Australian Government, Australian Government Actuary

Appendix 4: Liabilities at 30 June 2017

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 2017

A.4.3 Table 12 summarises the estimated accrued Scheme liabilities as at 30 June 2017. The Scheme liabilities are divided into outstanding compliance costs, those attributable to claims notified as at 30 June 2017, those attributable to IBNR claims as at 30 June 2017 and overall claims handling expenses.

Table 12: Run-Off Cover Scheme liabilities related to medical incidents prior to 30 June 2017 ($’m)

Total Run-Off Cover Scheme liabilities related to medical incidents prior to 30 June 2017 were $65.3 million as at 30 June 2017. This consisted of $2.3 million in outstanding compliance payments, $5.7 million in relation to claims paid by MIIs but not yet recovered from DHS, $14.0 million in relation to claims notified to MIIs but not yet paid by them, $39.7 million in relation to IBNR claims and $3.7 million in claims handling expenses.

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 generally 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. For this report, the estimate is based on the actual amount that DHS has paid to insurers after 30 June 2017 in respect of previous years’ operation.

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, we have compared the insurer past payments (including CHE) with the DHS reimbursements as at 30 June 2017. The difference is by definition the amount paid by insurers but not yet reimbursed by DHS.

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. The projected cash flow is 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 and being eligible for ROCS 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, and inflation and discount rates are applied 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.

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. This suggested that the industry’s estimates of future cash flows are broadly aligned with the historical trend. We have therefore used the industry projections without any margin. This is different to the previous review where we applied a 50% margin to industry projections.

Proportion of Scheme claims paid by the HCCS

A.4.15 Our model effectively assumes that 17 per cent of ROCS claims costs will be reimbursed by the HCCS, after the threshold change. This has been slightly revised downwards since last review in light of NCPD data. 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. Whilst superimposed inflation has been observed in “bursts” the past, the timing is unpredictable. As a consequence, superimposed inflation is typically allowed for with a constant assumption. Due to the limited data, there is some judgement required in selecting this assumption.
  • 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 at 30 June 2017.

Comparison of Actual and Expected Liabilities at 30 June 2017

A.4.17 In any valuation, it is informative to compare the ‘actual’ estimated liabilities11 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.4.18 Table 13 compares the ‘actual’ estimated Scheme liabilities in relation to prior medical incidents as at 30 June 2017 to the ‘expected’ amounts, which are based on the prior review and actual cash flows during 2016-17. 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 2017 ($’m)

Our estimate of the liability as at 30 June 2017 (excluding outstanding compliance costs and paid not yet reimbursed) based on the latest data was $9.3 million lower than what we expected in our last review. The “actual” liability in relation to notified not yet paid claims is $6.0 million lower than expected, and the “actual” liability in relation to IBNR claims is $3.3 million lower than expected.

A.4.19 The ‘actual’ estimated notified liability is about $9 million lower than the ‘expected’ liability based on the prior review. This is mostly due to a change in our methodology this year whereby we did not apply any margin to the industry actuaries’ cash flow projections. The actual payments during 2016-17 were similar to expected.

A.4.20 In regard to liabilities related to future incidents, we have updated a number of assumptions in our internal projection model in light of the NCPD data. This has led to slightly higher estimates of future liabilities from 2019-20.

Uncertainty in the Liability as at 30 June 2017

A.4.21 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.4.22 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.4.23 We have to rely extensively on the high-level cash flow projections provided by industry actuaries. Data often changes significantly year on year, and they are sometime very different to the historical payment trend as suggested by DHS payments data. Attempting to reconcile the two different sources of data is one area of difficulty when estimating run-off cover claims cost.

A.4.24 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.4.25 Ultimately, uncertainty is evidenced by the fact that the scheme is still immature. Less than 300 claims have been notified to insurers that have a case estimate attached to them, and less than 200 claims have been reimbursed by DHS. There is insufficient data for a more scientific modelling approach.

11 The estimates have been updated with the latest data, experience and assumptions.