A.4.1 The purpose of this appendix is to describe the approach taken (and assumptions used) to calculate the scheme liabilities.
A.4.2 Claims Liabilities have been assessed on an occurrence basis. New liabilities 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. The liabilities of the Scheme in respect of claims liabilities 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.
Summary of Liabilities as at 30 June 2016
A.4.3 Table 12 below summarises the estimated accrued Scheme liabilities as at 30 June 2016. The Scheme liabilities are divided into outstanding compliance costs, those attributable to claims notified as at 30 June 2016, those attributable to IBNR claims as at 30 June 2016 and overall claims handling expenses.
Table 12: Run-Off Cover Scheme liabilities related to medical incidents prior to 30 June 2016 ($’m)
A.4.4 This section describes the approach taken and the key assumptions used in the calculation of the key liabilities shown above.
Outstanding Compliance Costs
A.4.5 MIIs apply to DHS for a refund of the costs of complying with the scheme each year. At the end of any one year the government has a liability for any outstanding compliance costs in respect of the previous years’ operation of the scheme, that have not yet been refunded. This liability is based on the applications received by DHS and estimates by DHS in relation to applications that have not been received at the time of writing for compliance costs that have not yet been settled.
Liabilities in relation to notified claims
A.4.6 There are two categories of notified claims, those which have been settled by the insurer, but not yet recovered from DHS and those that are still being managed by the insurer.
A.4.7 In the case of settled claims, DHS maintains a database of these claims and the liability is simply the sum of settled claims. Claims handling expenses are considered separately below.
A.4.8 Where the claim is still being managed by the insurer, all notified claims have a case estimate placed against them by the relevant insurer. The industry has provided a projection of the expected claims payments based on the relevant year of notification. As with any estimate, it is to be expected that the actual payments that will occur to settle the claim will vary from the claims managers’ current estimate. After examination of historical experience, and to provide a margin, these estimates have been increased by the Adjustment Factor for projected cash flows (refer ‘Assumptions’ below). The resulting cash flow is then discounted using the expected long term earning rate to determine a net present value as at the valuation date.
Liabilities in relation to IBNR claims
A.4.9 Due to the nature of this type of liability, claims may be notified many years (potentially as long as 20 or more years) after the event that actually gives rise to the claim has occurred. Industry provides a projection of claims that will be notified in each year for the next five years. Given the previous comment, most of the claims that will be notified next year will have already occurred at the valuation date, and are therefore already a liability of the scheme.
A.4.10 Industry provides a projection of the total cost of expected notified claims for the next five years which are extrapolated. A proportion of these claims will have already occurred and therefore form part of the IBNR liability. Further, given that claims can be reported many years into the future, some claims that will be notified beyond this five year period will also already be part of the IBNR liability.
A.4.11 Taking this into account, the following approach is adopted to derive the IBNR liability from the industry estimate:
- The industry 5 year projection expressed in current real payments and is extrapolated for the next 20 years.
- We apply our observed pattern of the period of delay from an incident occurring to it being reported to determine the portion of the projected future total claims payments that have already occurred and are therefore already liabilities of the scheme.
- We then apply the observed cash flow patterns to allow for the time it takes to settle claims once notified, inflation and discount rate to determine the present value of the liability.
Claims Handling Expenses
A.4.12 The Scheme pays 5 per cent of the direct cost of each eligible claim to cover claims handling expenses. Where an eligible claim is partly covered by the HCCS, the allowance for claims handling expenses paid under the Scheme is 5 per cent of the total claim cost, including the portion covered by the HCCS. Claims costs are therefore grossed up by an allowance that represents the proportion of Scheme claims that are paid by the HCCS.
Industry cash flow projections
A.4.13 We rely heavily on industry projections of future cash flows to determine the value of outstanding notified claims as well as future IBNR claims. Each insurer prepares a projection of cash flows associated with notified claims and a projection of their expected future cash flows for claims expected to be notified over the next five years.
