Reporting Form MRF 210.0

Outstanding Claims Liabilities

Instruction Guide

Introduction

This form requires Medical Defence Organisations (MDOs) to report information about its outstanding claims liabilities (OCL). These are to be calculated in accordance with these instructions.

Audit Requirements

This form must be subject to audit review and testing on an annual basis or more frequently if necessary to enable the auditor to form an opinion on the accuracy and reliability of the data. The auditor must provide a certificate to the MDO specifying whether, in their opinion, the data provided by the MDO are reliable. The MDO must submit this certificate to APRA on an annual basis.

The scope and nature of audit testing required is outlined in the applicable Auditing and Assurance Guidance Statement issued by the Auditing and Assurance Standards Board

Actuarial requirements

MDOs are required to retain an actuary to calculate the MDO’s OCL in accordance with these instructions. The actuary must prepare a report (the liability valuation report) and this report must be submitted to APRA by the MDO on an annual basis. Half yearly actuarial reviews are not required to be conducted specifically for the purposes of completing this form.

Definitions

Definitions for data reporting items required by this form have been provided where possible in the instructions under the section headed ‘Specific Instructions’.

Reporting Obligations

MDOs are required to report on a half-yearly basis (that is, six monthly intervals), based on their financial year.

For annual reporting, MDOs must lodge a form within four months of the end of their financial year. The information required on an annual basis must be reported as at the last day of the reporting period on a financial year-to-date basis of the MDO.

For half-yearly reporting (that is, the half-year that does not correspond with the MDO’s financial year end), MDOs must lodge a form within 20 business days of the end of that six month period.

Unit of Measurement

This form is to be prepared in thousands of Australian dollars (AUD). Amounts denominated in a currency other than Australian currency are to be converted to AUD in accordance with AASB 121 The Effects of Changes in Foreign Exchange Rates (AASB 121).

Specific Instructions

OCL relate to all claims incurred prior to the calculation date, whether or not they have been reported. OCL are to be determined on a fully prospective basis; both net and gross of expected reinsurance and non-reinsurance recoveries.

The OCL is to be measured and reported in accordance with the instructions detailed below, that is, must be reported at the 75th percentile for the purpose of this form. As outlined above, MDOs are required to retain an actuary to calculate the MDO’s OCL in accordance with these instructions.

MDOs are free to provide for the OCL in MRF 300.0 Statement of Financial Position (MRF 300.0) at a level equal to or greater than the amount reported in this form (i.e. at a level above the 75th percentile).

Note: amounts in excess of the 75th percentile level reported in MRF 300.0 can be added back to Tier 1 capital in MRF 120.0 Capital Base (MRF 120.0).

Calculation of OCL

OCL relates to all claims incurred prior to the calculation date, whether or not they have been reported to the insurer. The value of the outstanding claims provision must include an amount in respect of the expenses that the insurer expects to incur in settling these claims. The value of outstanding claims provision must not include any Government charges imposed such as levies, duties and taxes. Also, a deferred acquisition cost must not be reported.

OCL are to be determined on a prospective basis; both net and gross of expected reinsurance and non reinsurance recoveries.

The valuation of OCL for each class of business must comprise:

• a central estimate (refer below); and
• a risk margin (refer below) that relates to the inherent uncertainty in each of these central estimates.

The valuation of insurance liabilities (i.e. OCL and premiums liabilities) reflects the individual circumstances of the MDO. In any event, the minimum value of insurance liabilities must be the greater of a value that is:

• determined on a basis that is intended to value the insurance liabilities of the insurer at a 75 percent level of sufficiency; and
• the central estimate plus one half of a standard deviation above the mean for the insurance liabilities of the MDO.

An MDO (after taking advice from its actuary) must determine a value for its OCL. In determining the value of the OCL, the actuary must ignore any discretions available to the MDO and assume that the MDO is contractually obliged to pay all members’ claims.

