Note 4. Assets and Liabilities Administered on Behalf of the Government

Accounting Policy

Receivables

Where receivables are not subject to concessional treatment, they are carried at amortised cost using the effective interest method. Gains and losses due to impairment, derecognition and amortisation are recognised through the statement of comprehensive income.

Accounting Policy

Administered Investments

Administered investments in subsidiaries, joint ventures and associates are not consolidated because their consolidation is relevant only at the Whole of Government level.

Administered investments, other than those held for sale are classified as available-for-sale and are measured at their fair value as at 30 June 2018. Fair value has been taken to be the Australian Government's proportional interest in the net assets of the entities as at end of reporting period.

Accounting Policy

Pension and compensation payments are paid in arrears following an entitlement period and any amounts determined as payable but unpaid as at 30 June 2018 are included as Administered Personal Benefits Payable.

Accounting Policy

Military Compensation Provision

The military compensation provision represents an estimate of the present value of future payments in respect of claims under the Military Rehabilitation and Compensation Act 2004 (MRCA) and the Safety, Rehabilitation and Compensation (Defence-related Claims) Act 1988 (DRCA) arising from service rendered before 30 June 2018. These claims may not be reported until many years after the event and subsequent payments for income support, health and rehabilitation services can extend over a long period of time. The injury profile within the schemes creates dynamic expenditure patterns. Some injuries can be of a temporary nature and give rise to a short term obligation for compensation while others may result in long term entitlements. Historically, expenditure has been highest in the earlier years after the incident giving rise to the claim for compensation, however the on-going entitlement to income support and treatment means that the liability has a long tail with payments expected to be made for the next 50 or more years. Entitlements are still being paid by DVA for dependants of World War 1 veterans, World War 2 veterans and their dependants.

Many sources of uncertainty exist when estimating a "long tail" provision. There are some inherent sources of uncertainty which arise from:

• differences between the actuarial models, methods and assumptions used to estimate the provision and the underlying claims process;
• historical data which may be inaccurate, incomplete or exhibit volatile claims trends;
• differences between the economic and environmental conditions assumed to prevail in future and actual outcomes; and
• the random element in the claims process whereby claim frequency, timing and magnitude cannot be determined with certainty, even if the model and its parameters are accurate.

There are also a range of factors which can complicate the process of setting assumptions, including:

• changes in service delivery which may accelerate or slow down the development and recording of paid or incurred claims, compared with the statistics from previous periods;
• changes in the legal environment; and
• medical and technological developments.

In the case of the military compensation provisions, there are also specific sources of uncertainty arising from the nature of the schemes and the data available: 

• the longer lag time between injury and claim, compared with other workers’ compensation schemes, presents difficulties in setting assumptions for recent accident years;
• the very long tail in payments means that the estimate of the liability is particularly sensitive to changes in the discount rate;
• the move from DRCA to MRCA is likely to have distorted the claims experience over the transition period, with a jump in DRCA claims immediately prior to closure and markedly lower than expected numbers of MRCA claims in the first few years of its operation;
• the higher level of operational deployments of the Australian defence forces for most of the last decade and a half has also almost certainly led to some distortion of claims reporting; and
• MRCA is far from fully mature with experience available for analysis limited to a maximum of thirteen and a half years after the injury date. This needs to be compared with DRCA experience which indicates that payments can extend out to 50 years or more after the injury. While it is necessary to rely on DRCA experience for these later development years in setting many MRCA assumptions, there is increasingly compelling evidence that the claims experience under the two schemes may not be consistent for some heads of damage.

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All of these factors create uncertainty around the assumptions adopted for future claims and the resulting estimate of the provision.

The estimate of the DRCA liability as at 2018 derived from the 2017 valuation is around 13% higher than was projected last year (on a constant 5% discount rate basis), driven by experience in the permanent impairment head of damage. The increase in permanent impairment was a result of increasing numbers of new claimants. There is still considerable uncertainty about future outcomes for DRCA, in particular, the trajectory of future claim numbers.

