Premiums are doubling, deductibles tripling, and insurers are abandoning the line. Charles Kolodkin explains why the condition of the market is quite rationale and not surprising.
A quick examination of the medical malpractice insurance marketplace in the second half of 2001 might lead a dispassionate observer to conclude this segment of the insurance industry is confused, in disarray, and generally in a state of disorder. Premiums are doubling, hospital deductibles are tripling, claims-free physicians are being nonrenewed, insurers are leaving territories en masse. Simply put, the market is in chaos.
Ask an insurance agent or broker specializing in medical malpractice coverage and you will no doubt receive confirmation of this turmoil. Survey a physician or hospital risk manager on this subject, especially one that has recently sought professional liability insurance protection, and you will likely hear a litany of complaints suggesting disgust, bewilderment, and helplessness. The reaction from insurers themselves may come with a wry smile, but they too will agree the market is in a chaotic state. Yet, in a perverse way, the condition of the medical malpractice market is actually quite rationale and not at all surprising.
The Problems of the Past
What is happening to the market for medical malpractice insurance in 2001 is a direct result of trends and events present since the mid to late 1990s. Throughout the 1990s and reaching a peak around 1997 and 1998, insurers were on a quest for market share, that is, they were driven more by the amount of premium they could book rather than the adequacy of premiums to pay losses. In large part this emphasis on market share was driven by a desire to accumulate large amounts of capital with which to turn into investment income.
In a perfect world, investment income would cover any deficiencies that might exist in underwriting results and the insurers' aggressive marketing and pricing strategy would prove to be successful. Alas, we do not live in a perfect insurance world and, as competition intensified, underwriting results deteriorated. Regardless of the level of risk management intervention, proactive claims management, or tort reform, the fact remains that if insurance policies are consistently underpriced, the insurer will lose money.
The following table displays the performance of insurers issuing medical malpractice coverage in the United States during the decade of the 1990s.
Net Premiums Written
Source: A.M. Best Co.
It only takes a quick view of insurance companies' results during the past few years to realize how poorly the sector has performed. As bad a year as 1998 was, evidenced by a combined ratio of 112 percent, 1999 results are worse, weakening to 126 percent. Preliminary information indicates the trend deteriorating in 2000 to 140 percent. In other words, for every $1.00 medical malpractice insurers were receiving in 2000 as premium, they will pay out $1.40 in losses and expenses.
Insurers Go Out of Business
Clearly a business cannot continue operating in this fashion indefinitely. Indeed, this has been the case for such long time writers of professional liability insurance as Frontier, Reliance, and P.I.E Mutual. These companies, who suffered through several years of weakening performance, have been liquidated or are otherwise inactive.
In August 2001, the list of impaired medical malpractice insurers got longer as the Pennsylvania Department of Insurance placed PHICO under state rehabilitation. PHICO, one of the ten largest writers of medical malpractice insurance, has been one of the more aggressive underwriters during the late 1990s. The company has seen its surplus decrease dramatically over the past year and half from almost $200 million to under $10 million. Regulatory intervention was necessary as it became obvious PHICO's premiums had been inadequate to cover losses.
The Industry Reacts
In light of these dismal results, the insurance industry realizes it must take action. A top executive of St. Paul Insurance Company, the country's largest writer of medical malpractice insurance, recently stated, healthcare liability "is the most dramatically underperforming segment of the marketplace." In response, the Minnesota based insurer is reevaluating its marketing strategy, examining not only its premium rating structure, but also the territories, product lines, and coverage limits it will offer.
St. Paul is hardly unique. It is safe to say every insurance company actively insuring hospitals and physicians has gone through an intensive introspection of its marketing strategy during the past 12 months.
Insurance companies are evaluating all aspects of underwriting, and not just premiums. As of 2001, the effects of this introspection by the medical malpractice insurance community remain unclear, although one thing is certain: the aggressiveness of the 1990s characterized by soft pricing is over. Insurers are now examining the territories they will write, the medical specialties to be targeted, the amount of coverage to make available, deductibles required, and the way they make underwriting decisions.
The following are examples of the way medical malpractice underwriting is changing:
Eastern Pennsylvania: Principally due to high jury awards, insurers are avoiding this venue. Employers Reinsurance Corporation (ERC), an insurance titan with over $10 billion in assets, has effectively pulled out of this market. Whereas, ERC formerly issued policies above $1 million to $2 million level, they now want to attach at $10 million. Moreover, their premium requirements have increased sometimes by as much as 500 percent.
West Virginia: The premium rates in the state have long lagged behind the loss experience, however the state insurance department has been slow to approve rate increases. Accordingly, most medical malpractice insurers are withdrawing from doing business in the Mountaineer State.
South Florida and Texas: Traditionally these territories have been viewed as problematic for the medical malpractice insurance industry on account of large jury awards. Although rates in these states are significantly higher than those in neighboring states like Georgia or Oklahoma, a number of insurers are choosing to discontinue offering policies in the second and fourth most populous states.
