Discussion (INT1047_11-04_COMPmay19_01-20)

Medical defence organisations (MDOs) previously offered ‘discretionary’ professional indemnity cover to their members, whereas general insurers offer professional indemnity ‘insurance’ cover to policyholders.  Both types of entities have issued claims-incurred contracts and claims-made contracts.  The view adopted in this Interpretation is that the accounting for these contracts by MDOs and by general insurers should be consistent, since the substance of the contracts is similar.  An insurance contract is defined in AASB 1023 as a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder.  Under the indemnity arrangements addressed in this Interpretation, the MDO formally has the discretion to decide whether to compensate a member if a specified uncertain future event adversely affects the member.

AASB 1023 addresses the accounting for general insurance contracts, but does not refer in any detail to claims-made insurance policies similar to the claims-made indemnity arrangements of MDOs.  AASB 1023 requires the recognition by general insurers of a liability for outstanding claims in relation to unpaid reported claims and claims incurred but not reported.  This requirement is reflected in this Interpretation.

Liabilities arising in respect of outstanding claims are recognised when it is probable that settlement will be required and the liabilities can be measured reliably.  Where there are a number of similar claims, the probability that settlement will be required may be determined by considering the class of claims as a whole.  Although the probability for any one claim may be small, or unascertainable, it may be probable that an outflow of resources will be required to settle the class of claims as a whole.  In that case, a liability (and expense) is recognised in relation to the class of claims where the amount can be measured reliably.

Claims include requests by members to their MDO for discretionary assistance in relation to adverse events involving them.  Claims arise from events alleged to be covered by indemnity arrangements that occur during the period of indemnity, whether or not a formal demand has been made by a party on account of an alleged loss.  Some events will occur and give rise to claims that are reported to the MDO and settled within the same reporting period.  Other reported claims may be unsettled at the end of a particular reporting period.  In addition, there may be events which give rise to claims which, at the end of a reporting period, have yet to be reported to the MDO, whether or not the member is aware of the event.  These claims are termed claims incurred but not reported (claims IBNR).  It is necessary to ensure that claims are recognised as liabilities and expenses in the correct reporting period, as discussed in the following paragraphs.

The view adopted in this Interpretation is that a liability should be recognised by an MDO once a claim has been reported to the MDO by a member.  MDOs typically have had a discretion to refuse assistance to a member in relation to a claim, but such action is rare.  The members of MDOs have valid expectations that their MDO normally will settle their claims, based either on the terms of the indemnity contracts directly or on the custom or practices of the MDO.  Accordingly, any discretion of MDOs to refuse assistance to a member normally is considered not to have substance for financial reporting purposes.  Thus, MDOs have at the least a constructive obligation in relation to the claims reported by members.  This basis for the identification of liabilities is explained in AASB 137 Provisions, Contingent Liabilities and Contingent Assets (paragraph 17).  Under this approach, if an MDO subsequently exercises its discretion to reject wholly or partly a reported claim that has been recognised as a liability, then the amount included in the outstanding claims liability for that claim is derecognised to that extent following that decision.

The claims IBNR issue is whether an MDO should recognise liabilities for professional indemnity claims that relate to events that have occurred during a member’s period of indemnity and prior to the end of the MDO’s reporting period, but which have not yet been reported to the MDO by the member.  Some of these events will have been reported by injured parties to the MDO’s members, whereas other events may not have been reported to the members or even may not yet be apparent to the injured parties.  These claims are all referred to as claims incurred but not reported, or claims IBNR.

This Interpretation requires MDOs to recognise a liability for claims IBNR arising under claims-incurred indemnity arrangements, based on the view that an MDO has a legal or a constructive obligation to meet the claims incurred but not reported.  This approach is supported on the grounds that the MDO’s discretion to refuse assistance to a member (where still relevant) normally is not substantive for financial reporting purposes, as explained in paragraph 20.  Furthermore, the identification of the event by the injured party, their reporting the event to the member, and the member’s reporting to the MDO, are all independent of the MDO’s future actions or conduct of its operations.  Therefore, the MDO is presently obliged as at the end of the reporting period to make future claims payments in respect of these claims IBNR as a result of past events, which is an essential characteristic of liabilities.