For MRCA, significant uncertainty arises not only from the difficulty of setting assumptions for an immature scheme in a changing operational environment, but also from the limitations of the data available for analysis. In particular, the fact that payments are recorded by individual rather than the injury giving rise to the payment and that a substantial proportion of medical and other care transactions are now made using a repatriation health card, means that approximations need to be made that add uncertainty to the estimation process. This uncertainty is likely to be an ongoing feature of the MRCA provision into the future. Given the short history of the scheme and the distortions in experience as a result of deployments over the last decade and a half, the estimate of the liability necessarily relies on DRCA experience in setting assumptions regarding the development of claims at durations for which there is no MRCA data. However, as noted above, there is increasing evidence that the experience may be different under the two schemes, and MRCA data is now being used to set assumptions for the development years where experience is available.

The estimate of the MRCA liability as at 2018 derived from the 2017 valuation is around 10% higher than was projected last year (on a constant 5% discount rate basis), driven by experience in the permanent impairment head of damage. Assumptions underpinning the 2018 liability estimate have been based on unit record data to 30 June 2017 and 31 December 2017 for some heads of damage. The size and persistence of the growth in MRCA outlays remains a very substantial source of uncertainty around the MRCA liability estimate. Furthermore, it will be a number of years before any significant stabilisation becomes apparent in the data. As such, the present uncertainty will persist. For MRCA, the additional uncertainty associated with the immaturity of the scheme and the distortions in early claims experience will be a feature of the analysis for a decade or more. The scheme liabilities will continue to be reviewed annually while the experience remains unstable.

The value of the provision represents the estimate of the present value of expected future payments against claims incurred (though potentially not reported) at the reporting date. The estimation of the liability in respect of claims which have not yet been received by DVA is generally subject to a greater degree of uncertainty than the estimation of the cost of settling claims already notified to DVA, where more information about the claim event is likely to be available. However, the nature of the compensation provided, including long term income support and lifetime coverage of relevant medical costs, means that there remains substantial uncertainty around even the latter category of claims.

The military compensation provision is recognised under AASB 137 Provisions, Contingent Liabilities and Contingent Assets.

The Australian Government Actuary (AGA) was engaged to provide an estimate of the provision as at 30 June 2018 for the estimated cost of claims incurred, but not necessarily reported, at the reporting date.

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For the purpose of estimating the provisions the different types of obligations are categorised and labelled as heads of damage. AGA analyses the experience under six heads of damage:

• incapacity payments, split between short-term and long-term payments;
• permanent impairment, including non-economic loss;
• medical;
• rehabilitation;
• death; and
• other payments, split between medical and legal expenses on the one hand and attendant and household care services on the other.

In calculating the estimated cost of future claims, a variety of estimation techniques are used, generally based upon statistical analyses of historical experience. Implicitly the valuation assumes that the development pattern of the current and future claims will be consistent with the trends apparent in recent experience.

Assumptions

The 30 June 2018 liability estimates are based on the results of the full valuation of the Military Compensation Scheme as at 30 June 2017. This valuation drew on unit record data to 30 June 2017 and 31 December 2017 for some heads of damage in setting assumptions. The following key assumptions are made in calculating the provision:

• numbers of new incapacity episodes are based on observed claim rates and survival rates are used to project the duration of these episodes, including the proportion of claimants who will progress to long term status. The assumed survival rates vary by age;
• the incapacity exit rates (the rates at which people who have been in receipt of incapacity payments for more than twelve months will exit from payment) vary by age at commencement and have been set by reference to observed rates of exit over the three calendar years from 2015 to 2017;
• DRCA data can be used as the starting point in setting assumptions for MRCA at durations where MRCA experience is not yet available or is unreliable, but MRCA experience should be used where it is available;
• transition probabilities that take account of the individual histories of usage of medical services for up to four years previously can be used to project the number of MRCA claimants who will have medical expenditure in future years;
• an allowance is made for payment inflation at rates higher than general price inflation (superimposed inflation) for most heads of damage as shown below;
• where there has been a sustained growth in usage rates, this is generally assumed to continue in the short term, though at a declining rate;
• payments will be made over an extended period (over 50 years); and
• future payments are discounted using interest rates based on a yield curve derived from the yields on Commonwealth bonds of various durations as at 30 June 2018 and extrapolated over the expected payment period (over 50 years);

In accordance with the accounting standards, the provision is calculated by discounting future payments using a yield curve derived from the yields on Commonwealth bonds of various durations as at 30 June 2018. The interest rates forming the yield curve vary from 1.9% in year 1 to a forward rate of 3.5% beyond year 40. These compare to respective rates of 1.6% and 4.6% in 2017. The net result of the change is an increase in the provision of approximately $700 million.