The OCL relates to all claims incurred prior to the 30th June 2003 (since MDOs ceased writing medical indemnity cover as at this date), whether or not they have been reported to the MDO. The value of the OCL must include an amount in respect of the internal expenses that the MDO expects to incur in settling these claims. The OCL is to be determined both net and gross of expected reinsurance recoveries.

The valuations of an MDO’s OCL must be realistic estimates, determined having regard to considerations of consistency with the basis for valuing assets, and the requirements of relevant Australian Accounting Standards.

The valuation of insurance liabilities must comprise:

• a central estimate value of the OCL; and
• risk margins that relate to the inherent uncertainty in the central estimate value.

The value of the OCL is the sum of the central estimate and the risk margin.

The valuation of OCL should reflect the individual circumstances of each MDO. Notwithstanding this, to ensure that valuation processes are consistent and sufficiently rigorous across all MDOs, the risk margin should be established on a basis that is intended to secure the OCL of the MDO at a given level of sufficiency – that level is

75 per cent.

Due to the highly skewed nature of some insurance distributions, the 75 per cent level of sufficiency may result in a value regarded as insufficient for prudent purposes. Therefore, the risk margin should not be less than one half of the coefficient of variation for the OCL of the MDO.

Risk margins should be shown separately in relation to the OCL.

Where the actuary thinks it appropriate, allowance for reinsurance should be made in determining the risk margin. The justification for and method of determining such reinsurance recoveries should be clearly documented and reported by the actuary.

The Central Estimate

The central estimate is intended to reflect the mean value in the range of possible values for the outcome (that is, the mean of the distribution of probabilistic outcomes). The determination of the central estimate should be based on assumptions as to future experience which reflect the experience and circumstances of the MDO and which are:

• made using judgement and experience;
• made having regard to reasonably available statistics and other information; and
• neither deliberately overstated nor deliberately understated.

Where experience is highly volatile, model parameters estimated from the experience can also be volatile. The central estimate should therefore reflect as closely as possible the likely future experience of the insurer. Judgment may be required to limit the volatility of the assumed parameters to that which is justified in terms of the credibility of the experience data.

The central estimate will generally be measured as the present value of the future expected payments. This measurement process will involve prospective calculations and modelling techniques, and will require assumptions in respect of the expected future experience, taking into account all factors which are considered to be material to the calculation, including::

• discount rates;
• claims escalation;
• claims and policy management expenses; and
• the pattern of claims run-off.

The assumptions used should be consistent for the estimation of both outstanding claims provision and premiums liabilities. Where they are not, the reasons must be documented.

The Risk Margin

The risk margin is the component of the value of the OCL that relates to the inherent uncertainty that outcomes will differ from the central estimate. It is aimed at ensuring that the value of the OCL is established at an appropriate and sufficient level. The risk margin does not relate to the risk associated with the underlying assets, including asset-liability mismatch risk.

Risk margins must be determined, for each class of business, and in total, on a basis that reflects the experience of the MDO. In any event, the risk margin must be valued so that the insurance liabilities of the MDO, after any diversification benefit, are not less than the greater of a value that is:

• determined on a basis that is intended to value the insurance liabilities of the insurer at a 75 per cent level of sufficiency; and
• the central estimate plus one half of a standard deviation above the mean for the insurance liabilities of the MDO.

The risk margins must be determined having regard to the uncertainty of the net OCL and to any uncertainty related to the estimate of reinsurance and non-reinsurance recoveries that are deducted from the estimate of gross insurance liabilities.

The Discount Rate

The value of an MDO’s OCL is typically independent of the value of the underlying assets. For this reason, a discount rate that is observable, market-based and objective is most appropriate.

The rate to be used in discounting the expected future claims payments for a class of business is the gross redemption yield net of the applicable tax rate, as at the calculation date, of a portfolio of sovereign risk securities with a similar expected payment profile to the insurance liabilities for that class (e.g. Commonwealth Government securities for Australian dollar liabilities).

Where the expected payment profile of the liabilities cannot be matched - for example, because the duration is too long - a discount rate regarded as consistent with the intention of these Instructions should be assumed.

