4. Financial management of the Run-Off Cover Scheme
4.1.1. Table 1 sets out the cash flow statement of the Notional Account for 2016-17.
Table 1: Cash flow statement of the Notional Account 2016-17
Comment on experience during 2016-17
4.2.1. In the last report, we expected payments of around $1,200 to be made by DHS during 2016-17 and around $131,000 to be accrued by the Notional Account for incidents that have occurred at 30 June 2017 which will give rise to ROC Commonwealth contributions. In reality, no payment was made by DHS during the year and MIGA has advised that no claim has been identified as potentially eligible for the ROC Scheme.
Changes to model and assumptions
4.2.2. This year, we reviewed all the assumptions in light of the NCPD data and the most recent MIGA projections. This has resulted in a number of changes described below. The full set of assumptions is set out in Appendix 4.
4.2.3. One of the key assumptions is the number of midwives who will become eligible for Commonwealth supported professional indemnity cover in future years. The growth in the number of eligible midwives has been consistently below expectation. Following discussions with MIGA and the Department of Health, we have revised down our projected number of midwives who become eligible to claim under the ROC scheme for each of the next five years.
4.2.4. We have also revised down our assumption for average claim size in light of the NCPD data. Due to the small number of claims against midwives to date, the average size is not statistically reliable. We have therefore adopted a claim size assumption of $200,000 (in 2018 dollars) which is about 80% of the average claim size against obstetricians. This assumption is very subjective, and we intend to review this assumption as more claim experience becomes available.
4.2.5. In addition, we have updated the assumed notification and payment patterns to align with medical practitioners.
4.3.1. This section sets out projections of ROC Commonwealth contributions for the next 5 financial years. The projections should be regarded as indicative only, and they are based on the assumptions described above. Table 2 sets out the projections, which are illustrated in Figure 1. The Scheme is not expected to become mature in a cashflow sense for many years. The payments projected below are in nominal dollars and have not been discounted to current dollar values.
Table 2: Projected Run-Off Cover Commonwealth contributions
Figure 1: Projected Run-Off Cover Commonwealth contributions
4.4.1. The estimation of the Commonwealth’s liabilities under the ROC Scheme in future years is an inherently imprecise process. The operation of the ROC 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 ROC Scheme with a high level of confidence. For example, the presence of even a single large claim in any given year would be expected to have a substantial effect on the total amount of ROC Commonwealth contributions for that year.
4.4.2. The liabilities of the ROC 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 incidents which were expected to give rise to professional indemnity claims which would attract a ROC Commonwealth contribution.
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 will be adopted for this purpose. The liabilities of the ROC Scheme will therefore be taken as the present value of future ROC Commonwealth contributions which relate to relevant pregnancy or birth-related incidents which occurred before the effective date of valuation.
4.4.4. The Scheme must be managed over a long time frame. As discussed previously, ROC Commonwealth contributions are likely to be ‘lumpy’ in nature and immature in size for many years. ROC support payments will be received well in advance of ROC Commonwealth contributions. As a result of the payment timing mismatch and the expected volatility in the ROC Commonwealth contribution 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.
4.4.5. 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 midwives and other taxpayers.
4.4.6. The Notional Account is credited with:
- ROC support payments; and
- Notional interest.
4.4.7. Notional interest is credited to the Notional Account to ensure that midwives derive the proper benefit of the time value of money since ROC support payments are received by DHS well in advance of any ROC Commonwealth contributions being made by DHS. Notional Interest is applied at the short term bond rate for consistency with section 44(4a) of the Act, which requires interest of the short term bond rate to be applied to the total run-off cover credit balances of individual midwives.
4.4.8. The Scheme ‘operates after’ the Level 1 and Level 2 Commonwealth contributions. The Level 1 Commonwealth contribution meets 80 per cent of the excess between $100,000 and $2 million, the Level 2 Commonwealth contribution meets the excess above $2 million. Table 3 sets out the funding sources for a ROC claim which costs $2.5 million.
Table 3: Funding sources for a $2.5 million claim which is eligible for the Run-Off Cover Scheme
4.4.9. The Act provides for payment of a midwife’s total run-off cover credit, should the Scheme ever be wound up without alternative arrangements being put in place. Thus, in this event, 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 Commonwealth contributions.
4.4.10. 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.
4.4.11. Table 4 sets out the balance sheet of the Notional Account as at 30 June 2017.
Table 4: Balance sheet of the Notional Account as at 30 June 2017
4.4.12. At 30 June 2017, the Notional Account has disclosed a surplus of approximately $83,000. Note again that no account has been taken for possible payments to midwives under division 4 of the Act, should the Scheme be wound up without alternative arrangement being put in place. Based on the data provided by DHS, this amount could be up to $158,000 as at 30 June 2017. Generally, the estimated surplus position should be regarded as highly uncertain.
4.5.1. Finally, it is appropriate to provide a benchmark projection of the liabilities of the Scheme. A simple model was developed within this office for the purpose of projecting future liabilities under this Scheme.
4.5.2. Table 5 sets out estimates of the liabilities at the end of each of the next five financial years. The numbers are very small, and there is very substantial uncertainty in these estimates. In effect they are based on an assumption of significantly less than one ROC claim per year for the next five years. It will be clear that the presence or absence of even a single ROC claim in any year would mean that the actual experience will turn out to be very different from the projected experience. The liability estimate as at 30 June 2017 is lower than the ‘expected’ estimate as presented in last year’s report because of assumption changes and that a small amount is released due to absence of any notification during 2016-17.
Table 5: Projected balance sheet liabilities of the Notional Account
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.
Guy Thorburn FIAA
Australian Government Actuary
30 April 2018