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This reverses the experience of the previous year, where increasing yields had led to a decrease of almost $1 billion between 2016 and 2017. The use of the yield curve for discounting purposes is likely to result in continuing volatility in the estimated provision. The impact of these movements and other movements in the provision is reflected in the Administered Statement of Comprehensive Income.

Superimposed inflation represents an estimate of how costs are estimated to increase over and above normal inflation rates. For example, while the legislation provides for permanent impairment payments to be indexed in line with the CPI, in practice average payments for DRCA have grown substantially faster. DVA has therefore allowed for a margin over the standard CPI assumption of 2.5% growth per annum for most heads of damage.

The estimates of the combined nominal rates of inflation (that is, normal inflation plus superimposed inflation) for each head of damage are below:

• short-term incapacity payments — 4.0% (2016–17: 4.0%);
• permanent impairment and non-economic loss (DRCA) — 5.0% (2016–17: 5.0%);
• permanent impairment (MRCA) — 2.5% (2016–17: 2.5%);
• medical — 4.0% (2016–17: 4.0%);
• rehabilitation (DRCA) — 5.0% (2016–17: 5.0%);
• rehabilitation (MRCA) — 4.0% (2016–17: 4.0%);
• death (DRCA) — 4.0% (2016–17: 4.0%);
• death (MRCA) — 2.5% (2016–17: 2.5%);
• other (Medical) (DRCA) – 6.0% (2016–17: 6.0%);
• other (Legal) (DRCA) — 3.0% (2016–17: 3.0%);
• other (Medical) (SRCA)—6.0% (2015–16: 3.0%);
• other (Legal) (SRCA)—3.0% (2015–16: 3.0%);
• other (Medical and Legal)(MRCA) — 6.0% (2016–17: 6.0%); and
• other (Household and Attendant Care) — 4.0% (2016–17: 4.0%).

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Account Adjustments

The actuary obtains a balance date estimate for the current year by applying roll-forward factors to a full valuation at 30 June of the preceding financial year. Adjustments are identified to the balances of the provision previously reported.

The adjustments for the last two years are explained below:

     Reconciliation of Provision

	2018	2017
	$m	$m
Projected Liability at beginning of financial year	10,954	9,928
Changes in estimated liability of head of damage
Incapacity	219	325
Permanent impairment (PI) / non-economic loss	893	221
Medical	154	867
Attendant care and household services / Medical examinations	(32)	7
Other	47	41
Total changes in estimated liability by head of damage	1,281	1,461
Revised Projected Liability at beginning of financial year	12,235	11,388
Roll forward adjustment
Notional premiums	995	983
Payments	(886)	(610)
Imputed interest	200	175
Projected Liability at 30 June before change in interest rate	12,544	11,937
Change in interest rate	708	(983)
Projected Liability at 30 June	13,252	10,954

The movement in the liability is the net effect of changes in assumptions as a result of analysis of new data that was not available as at 30 June 2017, the allowance for liabilities incurred or met over 2017–18 and the impact of the increase in yields between 30 June 2017 and 30 June 2018.

In terms of modelling and assumption changes, the major factors are:

• an increase in the permanent impairment liability of $893 million, as a result of increasing claims experience and a MRCA claim backlog which is likely to increase outlays in the short term;
• an increase in forecast incapacity costs of $219 million in total across both DRCA and MRCA, due primarily to increased projected claim numbers; and
• an increase in the medical liability of $154 million, primarily attributable to an increased number of claimants in MRCA.