Reinsurance Recoveries

Reinsurance refers to arrangements where some part of individual or aggregate insurance risks are ceded to an insurer (or reinsurer) or insurers (or reinsurers). Reinsurance recoveries are amounts expected to be recovered under arrangements in relation to the OCL.

The valuation of net (of reinsurance) OCL is to be determined in accordance with the principles of these instructions. The principles of these instructions should be applied with similar robustness to the valuation of gross (of reinsurance) OCL.

In practice, the estimation of the value of the OCL may be either undertaken on a gross basis, with a separate estimate of the value of reinsurance recoveries, or on a net basis. Where the process is undertaken on a net basis, it is still necessary to value separately estimates of the gross liability and the recovery amounts.

In determining the estimate of reinsurance recoveries, the principles of these instructions must be complied with when valuing the OCL, the actuary should also consider the estimation of reinsurance recoveries. Actuarial judgement should be used in the application of the principles of these instructions in those circumstances.

Non Reinsurance Recoveries

Non-reinsurance recoveries are amounts that may be recovered under arrangements other than reinsurance arrangements, such as salvage, subrogation and sharing agreements.

For each line of business report the Non Reinsurance Recoveries associated with the OCL.

Claims Escalation

Appropriate allowance must be made for future claims escalation when determining the central estimates of the OCL. Future claims payments may increase over current levels as a result of either or both of:

• wages or price increases (inflation); or
• court awarded interest, other environmental or economic causes (superimposed inflation),

and appropriate allowance must be made in both respects. Claims payments include third party costs incurred in settling those claims such as investigation, medical and legal fees, etc.

Materiality

Particular values are considered material to the overall result of a calculation when their misstatement or omission would cause the result to be misleading to the users of the information. Materiality tests assess the significance of the particular value by relating it to the amount of the overall result (the base amount) to which it contributes.

Materiality will always be a matter requiring exercise of judgement. It should be recognised that the level at which a difference becomes material can be considerably lower than a statistically significant difference. In these circumstances, careful exercise

Reporting

As required by this Reporting Standard and instructions, an MDO is required to seek actuarial advice in respect of its OCL. The actuary is required to prepare a report on an annual basis in respect of the valuation of the OCL (the liability valuation report). The MDO is required to submit that report to APRA.

The liability valuation report must address the matters set out in these instructions. Specifically the report must address:

General matters

• the name of the MDO in respect of which the report is being prepared;
• the name of the actuary preparing the report;
• the purpose of the report;
• the extent of compliance with these instructions and reasons where the report does not comply;
• definitions of terms and expressions used in the report that may be ambiguous or subject to wide interpretation;
• the extent to which any information is obtained from, or work undertaken by, other parties must be disclosed.

OCL

• the class/s of business for which a valuation has been undertaken;
• nature, appropriateness, accuracy and interpretation of data;
• analysis of policy and claims experience, highlighting significant aspects of recent experience;
• valuation model or models and the claim experience assumptions adopted for the projection of the OCL. These models should be clearly described and the derivation of assumptions clearly explained with reference to the analysis of data. Any limitations should also be stated;
• changes to the approach, model or models and claim experience since the previous report of this nature;
• comparisons of actual experience with that expected under the assumptions of the previous report of this nature;
• approach to the assessment of uncertainty, 75th percentile and/or coefficient of variation and derivation of the risk margin; and
• results of the valuation that clearly identify:

- the central estimate of OCL by class of business;

- the coefficient of variation (if applicable) and risk margins by class of business; and

• details of how the Maximum Event Retention (MER), if any, has been considered and applied in the calculation of the OCL (where this will be reported as Incurred but Not Reported Claims) and details of the scenarios upon which the MER has been based (for example, a single large loss or a series of losses arising from the one dependent cause where that cause is also detailed);
• claims development; and
• details of losses arising from both claims made covers and claims incurred covers.

Reinsurance recoveries

• where reinsurance recoverables are due from a related entity, details of the reinsurance arrangements in place between the MDO and the related entity