Extended reporting benefits (ERB), death, disablement or retirement (DDR) indemnity arrangements and other run-off cover are not relevant to MDO members who have claims-incurred indemnity, since those members are entitled to report claims relating to events that have occurred during their period of indemnity at any time, including after the end of their membership period.  Accordingly, ERB, DDR and other run-off cover are sometimes referred to as a type of claims-made indemnity.

This Interpretation requires MDOs to recognise a liability for claims IBNR arising under ERB, DDR and other run-off indemnity arrangements where members have qualified for any of those arrangements at some time prior to the end of the reporting period.  ERB, DDR and other run-off cover allow a member (or their representative) to report claims arising from events occurring during the indemnity period at any time in the future without further subscription.  This is no different from the coverage of claims-incurred indemnity.  Accordingly, the same accounting is justified.

A liability for outstanding claims is also required to be recognised for claims IBNR in relation to members who are expected to qualify in the future for ERB, DDR and other run-off indemnity arrangements as members of the MDO.  This approach is based on the view that the obligation to make future claims payments in these circumstances is independent of the MDO’s future actions or conduct of its operations.  The death or disablement of members is beyond the control of an MDO, and reliable estimates of their incidence may be able to be made.  MDOs may also offer continuing reporting benefits upon the resignation or retirement of a member where the member has been a financial member for the minimum qualifying period specified by the MDO, without further subscription.  MDOs may have a discretion not to accept membership renewals, however in practice this discretion has been rarely exercised.  Accordingly, that discretion is considered not to have substance for financial reporting purposes.  Thus, MDOs have a constructive obligation in these circumstances.  Where reliable estimates can be made of members qualifying for ERB, DDR or other run-off cover, a liability is required to be recognised in relation to that cohort of members for events that have occurred to the end of the reporting period and which are expected to result in future claims payments by the MDO.

Under claims-made indemnity, members are required to report claims to an MDO during their membership period.  If they cease to be a member of the MDO and have no additional claim reporting rights, then any claims that they report to the MDO after that time are not required to be settled by the MDO, and are not liabilities.  AASB 1023 notes that an insurer theoretically cannot have claims IBNR under claims-made insurance contracts.

However, in some cases, the additional rights of members with claims-made indemnity may be such that the indemnity is effectively the same as claims-incurred indemnity.  These additional rights can mean that members are effectively ‘locked in’ as members of an MDO.  This Interpretation requires MDOs to recognise a liability for claims IBNR arising under claims-made indemnity arrangements in such circumstances, because in substance the arrangements represent claims-incurred indemnity.  For example, members may have the right to purchase extended reporting benefits upon resignation or retirement (when the member is ineligible for the mandatory run-off cover scheme) for fixed or determinable subscription rates that make it probable that the members will purchase those benefits.  However, where a member can only purchase extended reporting benefits upon resignation or retirement from the MDO for fair value at that time, the MDO is not obligated in respect of claims IBNR until the purchase by the member occurs.  The determination of fair value would incorporate an assessment of the member’s circumstances at that time, including claims history and claims IBNR.

The purpose of the disclosures required by this Interpretation is to provide users of an MDO’s financial statements with information that will enhance their understanding of the basis upon which claims liabilities have been measured and recognised by the MDO.  The disclosure requirements are consistent with those in AASB 1023.  Various assumptions are required to be made in estimating the future cash flows arising in relation to claims liabilities, such as the incidence of events occurring to the end of the reporting period, the timing of settlement of claims, inflation and discount rates, member retention rates, and the likelihood of members qualifying for ERB, DDR or other run-off indemnity arrangements.  Disclosure of the key assumptions applied by an MDO in measuring its claims liabilities assists users of financial statements in assessing the amount, timing and uncertainty of future cash flows.

Future cash flows of an MDO are affected by the different types of claims indemnity arrangements offered by the MDO, such as claims-incurred or claims-made indemnity and ERB, DDR and other run-off arrangements.  Accordingly, disclosures are required about the nature of the indemnity arrangements, the extent to which they apply in the MDO’s business, and their major terms and conditions.  For example, where ERB arrangements are material for an MDO, it discloses any membership period requirements and the basis for determining any exit subscription rates (whether at fair value or otherwise) under which members qualify for those arrangements.

This Interpretation applies to reporting entities that are or include medical defence organisations.  It also applies to general purpose financial statements that encompass MDOs.  The Interpretation applies to an MDO’s own financial statements and to the consolidated financial statements where a group of entities includes an MDO.  The Interpretation applies to the discretionary medical indemnity arrangements of the MDO.