Australian Government, Australian Government Actuary

Appendix 4: Methodology, assumptions and uncertainty

Liabilities as at 30 June 2015

A.4.1 Table 10 below summarises the estimated accrued Scheme liabilities as at 30 June 2015. The Scheme liabilities are divided into those attributable to claims notified as at 30 June 2015 and those attributable to IBNR claims as at 30 June 2015. For simplicity, the liability for outstanding compliance costs is not included.

Table 10: Run-Off Cover Scheme liabilities related to medical incidents prior to 30 June 2015 ($’m)
Liabilities in relation to claims notified as at 30 June 2015 11.6(a)
Liabilities in relation to IBNR claims as at 30 June 2015 37.5(b)
Total Run-Off Cover Scheme liabilities.  49.1

(a) Including $0.7 million CHE and $1.7 million paid by MIIs but not yet recovered.
(b) Including $2.3 million CHE.

A.4.2 Table 11 below compares the ‘actual’ estimated Scheme liabilities in relation to prior medical incidents as at 30 June 2015 to the ‘expected’ amounts, which are based upon information to 30 June 2014. For simplicity, the liability for the amount paid by MIIs but not yet recovered is not included.

Table 11: Actual versus expected liability estimates as at 30 June 2015 ($’m)
Actual Expected Actual minus expected
Notified but not yet paid 9.2 10.0 -0.8
IBNR 35.2 48.7 -13.5
Total 44.4 58.7 -14.3

A.4.3 The ‘actual’ estimated notified liability is about $0.8 million lower than the ‘expected’ liability based on last year’s review. While there was an upward revision in the industry actuaries’ liability estimates in relation to claims that have been previously notified, this was more than offset by the higher than expected payments during 2014-15 for these claims.

A.4.4 For incidents which had not been notified as at 30 June 2015, industry actuaries have significantly revised down their liability estimates. This has led to a lower estimated IBNR liability than expected (based on last year’s review). This downward revision is apparent in the estimates provided by most MIIs. Due to the size of the reduction in the industry projections, we have carried out reasonableness checks by using the actual ROC indemnity payment data provided by DHS. However, it is difficult to rely heavily on that payment data as it pertains only to around 330 claims which have been found eligible for the ROC Scheme. Moreover, for some of those claims, full indemnity payments will not yet have been made. Finally, it is likely that, in future, more ROC eligible claims will show up which have been notified before 2015. All of this makes analysis of this data problematic and, as a result, we have made a number of adjustments to the data to try to approximately account for these issues. We conclude that, although the industry projections demand a significant downwards revision to the implied ROC liability compared with the previous year, analysis of the actual ROC Scheme indemnity payment data does not provide strong evidence that the revised estimates are now unreasonably low.

A.4.5 After considering the differences between the estimates produced by our internal model and the estimates being prepared by industry actuaries, along with the data issues surrounding the industry’s estimates, we have retained the margin on IBNR at 20 per cent. As was the case in last report, our model is still producing a higher estimate of accrual than we would expect to be produced by the industry actuaries.

Description of the model used to project the accrual of new Run-Off Cover Scheme liabilities after 30 June 2015

A.4.6 The approach involved projecting the expected future ROC indemnity payments for each doctor who was practising as at 30 June 2015. 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.

Run-Off Cover claims

Components of claim cost

A.4.7 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.4.8 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.4.9 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.4.10 Claim experience in 2014-15 has been heavier than expected. However, a short period of emerging experience should not necessarily be relied on as a guarantee that underlying assumptions are inappropriate for such a long-tail and uncertain line of insurance as medical indemnity. This is especially true in relation to the Scheme, due, for example, to the following factors:

  • ROC claims are very long-tail and model projections are particularly sensitive to assumptions; and
  • the Scheme is relatively immature.

A.4.11 We conducted an experience analysis last year, and as a result, altered the claim frequency and claim size assumptions. We have retained these assumptions for this review.

A.4.12 We have not altered any of the demographic or financial assumptions in this review.

