Australian Government, Australian Government Actuary

4. Financial management of the Run-Off Cover Scheme

4.1 2016 – 17 Cash Flow

4.1.1. Table 7 sets out the cash flow statement of the Notional Account for 2016-17.

Table 7: Cash flow statement of the Notional Account 2016-17

Net cashflow was $17.4 million over 2016-17. This was calculated from income of $21.8 million (i.e. support payments and notional interest) and expenses of $4.4 million (i.e. indemnity payments and administration cost).

4.2 Experience and Model

Comment on experience during 2016-17

4.2.1. In relation to Scheme-eligible claims which had been notified at the time of the previous review (30 June 2016) but not yet paid, actuarial estimates of the corresponding ROC indemnity payments had a present value then of $15.8 million (excluding claims handling costs). In 2016-17, claim payments of about $3.9 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 2017 of about $12.7 million in today’s dollars. Updated industry estimates put this number at around $9.2 million (excluding 2016-17 notifications), which is around $3.5 million lower than expected. This is mainly because we did not apply any margin to the insurer data this year. There was a significant upward revision in the industry’s liability estimates this year which brought them more into line with the trend implied by the historical experience, as provided by DHS. Therefore, we believe a margin is not necessary this year.

4.2.2. Based on input from industry actuaries and a margin of 50%, the previous report estimated the incurred-but-not-reported (IBNR) Run-Off Cover Scheme liability at 30 June 2016 as $38.4 million (excluding claims handling costs). Implied within that estimate was an expectation that approximately $5.2 million in new notifications would emerge during 2016-17, $5.5 million during 2017-18, $5.9 million during 2018-19 and $6.3 million during 2019-20. The most recent actuarial estimates (without margin) predict about $4.8 million for 2016-17, $5.3 million for 2017-18, $5.7 million for 2018-19 and $5.9 million during
2019-20. Considering the uncertainty in the scheme, these estimates are not too dissimilar.

Changes to model and assumptions

4.2.3. This year, for the first time we have had access to the NCPD data. This has allowed us to review a range of assumptions, and we have made certain changes as described below.

4.2.4. We have updated our assumption for the claim reporting and size pattern to align with historical experience and assumptions. We have revised down our average size assumption from around $150,000 to around $140,000 (net of HCCS) in light of the NCPD experience. The NCPD data also indicated that while claims against obstetricians were on average higher than those against non-obstetricians, the difference is not as significant as we previously thought. As a result, we have set the same assumptions for all specialties in this review.

4.2.5. We have also updated our assumption for the payment pattern, to align with industry experience.

4.2.6. We have not changed our claim frequency assumption as it does not appear to be inconsistent with the NCPD data.

4.2.7. We have performed a comprehensive analysis of the eligibility data provided by the industry as shown in Table 2. This analysis gave us more confidence in the credibility of the eligibility data provided by the industry. We have therefore used the data with minimal adjustments. As a result, we have revised up our eligibility assumptions for future new entrants to align with historical experience.

4.2.8. Unlike our previous review, we have not applied any margin to the industry’s estimates of future cash flows as the data provided by the industry in late 2017 was broadly consistent with the trend implied in the past payments data provided by the DHS.

4.2.9. Appendix 4 sets out the main assumptions and describes the methodology that was used to estimate the liabilities at 30 June 2017. Appendix 5 describes the assumptions and methodology used to project future liabilities. Appendix 6 considers the effect of the High Cost Claims Scheme (HCCS). The applicable HCCS threshold will be changed from 1 July 2018 and our model has been adjusted accordingly.8

4.3 Results: Projected Run-Off Cover Indemnity Payments

4.3.1 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 Appendices 4 and 5, with the calculations summarised in Table 20. Table 8 below sets out the projections, which are illustrated in Figure 4. The Scheme is not expected to become mature in a cash flow sense for a number of years. The payments projected below are in nominal dollars and have not been discounted to current dollar values.

4.3.2 The payment figure for 2017-18 is a blend of actual payments to the end of December 2017 and projected payments. Generally, ROC indemnity payments are assumed to be made at the same time as the corresponding claim payment. However, there is strong evidence of a lag when we compared insurers’ past payments and DHS reimbursements. According to the industry data provided in late 2017, the amount paid by insurers but not yet reimbursed by DHS was estimated to be $5.7m as at June 2017. While it is reasonable to expect that DHS reimbursements will always lag insurer payments, the DHS payments data to December 2017 indicates that a significant proportion of the $5.7m could be paid in 2017/18. Hence we have adjusted the insurers’ projected cash flow for 2017/18 before blending with actual payments to December 2017. The projected indemnity payments include indirect costs associated with handling claims, referred to as indirect claims handling expenses (CHE).

