4. Financial management of the Run-Off Cover Scheme
4.1 Future liabilities of the Run-Off Cover Scheme
4.1.1. The estimation of the Commonwealth’s liabilities under the Scheme in future years 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.
4.1.2. 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.
4.1.3. 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.
Comment on experience during 2013-14
4.1.4. In any actuarial investigation it is appropriate to compare the emerging experience with that previously projected. This analysis informs the assumption setting process for the current investigation.
4.1.5. Based on input from industry actuaries and some judgement, the previous report estimated the incurred-but-not-reported (IBNR) Run-Off Cover Scheme liability at 30 June 2013 as $44.9 million. Implied within that estimate was an expectation that approximately $4.1 million in new notifications would emerge during 2013-14. The most recent actuarial estimates predict about $1.8 million of notifications for 2013-14 and $4.1 million for 2014-15. This example highlights the difficulty in undertaking reliable projections in this context.
4.1.7. In relation to Scheme-eligible claims which had been notified at the time of the previous review (30 June 2013) but not yet paid, actuarial estimates of the corresponding ROC indemnity payments had a present value then of $8.1 million. In 2013-14, claim payments of about $2.5 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 2014 of about $6.0 million in today’s dollars. Up to date actuarial estimates put this number at around $5.8 million (excluding 2013-14 notifications)8, which is quite close to expected. However, industry actuaries have taken a generally less cautious view of future liabilities. Thus, industry projections of future notifications have generally decreased when compared with the corresponding projections last year.
Changes to model and assumptions
4.1.8. We investigated the recent eligibility experience. During 2013-14, our model projected lower numbers of new entrants than the numbers reported by industry. This increase appears to be driven by an increase in the number of overseas doctors ceasing practice. More recent eligibility experience for 2014-15 indicates that the number of new entrants has fallen back towards more normal historical levels. More generally, there is substantial variability in the reporting of eligible practitioners among the insurers. Furthermore, the data can vary significantly between months of reporting, which undermines the reliability of the data. Accordingly, we have decided to leave our new entrant assumptions unchanged.
4.1.9. We revised our model this year to improve the process of projecting liabilities arising from incidents that will occur during the first projection year. In particular, we separately modelled obstetricians and non-obstetricians. Based on analysis of available DHS payment data it appears that obstetricians are likely to have different claim experience from non-obstetricians. This is also evident in the claims data provided by the industry. All available data suggest that obstetricians experience higher average claim costs than non-obstetricians, and this difference is reflected in their premiums. As a result, we have decided to model these two groups separately for this review. Further details are provided later in the report.
4.1.10. We have not changed the way in which we have estimated the IBNR liability. For this review we have again based our IBNR estimate on industry actuarial estimates of future notified cost. We have used our claim reporting assumptions to split the estimates of future notified cost between past and future medical incidents. We have again added a margin to the base IBNR estimate in order to bring it broadly into line with our estimate of new accrual. We have maintained the margin of 20 per cent. We remain satisfied that the approach is not unreasonable.
4.1.11. Appendix 4 sets out the main assumptions and describes the methodology that was used to estimate the liabilities. Appendix 5 looks at the effect of the High Cost Claims Scheme (HCCS).
Projected Run-Off Cover indemnity payments
4.1.12. This section sets out projections of ROC indemnity payments for the next 10 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 Appendix 4, with the calculations summarised in Table 16. Table 5 below sets out the projections, which are illustrated in Figure 4. The Scheme is not expected to become mature in a cashflow sense for a number of years. The payments projected below are in nominal dollars and have not been discounted to current dollar values.
4.1.13. The payment figure for 2014-15 is a blend of actual payments to the end of May 2015 and projected payments. It is significantly higher than the estimated payment for 2015/16 due to a $2 million single payment made in April 2015. Generally, ROC indemnity payments are assumed to be made at the same time as the corresponding claim payment. The estimates include indirect costs associated with handling claims, referred to as indirect claims handling expenses (CHE) (see paragraph 4.2.8).
Table 5: Projected Run-Off Cover indemnity payments (including CHE)
| Year ending 30 June | Projected ROC indemnity payments plus CHE $’000(a) |
|---|---|
| 2015 | 5,815 |
| 2016 | 3,263 |
| 2017 | 4,556 |
| 2018 | 6,207 |
| 2019 | 7,481 |
| 2020 | 9,032 |
| 2021 | 10,627 |
| 2022 | 12,253 |
| 2023 | 13,954 |
| 2024 | 16,022 |
(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: Projected Run-Off Cover indemnity payments (including CHE)
4.2 Notional Account
4.2.1. 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.
4.2.2. 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.
4.2.3. The Notional Account is credited with:
- ROC support payments;
- amounts to offset ROC indemnity payments which relate to doctors who were eligible at the commencement of the scheme; and
- notional interest.