Adjustment factor to projected cash flows
A.4.14 There is limited opportunity to independently review the industry projections noted above. This year we reviewed the historical actual payments data provided by the DHS and compared this to the industry projections. We also reviewed the pattern of individual claim estimates from year to year. This suggested that the industry’s estimates of future cash flows are considerably below the historical trend. To compensate for this, this year we have added a margin of 50 per cent to industry projections for the purposes of determining the liability in respect of notified claims and IBNR claims.
Proportion of Scheme claims paid by the HCCS
A.4.15 Our model effectively assumes that 18.5 per cent of ROCS claims cost will be reimbursed by the HCCS. This has been revised downwards since last review to reflect the change in the HCCS threshold. Our assumption is not dissimilar to most insurers.
Economic assumptions – claims inflation & long term discount rate
A.4.16 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 long term 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.4.17 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.
Comparison of Actual and Expected Liabilities at 30 June 2016
A.4.18 In any valuation, it is informative to compare the ‘actual’ estimated liabilities12 at the valuation date with that which was expected in the prior review. This can highlight areas where a change in approach, or experience has impacted the results.
A.4.19 Table 13 compares the ‘actual’ estimated Scheme liabilities in relation to prior medical incidents as at 30 June 2016 to the ‘expected’ amounts, which are based on the prior review and actual cash flows during 2015-16. For simplicity, the liability for the amount paid by MIIs but not yet recovered and claims handling expense allowance are not included.
Table 13: Actual versus expected liability estimates as at 30 June 2016 ($’m)
A.4.20 The ‘actual’ estimated notified liability is about $7.8 million higher than the ‘expected’ liability based on the prior review. The increase is mostly due to a change in our methodology this year whereby we applied a 50 per cent margin to the industry actuaries’ cash flow projections. This was informed in part by upward revisions in the industry actuaries’ liability estimates in relation to claims that have been previously notified. The actual payments during 2015-16 were very similar to expected.
A.4.21 This new approach was also applied to estimate the IBNR liability. It replaced the previous approach which applied an explicit margin to the IBNR liability. This new approach adjusts future cash flows provided by the industry actuaries to bring them more in line with the trend exhibited by the historical payments data provided by the DHS, making the adjustment more transparent and
A.4.22 In addition, the increase in HCCS threshold from $300,000 to $500,000 for claims notified from 1 July 2018 slightly increased the IBNR component of the ROCS liability as well as future incidents. The overall impact is a slightly higher than expected liability as at 30 June 2016.
A.4.23 In regard to liabilities related to future incidents, we have weakened the basis in our internal projection model after considering the differences between the accrual estimates produced by our internal model and those provided by industry actuaries, and the historical payments data provided by DHS. This has led to lower estimates of future liabilities. For example, the ‘expected’ liability as at 30 June 2020 in this review is 27 per cent lower than last year’s review. Our estimates of future interest cost and cash flows have also been reduced accordingly.
Uncertainty in the Liability as at 30 June 2016
A.4.24 The greatest uncertainty arises from the nature of the scheme. Run-off cover claims are inherently long-tailed, which means that it can take decades for the scheme to mature in a cash flow sense. In addition, claims cost related to bodily injury is highly variable and tend to be dominated by a small number of large claims. Therefore, it is impossible to estimate the scheme liability with certainty.
A.4.25 Our approach for estimating scheme liability, by necessity, focuses on reasonableness of assumptions, of the methodology and monitoring the progress between projected and actual payments over time.
A.4.26 We have to rely extensively on the high-level cash flow projections provided by industry actuaries. The data provided in late 2016 were significantly below historical payment trend as suggested by DHS payments data. Therefore, we have applied a 50 per cent margin to the industry’s projections. Attempting to reconcile the two different sources of data is one area of difficulty when estimating run-off cover claims cost.
A.4.27 The IBNR component is also dependent on the assumed notification pattern. This has been updated a number of times since the beginning of the scheme as more data has become available. This has reflected the shorter notification delays that we have observed. In theory, a shorter notification pattern would imply a lower ROCS liability as the medical practitioner is less likely to have ceased private practice at the time of notification.
A.4.28 Ultimately, uncertainty is evidenced by the fact that the scheme is still immature. Less than 250 claims have been notified to insurers that have a case estimate attached to them. There is insufficient data for a more scientific modelling approach.
12 The estimates have been updated with the latest data, experience and assumptions.