Unattractive Medical Specialties: Many insurers have found certain medical specialties to be either entirely unprofitable or simply difficult to classify. Primary care physicians such as family practitioners, pediatricians, and internists are no longer a targeted class of business. This is mainly a result of their relatively low premiums and the fact that managed care has placed more demands on these physicians, in effect increasing their loss exposure. Emergency medicine is a medical specialty that few, if any, insurers are eager to write in 2001. The transitional nature of the patient-physician relationship, the potential for catastrophic outcomes if there is a misdiagnosis or premature discharge, and the sector's historically poor claims experience has made this an unappealing business class. Surprising to many, radiologists are having difficulty garnering interest in the insurance marketplace. In the past, this group has been categorized as a lower risk group, yet their susceptibility to failure to diagnose claims has many underwriters perplexed about how to properly rate radiologists. Therefore, the simplest solution is to avoid the specialty.
Unattractive Healthcare Sectors: Certain healthcare sectors are increasingly being avoided due to their unfavorable claims history. This is complicated by the insurance industry's inability to project future losses with any degree of confidence. Thus, insurers basically abandon a sector. This has been the case with the well-publicized insurance crisis being experienced by the nursing home industry. The correctional care sector (clinics serving prisons and jails) is in a similar predicament. Academic medicine, encompassing large teaching hospitals usually located in urban settings, falls into this category as well.
Structured Underwriting: Several insurers have imposed stricter guidelines on their underwriters by establishing acceptable levels of claims frequency and claims severity an applicant may have. This is usually accomplished through objective standards, such as no more than 1 claim in the past 5 years for physicians. Acceptable claim severity for a potential insured physician might be under $100,000 (exclusive of defense costs) for all settlements, including open cases.
Centralized Underwriting: Insurers are more and more frequently implementing a chain-of-approval process for accepting and rating insureds. The companies' home offices are increasingly requiring to sign-off on the proposals prepared by field offices. SCPIE, an "A"-rated insurer focused exclusively on the healthcare industry, recently closed their regional offices and are centralizing underwriting decisions within their Los Angeles home office.
Forecast for 2002
The immediate prospects for the buyer of hospital professional liability insurance or physician malpractice coverage are not promising. Rates likely will continue to increase, market capacity will further shrink, and insurers will be highly selective about the risks they will write.
Rate Increases Will Continue. Although premium rates started their climb in 2000 and noticeably increased in 2001, most underwriters feel they are still insufficient to cover losses. Indications for 2002 are more rate increases. St. Paul raised rates for large hospitals it has renewed thus far in 2001 by an average of 76 percent. The company's price increases have been even steeper in recent months, with renewal increases in July 2001 up 103 percent from last year. This is not an isolated phenomenon.
Underwriting Standards Will Tighten. During the soft market a prospective insured really was not closely scrutinized when it applied for coverage. This was the case for both institutions as well as physicians. In the quest for market share, insurers would issue a quote in days, if not hours. The information requests of underwriters were hardly exhaustive.
The tide has turned. All insurers insist on a detailed, completed application from the insured with a comprehensive summary of operations. For many hospitals, the insurance company will not prepare a quote without first performing a site visit. In today's world, underwriters require thorough loss information, including a current loss run identifying an insured's open and closed claims. In the event any of these materials are not submitted, it is doubtful an underwriter will release a quotation.
Limited Number of New Players. In view of the woeful operating results in the medical malpractice insurance segment, an influx of new insurers is unlikely in 2002. Most potential risk bearers will await the outcome of the changes that have occurred in 2001, such as higher rates and focused underwriting, before committing capital and resources to the industry. It is important to realize the impact of these changes may take a number of years to be fully understood, particularly since medical malpractice claims are among the slowest in the industry to develop. Thus, additional capacity in the form of new insurance companies entering the medical malpractice environment appears far off.
Reemergence of Alternative Risk Funding Vehicles. One source of possible relief for hospitals and physician groups may be in the reemergence of alternative risk funding vehicles, for example, captive insurance companies, both group and single-parent sponsored; rent-a-captives; risk purchasing pools; risk retention groups; and insurance reciprocals. These structures, popular in both the late 1970s and again in the mid-1980s, lost much of their allure as insurance companies slashed premiums. But with the return of hard market conditions, buyers will seek options outside of the commercial marketplace. These alternative risk funding vehicles promising pricing stability and more control for the insured should again prove increasingly attractive.
To an experienced and keen insurance professional, the dreadful operating results medical malpractice insurers are now suffering are scarcely surprising and are a direct outcome of an inadequately priced product. Although a hardening of the market with significant premium increases has long been anticipated, the extent of the change has surprised many. Insurers have been forced to not only reevaluate their pricing, but their entire business strategy. While this process continues, the medical malpractice insurance industry will remain in upheaval—a state of chaos.
Author's note: Due to the timeliness of the subject matter, several writers and groups have used quotations from this article. Although it is flattering when your work is cited as a reference, it is important that proper context be maintained. The chaos in the medical malpractice insurance marketplace has been created by a historically underpriced product. Premiums, along with investment income, have been inadequate to cover the claims costs and expenses insurance companies have incurred.
Insurance 101: If premiums are too low or if losses are too high, then insurers lose money. The end result is premiums must increase, losses must decrease, or the insurer will eventually cease operating. CK, July 2002
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