It should be noted that the estimate of the liability at the beginning of each year has been calculated using the yield curve for Commonwealth Government securities that applied at that time. Similarly, the notional premium and interest cost are calculated using the yield curve applying at the opening balance date.

Discount Rate

The provision is calculated by the AGA as the discounted value of future cashflows. Cashflows are assumed to extend over a period of more than 50 years and, as a result, the estimate of the provision is very sensitive to the interest rate used for discounting. The choice of discount rate, while not affecting the projected future cash flows themselves, will alter the present value assigned to those cash flows, and hence the estimate of the liability.

Since 2012–13 DVA has adopted a yield curve derived from the yield of Commonwealth bonds of varying duration, for the purposes of discounting estimated future cashflows. For the preparation of the 2017–18 Financial Statements, DVA has used a yield curve derived from the yields on Commonwealth Government securities as at 30 June 2018.

If the yield curve as at 30 June 2017 (rolled forward to 2018) continued to be used the liability would increase to $12,544 million. Alternatively if the long term discount rate used in the 2017 actuarial review (5.0%) was used, the estimated liability at 30 June 2018 would reduce to $10,266 million.

Sensitivity Analysis

Given the changes in experience observed over recent years, there is necessarily considerable uncertainty around the assumptions to be adopted. The AGA has provided some advice on the sensitivity of the liability estimate to some of the key assumptions for two of the larger heads of damage.

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Incapacity

Exit rates from incapacity declined substantially over the decade to 2014. There has been a slight increase in exit rates over the three subsequent years but they remain below the rates that applied a decade ago. To illustrate the sensitivity of the liability to relatively small changes in exit rates, a scenario incorporating higher exit rates has been modelled. Under this scenario, it is assumed that 10% fewer short term recipients aged less than 50 will reach the 12 month duration and transition to long term status, while exit rates for long term recipients aged less than 35 will increase by 20%. The estimated liability for incapacity payments under this scenario reduces by around 7%.

Accrued Component of Medical Liabilities

The approach to modelling the MRCA medical head of damage relies on an assumption around the proportion of future outlays for claimants with at least one incident predating the valuation date that relate to those incidents. That is, it is assumed that a proportion of future expenditure for those claimants will relate to incidents after the valuation date and, hence, does not form part of the accrued liability. However, the available data does not support attribution of MRCA expenditure to individual claims and there is thus significant uncertainty around this assumption. Assuming that all of the future expenditure relates to claims already incurred, which provides an upper bound on the sensitivity to this assumption, results in an increase in the MRCA medical liability of around 20%.

Veterans' Entitlement Act 1986 (VEA)

No provision is calculated for future payments under the VEA as this Act differs in nature from both MRCA and DRCA.

Outstanding Treatment Accounts System (TAS) claim provision

The Outstanding TAS claims provision is an estimate of the liability outstanding for payment of eligible treatment claims on the TAS as at 30 June 2018. An estimation methodology has been applied for calculating the approximate amount of outstanding claims which will be paid in future years. This provision is not discounted as all amounts are expected to be paid within the next financial year.

Repatriation Pharmaceutical Benefits Scheme (RPBS) provision

The RPBS provision is an estimate of the liability outstanding for payment of eligible claims on the RPBS as at 30 June 2018. An estimation methodology has been applied for calculating the amount of outstanding claims which will be paid in future years. This provision is not discounted as all amounts are expected to be paid within the next financial year.

Provisions for payments to hospitals

A provision has been made for outstanding eligible hospital payments. Due to the uniqueness of each state’s approach to the delivery of health care services in public institutions there is an element of uncertainty in the provision. Specifically, DVA funds veteran services in the state public hospital sector on the basis of estimating the expected cost, advancing funds based on that estimate and then receiving data after services have been provided. The data may be received well after the services have been delivered and is a consequence of the delays in the information flows from state health departments and ongoing contract management issues, which may give rise to adjustments. DVA attempts to mitigate the uncertainty through analysis of prior year trends and monitoring price movements for diagnostic related groups. This gives DVA confidence that the uncertainty is kept within manageable bounds and will not cause any material misstatement.

This provision is not discounted as all amounts are expected to be paid within the next financial year.