A.4.13 Practitioners with total medical indemnity payments (including both medical indemnity premiums net of discounts and loadings plus membership fees) of less than $1,700 were excluded from the analysis in order to ensure that only genuine ‘at-risk’ 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. About 81,840 practising doctors have paid some medical indemnity premium. After excluding those doctors with total medical indemnity payments of less than $1,700 we were left with 45,001 ‘at-risk’ doctors. This approach is unchanged from our previous reports.

Claim frequency assumptions

A.4.14 The overall claim frequency was assumed to be 4 per cent. That is, on average each ‘at-risk’ doctor was assumed to have a 4 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 last year.

A.4.15 Individual claim frequencies were then adjusted based on premium as discussed below. This approach has not been changed from our previous reports.

Adjustment to individual claim frequencies based on premium

A.4.16 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.4.17 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 ‘at-risk’ doctors.

A.4.18 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.4.19 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 ‘at-risk’ doctors shown in Figure 5 below. Note that age and gender were not available for a small number of doctors.

Figure 5: Relative premiums by age for ‘at-risk’ doctors

Figure 5: Relative premiums by age for ‘at-risk’ doctors.This chart shows that the proportion of premiums paid is greater than the proportion of ‘at-risk’ practitioners aged between 40 and 50.  The proportions are similar for doctors aged between 50 and 70.  For all other ages, the proportion of premiums paid is slightly lower than the proportion of practitioners.

Note: The graph includes all practitioners with total payments (including membership fees) of at least $1,700 from all MIIs.

Adjustment to individual claim frequencies based on assumed wind down of risky practice

A.4.20 The relative premiums of older doctors appear to indicate a reduction in risky practice as doctors approach retirement. Actuaries have also suggested that doctors tend to wind down their risky practice approaching retirement. However, relative premiums may not capture the full extent of the reduction, since premiums are calculated on a claims-made rather than claims-occurring basis.

A.4.21 Again, for this valuation, doctors are assumed to wind down their risk exposure from age 60, at a rate above that reflected in the premiums. Premium relativities are augmented with a wind down from age 60 according to the formula 0.933(age-59), 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.4.22 This assumption is very subjective, and is not amenable to objective validation. Nonetheless, it does not appear unreasonable in light of observed claim experience and discussions with actuaries.

Claim size assumptions

A.4.23 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.4.24 The average claim size for a non-obstetrician was assumed to be around $130,000, whereas the average claim size for an obstetrician was assumed to be around $1.0 million. This makes an average claim across the board to be around $150,000. This is unchanged from last year.

A.4.25 The assumed claim reporting patterns for obstetricians and non-obstetricians are shown in Table 12 below. The historical claims processing data supplied by DHS reveal that the claims for obstetricians appear to have similar delays in reporting to those for non-obstetricians. We have therefore set the same assumptions for them. Assumed claim sizes presented in the table do not include allowance for inflation or superimposed inflation. Adjustment for inflation and superimposed inflation is discussed below.

Table 12: Claim reporting and size pattern

    Gross average claim size
Development
year
Proportion of number
of claims notified 
(per cent)
Obstetrician
claims
($’000)(a)
Non-obstetrician
claims
($’000)(a)
1 26.5 500 100
2 25.0 700 110
3 11.2 1000 130
4 15.7 1000 150
5 7.5 1500 150
6 4.5 2000 150
7 2.4 2500 150
8 2.0 2500 150
9 1.4 2500 150
10 1.5 2500 150
11 0.6 2500 400
12 0.5 2500 400
13 0.4 3000 400
14 0.2 3500 400
15 0.1 4000 400
16 0.1 4500 400
17 0.1 5000 400
18 0.1 5500 400
19 0.1 6000 400
20 0.1 6500 400

(a) Gross average claim sizes presented in the table are intended to be in 2015 dollars and do not include allowance for inflation and superimposed inflation.

A.4.26 The projected ROC claims cost is 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.

A.4.27 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.