Table 8: Projected Run-Off Cover indemnity payments (including CHE)

We project the indemnity payments to be $5.7 million in 2018 and gradually increase from $4.8 million in 2019 to $9.7 million in 2027.

(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: Historical and projected Run-Off Cover indemnity payments (including CHE)

This chart shows the historical and projected ROC indemnity payments (including CHE) in nominal dollars.  ROC indemnity payments have averaged around $3.8 million per year for the three years to 30 June 2017. They are projected to be $5.7 million for the year ending 30 June 2018 and will increase from $4.8 million to $9.7 million for the year ending 30 June 2027.  The specific numbers are set out in Table 8.

4.4 Results: Liability at 30 June 2017 & Notional Account

4.4.1 The estimation of the Commonwealth’s liabilities under the Scheme 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.

4.4.2 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.

4.4.3 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.

4.4.4 The Commonwealth’s liabilities under the scheme at 30 June 2017 are considered under the following categories:

  • Outstanding compliance costs as at 30 June this year;
  • Scheme eligible claims which had been notified at the time of the review and paid by the MIIs, but not yet recovered from DHS;
  • Scheme eligible claims which had been notified to the MIIs at the time of the review but not yet paid;
  • Incurred claims that have not yet been reported to the MIIs; and
  • Claims handling expenses.

4.4.5 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.

4.4.6 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.

4.4.7 The Notional Account is credited with:

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

4.4.8 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.

4.4.9 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 annually with amounts to offset any ROC indemnity payments which relate to medical practitioners who were eligible at the commencement of the Scheme.

4.4.10 The Notional Account is charged with:

  • ROC indemnity payments; and
  • Payments made under the ROC Claims and Administration Protocol.

4.4.11 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.

4.4.12 Appendix 2 provides more detail on claim amounts eligible under the Scheme.

4.4.13 Note that the Scheme ‘operates after’ the HCCS. The effect of the HCCS is described in detail in Appendix 6.

4.4.14 Table 9 describes how an eligible $1 million claim notified after 1 July 2018 would be funded9. The total amount paid of $1,050,000 includes claim costs of $1 million and CHE of $50,000.

Table 9: Funding sources for a $1 million claim which is eligible for the Run-Off Cover Scheme

HCCS will cover $250,000. The total reimbursement under the Run-Off Cover Scheme will be $800,000 which includes $50,000 CHE.

4.4.15 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.

4.4.16 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.

4.4.17 Table 10 below sets out the balance sheet of the Notional Account as at 30 June 2017.

Table 10: Balance sheet of the Notional Account as at 30 June 2017

The notional account had $231.5 million assets and $65.3 million liabilities as at 30 June 2017. The liabilities consisted of $2.3 million outstanding compliance costs, $5.7 million paid by MIIs but not yet recovered from Medicare Australia, $14.0 million notified to MIIs but not yet paid by them, $39.7 million incurred but not yet notified to MIIs and $3.7 million claims handling expenses.

(a) Based on actual payments made by DHS in 2017/18 in relation to prior claim years.
(b) Based mainly on estimates provided in relation to claims/incidents notified to MIIs and MDOs by 30 June 2017.
(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).

4.4.18 The Notional Account at 30 June 2017 has disclosed an estimated notional surplus of about $166 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 could be up to $306 million as at 30 June 2017. Generally, the estimated surplus position should be regarded as highly uncertain.

4.5 Results: Projected Liabilities of the Scheme

4.5.1 Finally, it is appropriate to provide a benchmark projection of the liabilities of the Scheme. Future liabilities under the scheme are projected having regard to the annual rate at which future liabilities will accrue, the payment of claims and the interest that is required to accrue to the (discounted) reserves each year.

4.5.2 Table 11 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 not too dissimilar from the corresponding amounts presented in last year’s report. Detailed actual versus expected analysis is contained in Appendix 4.

Table 11: Projected balance sheet liabilities of the Notional Account

The liability as at 30 June 2017 was estimated to be $65.3 million, and this number is expected to grow steadily to $108.9 million by 2022. We estimated new accrual to be $8.0 million in 2018 and allowed this number to increase with inflation.

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

4.6 Actuarial management

4.6.1 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]

Guy Thorburn FIAA
Australian Government Actuary
30 April 2018


8 As announced by the Government on 19 December 2017 in the Mid-Year Economic and Fiscal Outlook 2016-17, the High Cost Claim Threshold will increase from $300,000 to $500,000 from 1 July 2018.

9 As announced by the Government on 19 December 2017 in the Mid-Year Economic and Fiscal Outlook 2016-17, the High Cost Claim Threshold will increase from $300,000 to $500,000 from 1 July 2018.