,773

(a) These projected payments do not include ongoing administration amounts payable to insurers under the ROC Claims and Administration Protocol which are different to CHE.

Figure 4: Projected Run-Off Cover indemnity payments (including CHE)

Figure 4: Projected Run-Off Cover indemnity payments (including CHE).This chart shows the projected ROC indemnity payments (including CHE) in nominal dollars for the next 10 financial years.  ROC indemnity payments are projected to increase from $2.5 million for the year ending 30 June 2016 to $14.8 million for the year ending 30 June 2025.  The specific numbers are set out in Table 5.

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 ROC 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;
  • amounts to offset ROC indemnity payments which relate to doctors who were eligible at the commencement of the scheme; and
  • notional interest.

4.2.4. Notional interest is credited to the Notional Account to ensure reasonable treatment of the time value of money since ROC support payments are received by DHS well in advance of any ROC indemnity payments being made by DHS. 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. Since the commencement of ROC indemnity payments, effect has been given to this commitment by ensuring that the Notional Account is credited with amounts which offset any ROC indemnity payments which relate to doctors who were eligible at the commencement of the Scheme.

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 Scheme ‘operates after’ the 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 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 6 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 6: 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 $50,000
Run-Off Cover Scheme (Total) $700,000

4.2.9. Appendix 3 provides more detail on claim amounts eligible under the 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. 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 7 below sets out the cashflow statement of the Notional Account for 2014-15.

Table 7: Cashflow statement of the Notional Account 2014-15
  $’000
Income  
ROC support payments (received 30 June 2015) 14,739
ROC support payments (in respect of doctors eligible at 1/7/2004 start up) 816
Notional interest  3,743
Expenses
ROC indemnity payments (in respect of doctors eligible at 1/7/2004 start up) 816
ROC indemnity payments (in respect of doctors eligible post 1/7/2004) 5,044
Administration cost payments to MIIs 1,597
Net cashflow 11,842

Table 8: Balance sheet of the Notional Account as at 30 June 2015
$’000
Assets
Cash as at 1 July 2014 186,350
Net cashflow 11,842
Total  198,192
Liabilities
Outstanding compliance costs 675(a)
Paid by MIIs but not yet recovered from DHS 1,732(b)
Notified to MIIs but not yet paid by them 9,211(c)
Incurred but not yet notified to MIIs 35,218(d)
Claims handling expenses 2,998(e)
Total 49,838

(a) Estimate only — some MIIs have not lodged applications with DHS.
(b) Based on estimates provided in relation to claims/incidents notified to MIIs and MDOs by 30 June 2015.
(c) Based mainly on estimates provided by industry actuaries.
(d) Based on estimates provided by industry actuaries and models developed within this office.
(e) 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 2015 has disclosed an estimated notional surplus of about $148 million. Note again that no account has been taken for possible payments to practitioners under Subdivision E of the Medical Indemnity Act, should the Scheme be wound up without alternative arrangements being put in place. Based on the data provided by DHS, this amount is around $233 million as at 30 June 2015. Generally, the estimated surplus position should be regarded as highly uncertain.

4.2.15. Finally, it is appropriate to provide a benchmark projection of the liabilities of the Scheme. Table 9 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 have been discounted to the end of the relevant financial year but have not been discounted to give values in today’s terms. The projected liabilities are, in general, about 25 per cent lower than the corresponding amounts presented in last year’s report. Detailed actual versus expected analysis is contained in Appendix 4.

Table 9: Projected balance sheet liabilities of the Notional Account

Year ending
30-Jun
Liability
($'000)
New accrual
($'000)
Interest cost
($'000)
Payments
($'000)(a)
2015 49,838
2016 62,687 11,756 3,620 2,528
2017 76,200 12,521 4,410 3,417
2018 90,444 13,334 5,242 4,332
2019 105,445 14,201 6,119 5,319
2020 121,278 15,124 7,044 6,336

(a) ROC indemnity payments plus CHE only. Does not include liability in respect of outstanding compliance costs. Refer Appendix 4 for further information.

4.3 Actuarial management

4.3.1. 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.

[SIGNED]

Peter Martin FIAA
Australian Government Actuary
15 June 2016


8 $9.2 million including 2014-15 notifications but excluding claims handling costs.