A.4.28 We have assumed different percentages of high cost claim indemnities for obstetrician and non-obstetrician claims. This is because obstetrician claims tend to be much larger and attract higher HCCS indemnity payments. The model effectively assumes that 33 per cent of the ROC discounted claims cost (in relation to future medical incidents related to obstetricians) and 23 per cent of the ROC discounted claims cost (in relation to future medical incidents related to non-obstetricians) will be met by the HCCS. This is explained in more detail in Appendix 5.

Probability of a claim falling under the Run-Off Cover Scheme

A.4.29 The model involved projection of the proportion of the total accrual of liabilities which falls under the Scheme.

A.4.30 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.4.31 The probability of becoming eligible for the Scheme was estimated for each practitioner based on their age as at 30 June 2015 and their sex. Note that practitioners do not become eligible by means of resignation until three years have passed since cessation of practice.

A.4.32 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.4.33 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.4.34 It was assumed that on average practitioners who become eligible for the Scheme do so half-way through the financial year.

Demographic assumptions

A.4.35 The probabilities of death and disablement are assumed to be an increasing multiple of the probabilities of death in Australian Life Tables 2010-12 (ALT 2010-12). The probabilities of death are assumed to be 35 per cent of ALT 2010-12 until age 64, 50 per cent from age 65 to 69, and 60 per cent of ALT 2010-12 thereafter. The probabilities of permanent disability are assumed to be 15 per cent of ALT 2010-12 up to age 24, an increasing multiple of ALT 2010-12 from 15 to 30 per cent from age 25 to 64, and 0 from 65 onwards.

A.4.36 The assumed probabilities of maternity leave are unchanged and 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.

A.4.37 The probabilities of resignation are assumed to be 0.3 per cent between ages 39 and 53, increasing linearly to 1 per cent at age 60, and increasing linearly to 2 per cent at age 64.

A.4.38 The probabilities of retirement are 12 per cent at age 65 and 5 per cent at age 66 increasing linearly to 11.9 per cent at age 89. The probabilities of retirement were assumed to be 100 per cent for ages 90 and above, given the negligible effect on the results.

A.4.39 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 13 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. The assumed probabilities are unchanged from last year.

Table 13: Assumed probabilities of eligibility for the Run-Off Cover Scheme over the next 10 financial years for male doctors
Year ending
30-Jun
Age at 30 June 2015
20 30 40 50 60 70 80
2016 0.0003 0.0004 0.0007 0.0017 0.0042 0.0720 0.1231
2017 0.0006 0.0009 0.0016 0.0036 0.0088 0.1427 0.2372
2018 0.0009 0.0014 0.0024 0.0056 0.0138 0.2116 0.3420
2019 0.0012 0.0019 0.0063 0.0109 0.0292 0.2784 0.4377
2020 0.0016 0.0024 0.0103 0.0163 0.0474 0.3430 0.5243
2021 0.0019 0.0030 0.0144 0.0219 0.1810 0.4050 0.6018
2022 0.0022 0.0035 0.0185 0.0277 0.2410 0.4641 0.6706
2023 0.0026 0.0042 0.0227 0.0347 0.3012 0.5203 0.7310
2024 0.0030 0.0048 0.0271 0.0429 0.3452 0.5734 0.7833
2025 0.0034 0.0055 0.0315 0.0523 0.3888 0.6232 0.8280

A.4.40 Figure 6 below depicts the number of ‘at-risk’ practitioners projected to become eligible for the Scheme by various means during the 2015-16 financial year. Although doctors will become eligible for the Scheme during 2015-16 by way of cessation of practice (having ceased practice during 2012-13), the number below refers to doctors who will actually become eligible during 2018-19.

Figure 6: Projected entries of ‘at-risk’ practitioners to the Run-Off Cover Scheme based on decrement assumptions

Figure 6: Projected entries of ‘at-risk’ practitioners to the Run-Off Cover Scheme based on decrement assumptions.This chart shows the projected numbers of new entrants during 2015-16 to the ROC Scheme based on decrement assumptions. We project 488 new entrants as a result of retirement from private medical practice, 145 new entrants as a result of either death or permanent disability, 461 new entrants due to maternity leave, and 190 new entrants due to cessation of practice for other reasons. 

