Medical Malpractice and Alternative Risk: Not What the Doctor Ordered?
April 2004
With the current malpractice coverage void,
captives and risk retention groups may seem the ideal solution. However, their
formation and management are not for the short-sighted. Initiators need to enter
these facilities knowing they're in for the long haul.
by Michael
R. Mead
M.R. Mead &
Company, LLC
Over the past year or two several traditional insurers have either left the
market for medical malpractice, reduced their writings, or disappeared from
the active ledgers in one manner or another. The retreat from offering coverage
by St. Paul was the most notable event as it was one of the largest providers
of coverage at the time of its market withdrawal.
This seismic shift in the marketplace for protection against claims has driven
many hospitals, medical facilities, and doctor groups to more closely consider
the alternative market. By way of disclosure and clarification, the author is/has
been involved in the formation and management of several such programs. Clearly
then, I view the alternative market as a viable option.
That said, today I wish to caution those considering the alternative market
to approach it with the realization that if the traditional insurers with large
bank accounts, experience, and resources are unable to continue to feed the
appetites of the plaintiff’s bar, then those thinking to do better should study
the situation very carefully.
To frame our reflections at this point I will offer that I agree that patients
injured, damaged, or whose quality of life or even death is caused by the actions
of a professional or a facility are entitled and deserve just compensation.
However, I sincerely believe that the current crisis is rooted in the greed
of the plaintiff’s bar. I further agree that rate increases are often caused
by poor investment choices made by insurers, but the negative results of those
choices are miniscule when compared to the actual dollars generated by emotionally
outraged juries and the egregious workings of attorneys.
Medical claims are simply not like claims in other lines of work. The emotional,
social, and cultural impediments to reasoned and logical judgments are substantial,
real, and complex. That fact cannot be discounted in any manner.
But the point of this article is not to solve cultural and societal issues,
so we turn to the actual process of considering the formation of an alternative
structure. As with all who consider a captive or risk retention group, study
and caution are important. Claims will occur and must be paid.
Consider Risk Retention Groups
For those seeking alternatives to traditional insurance, captives often first
come to mind. However, they are very difficult to do in today’s market. If a
traditional carrier does not write medical malpractice for its own shareholders,
then it will not agree to “front” it for a newly formed, perhaps thinly capitalized
and naively managed, reinsurer. For those reasons, the better choice for consideration
today is a risk retention group.
Risk retention groups, briefly, are permitted by a federal act. They are
limited in many ways and must be approved in one state before offering coverage,
but can then offer coverage in any other state free of most insurance regulatory
impediments. They are, as a structure, a very good choice for this situation.
A risk retention group, like a captive of which they are but another form,
is an insurance company. It must be formed using considerable sound actuarial
data, market studies, and investment capital. It is regulated and requires professional
insurance management. The policyholders are all shareholders, so that there
are corporate governance issues not usually associated with other forms of captive.
So, not only will the risk retention group require meaningful funding, it will
require a substantial allocation of time by the initiators and their fellow
owners.
In the decision-making process, there comes a defining moment early on, hopefully,
when the initiators realize that not only will their premiums not reduce, but
they must also provide capital and surplus. This is a deal breaker, and should
be so.
The point of the exercise is always to form an alternative structure to benefit
in the long term from superior risk management and operational practices. If
short-term cost reduction is your goal, then you are in for some unhappy moments.
You will not likely achieve the results that you seek.
Implementing a Risk Retention Group
If it is determined that the risk retention group structure is the way to
go, then the process begins with writing the business plan. The business plan
should contain not only an actuarial feasibility study but also market data
as to in what geographic area it will operate, and what practices will be covered
and not.
The determination of the practice area is critical as it will examine the
claims awards and settlements by judicial territory. While the group can operate
anywhere, the local climate for the judicial system is an important factor in
shaping the risk management practices to be followed by the group.
Another important element is the defense team. The quality and availability
of defense counsel will vary across the land. The initiators and their consultants
cannot assume that adequate counsel is readily available in their target jurisdiction.
The attraction of large jury awards or settlements has caused, in many jurisdictions,
a shift of legal talent to the plaintiff’s bar from the defense side. Also,
any large local insurer or other professional liability entity may have committed
the best defense counsel to their own use and do not share with others. Identifying
and retaining superior counsel to achieve the goals of the group is also a deal
breaker.
Rate adequacy is another important and often overlooked issue. Rates are
determined by actuaries employed by insurers. The rates are intended to provide
the guides to making profitable underwriting decisions. Many smallish insurers
use rates that have been promulgated by larger firms by filing what are called
“me-too” filings with regulatory authorities. The fact is that much of the rate
adequacy work in recent years was done by St. Paul. Since it is out of the business,
it has not maintained filings in relation to current developments in awards,
settlements, medical costs, etc. Any risk retention group considering going
into business must carefully examine these issues with their selected actuary.
Shortcuts like “me-too” filings would be a poor choice when it is now your money.
Of course, these elements require that adequate capital be committed. It
must be clear that significant capital and surplus must be made available to
support the risk retention group. This is a difficult matter for physicians
especially who are already squeezed by managed care and the everyday issues
of running a business. It cannot be said too often that the rewards of financing
your own risk come down the road, not in the beginning.
Conclusion
Experience shows that initiators who take the proper amount of time, select
their advisers thoughtfully, and are committed to providing the necessary capital
and human resources will see a meaningful return on their investment. The road
is rocky, but the rewards are there for those who stay the course and walk prudently.
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