Expert Commentary

Medical Malpractice and Alternative Risk: Not What the Doctor Ordered?

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.

April 2004

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 insurer 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.


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.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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