4.2.4. 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.
4.2.5. 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 with amounts which offset any ROC indemnity payments which relate to doctors who were eligible at the commencement of the Scheme.
4.2.6. The Notional Account is charged with:
- ROC indemnity payments; and
- payments made under the ROC Claims and Administration Protocol.
4.2.7. The Scheme ‘operates after’ the HCCS. The HCCS meets 50 per cent of the excess above $300,000 of the cost of individual large claims. For example, for a claim which costs $1 million, the HCCS will pick up:
50 per cent × ($1,000,000 — $300,000) = $350,000
4.2.8. 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. Table 6 below describes how an eligible $1 million claim would be funded. The total amount paid of $1,050,000 includes claim costs of $1 million and CHE of $50,000.
Table 6: Funding sources for a $1 million claim which is eligible for the Run-Off Cover Scheme
| Funding source | Amount |
|---|---|
| HCCS | $350,000 |
| ROC indemnity payment (direct claim costs) | $650,000 |
| Run-Off Cover Scheme CHE | $50,000 |
| Run-Off Cover Scheme (Total) | $700,000 |
4.2.9. Appendix 3 provides more detail on claim amounts eligible under the Scheme.
4.2.10. 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.
4.2.11. 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.
4.2.12. Table 7 below sets out the cashflow statement of the Notional Account for 2013-14.
Table 7: Cashflow statement of the Notional Account 2013-14
| $’000 | |
|---|---|
| Income | |
| ROC support payments (received 30 June 2014) | 14,627 |
| ROC support payments (in repect of doctors eligible at 1/7/2004 start up) | 63 |
| Notional interest | 4,531 |
| Expenses | |
| ROC indemnity payments (in repect of doctors eligible at 1/7/2004 start up) | 63 |
| ROC indemnity payments (in repect of doctors eligible post 1/7/2004) | 1,907 |
| Administration cost payments to MIIs | 1,224 |
| Net cashflow | 16,027 |
4.2.13. Table 8 below sets out the balance sheet of the Notional Account as at 30 June 2014.
Table 8: Balance sheet of the Notional Account as at 30 June 2014
| $’000 | |
|---|---|
| Assets | |
| Cash as at 1 July 2013 | 170,323 |
| Net cashflow | 16,027 |
| Total | 186,350 |
| Liabilities | |
| Outstanding compliance costs | 1,597(a) |
| Paid by MIIs but not yet recovered from Medicare Australia | 748(b) |
| Notified to MIIs but not yet paid by them | 7,724(c) |
| Incurred but not yet notified to MIIs | 46,209(d) |
| Claims handling expenses | 3,558(e) |
| Total | 59,836 |
(a) Estimate only — the amounts of some components of this liability are currently unknown.
(b) Based on estimates provided in relation to claims/incidents notified to MIIs and MDOs by 30 June 2014.
(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).
4.2.14. The Notional Account at 30 June 2014 has disclosed an estimated notional surplus of about $127 million. Note again that no account has been taken for possible payments to practitioners under Subdivision E of the Medical Indemnity Act, should the Scheme be wound up without alternative arrangements being put in place. Generally, the estimated surplus position should be regarded as highly uncertain.
4.2.15. Finally, it is appropriate to provide a benchmark projection of the liabilities of the Scheme. Table 9 below sets out estimates of the liabilities of the Notional Account at the end of each of the next five financial years. The purpose is to illustrate the short-term development of the Scheme. There is very substantial uncertainty in these estimates. The numbers shown have been discounted to the end of the relevant financial year but have not been discounted to give values in today’s terms. The projected liabilities are, in general, about 15 per cent lower than the corresponding amounts presented in last year’s report.
Table 9: Projected balance sheet liabilities of the Notional Account
| Year ending 30-Jun |
Liability ($'000) |
New accrual ($'000) |
Interest cost ($'000) |
Payments ($'000)(a) |
|---|---|---|---|---|
| 2014 | 59,836 | |||
| 2015 | 69,196 | 10,681 | 4,069 | 5,391 |
| 2016 | 82,044 | 11,375 | 4,736 | 3,263 |
| 2017 | 95,116 | 12,115 | 5,513 | 4,556 |
| 2018 | 108,105 | 12,902 | 6,295 | 6,207 |
| 2019 | 121,452 | 13,741 | 7,086 | 7,481 |
(a) ROC indemnity payments plus CHE only. Does not include liability in respect of outstanding compliance costs. Refer Appendix 4 for further information.
4.3.1. 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]
Peter Martin FIAA
Australian Government Actuary
17 June 2015
8 $7.7 million including 2013-14 notifications but excluding claims handling costs
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