A.4.41 As in the previous reports, the numbers of practitioners projected to enter the Scheme was generally higher than the number provided by the insurers (see Table 1).

A.4.42 Where the date of birth or gender was not available for a practitioner, these were assigned randomly according to the age and gender distribution of ‘at-risk’ doctors.

Payment patterns, inflation and discounting

A.4.43 ROC indemnity payments in relation to medical incidents occurring after 30 June 2015 were projected assuming the payment patterns in Table 14 below.

A.4.44 This payment pattern has not changed from that adopted in last year’s report. We examined the most recent financial reports of MIIs and concluded that this payment pattern is not inconsistent with industry experience.

Table 14: 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.4.45 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.

A.4.46 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 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 ‘at-risk’ doctors

A.4.47 Table 15 summarises the age distribution of the cohort of ‘at-risk’ 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 15: Cohort of ‘at-risk’ doctors
  Obstetricians Non-obstetricians
Age at
30-Jun-15
Number
‘at-risk’
Total
premium
($'000)
Proportion
males
(per cent)
Number
‘at-risk’
Total
premium
($'000)
Proportion
males
(per cent)
30 38 102 53
30-34 19 256 47 1,277 4,551 49
35-39 73 1,918 40 4,451 24,654 60
40-44 132 6,063 44 6,435 45,069 62
45-49 141 7,076 55 6,716 48,486 63
50-54 140 7,770 67 7,024 49,324 64
55-59 94 4,905 64 6,440 42,889 68
60-64 74 3,754 84 5,229 34,007 75
65-69 43 2,131 95 3,646 23,538 83
70-74 18 1,008 100 1,925 11,349 85
75-79 1 71 100 777 4,023 89
80-84 - - - 227 974 93
85 - - - 81 277 94
Total 735 34,953 61 44,266 289,243 68

Note: Numbers may not add due to rounding. Total premium includes membership fees. If membership fees are excluded, total premium is approximately $294 million.

Projection of future Run-Off Cover Scheme costs

A.4.48 Table 16 below summarises the next 10 years’ ROC indemnity payments which were aggregated to derive the projected Scheme costs in future years. The payment projected for 2015-16 is a blend of actual payments made by DHS to the end of December 2015 and projected payments for 2015-16 by industry actuaries.

Table 16: Calculation of projected Run-Off Cover indemnity payments

  Medical incidents
pre 1 July 2015
  Medical incidents
post 1 July 2015
 
Year ending
30-Jun
Notified as
at 30/06/2015
($m)
IBNR as at
30-Jun-15
($m)
Total
($m)
Total
($m)
Grand Total
($m)
2016 2.4 0.1 2.5 0.0 2.5
2017 2.4 0.8 3.2 0.2 3.4
2018 2.0 1.8 3.8 0.5 4.3
2019 1.4 2.8 4.2 1.2 5.3
2020 1.0 3.3 4.2 2.1 6.3
2021 0.6 3.7 4.3 3.4 7.6
2022 0.3 3.9 4.3 4.9 9.1
2023 0.2 4.1 4.4 6.5 10.8
2024 0.2 4.2 4.4 8.2 12.6
2025 0.2 4.5 4.7   10.0 14.8

Note: The costs of notified and IBNR claims do not always sum to the total cost of medical incidents pre 1 July 2015 due to rounding.

Uncertainty in relation to liability projections

A.4.49 The projected ROC indemnity payments summarised in Table 16 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 late-reported 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.4.50 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.4.51 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.4.52 An estimate of the projected accrual of ROC liabilities during the 2015-16 financial year was provided by each of the actuaries of the MIIs directly and indirectly; these summed to $6.3 million (including CHE). This can be compared to the estimate produced by our model (including CHE) of $11.8 million.