The Governmental Accounting Office (GAO) recently completed an extensive study of the medical malpractice insurance industry and the factors that have caused premium rates to increase. The study found this business line to be unprofitable mainly on account of a persistent upward trend in claims costs. Due to its thoroughness and the lack of bias of its authors, the GAO report should be the basis for discussion on issues effecting medical malpractice insurance, including tort reform.
Anyone seeking a comprehensive, insightful, and impartial discussion of medical malpractice insurance can find it by simply contacting the federal government. This is not sarcasm, but true! The General Accounting Office (GAO), the audit, evaluation, and investigative arm of Congress prepared perhaps the best analysis that has recently been done of the factors influencing medical malpractice insurance. The report issued on June 29, 2003, GAO-03-702, "Medical Malpractice Insurance: Multiple Factors Have Contributed to Increased Premium Rates," focuses exclusively on physician medical malpractice insurance; it does not address liability insurance for hospitals and nursing homes.
It is regrettable that this excellent research has received such little fanfare or publicity. Senator Richard Durbin (D-IL) along with eight Democratic congressmen, including Representatives John Conyers (D-MI) and John Dingell (D-MI) requested the GAO conduct a study on why medical malpractice insurance rates increased so much in the past few years and what, if anything should be done in response.
The report, the result of over a year of research, concludes that multiple factors contribute to the rise in rates, but the chief culprit is increased losses. Perhaps because the GAO did not conclude that insurance company mismanagement, malfeasance, or misconduct caused the current medical malpractice insurance problems and the agency did not make significant recommendations for alleviating the problems, the study's sponsors felt it did not merit further attention. Unfortunately the media has not publicized the GAO findings widely, even as debate about tort reform amplifies and the need for unbiased information increases.
In studying the rather complicated subject of medical malpractice insurance, the GAO selected a sample of seven states, California, Florida, Minnesota, Nevada, Pennsylvania, Mississippi, and Texas, for in-depth review. These states represent a valid mix of locations that are considered in "crisis," have had a rapid rise in premium rates and/or have non-economic damage caps.
As part of its research the GAO interviewed insurance regulators, medical malpractice insurers, actuaries, consumer advocates, medical professionals, and trial attorneys. Data provided by insurance companies, state insurance departments, the National Association of Insurance Commissioners (NAIC), and A.M. Best Co. was also evaluated. In its assessment of premiums, the GAO focused on base rates charged to three medical specialties—internal medicine, general surgery, and obstetrics/gynecology. Rates examined were for one of the most common policies purchased, a mature claims-made policy with coverage limits of $1 million each event and $3 million in the aggregate.
As the title indicates, multiple factors have contributed to increased medical malpractice insurance rates for physicians, but the principal contributor has been the rapid growth in insurers' losses from claims. Claim losses include not only the settlements and judgments paid by carriers to the claimants on behalf of their physician-insureds, but also most of the expenses incurred in the defense of a claim.
The swift rise in loss costs has become more pronounced since 1998. After adjusting for inflation, the GAO found paid losses rose approximately 3.0 percent annually from 1988 to 1997, but rose 8.2 percent annually from 1998 to 2001. The trend for incurred losses was even harsher: from 1988 to 1997, incurred losses rose approximately 3.7 percent annually, but from 1998 to 2001 the annual increase was 18.7 percent.
Interestingly, the GAO found wide disparities in rates of increases among the seven states, with some states experiencing significantly higher increases in losses than others. For example, during the period 1998 to 2001, paid losses in Pennsylvania and Mississippi rose approximately 76.9 and 142.1 percent, respectively, while paid losses during the same period in California and Minnesota increased only 38.7 and 8.7 percent, respectively. Thus, it is not really surprising that Pennsylvania and Mississippi physicians are having more difficulty finding affordable insurance coverage than are their peers in Minnesota and California.
Incurred losses are the largest cost component for medical malpractice insurers. The GAO examined the 15 largest insurers of medical malpractice coverage for 2001 and found incurred losses, including payments to claimants and the expenses associated with defending claims, comprised around 78 percent of the insurers' total costs. Since insurance companies calculate their premium rates based on their expected costs, anticipated losses are the key determinant of premium rates.
Another factor that has created an upward spiral in pricing is the decrease in investment income experienced by medical malpractice insurers. Generally, insurers are required by state insurance regulators to reflect expected investment income in their premium rate calculations, so bad investment performance will put upward pressure on rates. The fall in investment returns suffered by insurance companies over the past 3 to 4 years is a circumstance that has been poorly understood and explained. A number of commentators attribute the decline in insurance company investment income to equities, mention the stock market bust, and then point to the Dow Jones Index as evidence.
In actuality, state laws restrict medical malpractice insurers to conservative investments, primarily bonds. On average, the 15 largest writers of this insurance had about 79 percent of their assets invested in bonds, usually a combination of U.S. Treasury, municipal, and corporate bonds. Yields on bonds have certainly dropped over the past couple of years, but according to the GAO, declines in investment returns have probably caused premium rates to increase just 7.2 percent from 2000 to 2002. Thus, the decline in investment income has had only a modest influence on premium rates, far less than the adverse claim payment trend.
Almost all medical malpractice insurers purchase reinsurance to protect themselves against large, unpredictable losses. This is particularly true of the smaller physician-controlled insurers who are typically members of the Physician Insurers Association of America (PIAA), and sometimes warmly referred to as "bedpan mutuals." The GAO found physician-owned insurers now cover about 60 percent of the marketplace. These insurers depend significantly on reinsurance to help stabilize their income statements and cash flow since a few large claims will have a measurable impact on their surplus.
Reinsurance costs incurred by medical malpractice insurers have noticeably risen the past couple of years. The GAO identifies two reasons: (1) overall reinsurance rates have increased as a result of reinsurers' losses from the September 11, 2001, terrorist attacks, and (2) reinsurers have seen higher losses from medical malpractice than other lines of insurance and are raising their rates to compensate for the increased risk associated with medical malpractice. Accordingly, medical malpractice insurers are passing along these higher reinsurance costs to their physician-insureds.
The GAO report confirms that since 1999, the profitability of the medical malpractice insurance market as a whole has declined. This has occurred even in an environment of rising premium rates. The effect on insurance companies has been pronounced as depicted in Figure 7 from the GAO report. Profitability declines have caused a number of insurance companies to exit the marketplace, which in turn reduces the competition and minimizes any downward pressure on premium rates. The negative trend in profitability has occurred in all of the states studied by the GAO, however, it is less evident in California, which helps explain why California premium rates have not been as volatile as other states.
Scarcity of Data
A continuing source of frustration to anyone wishing to do an in-depth analysis of medical malpractice claims frequency and claims severity patterns is the lack of comprehensive claims data. The GAO experienced this during its research. Data submitted by insurers to the NAIC regarding number of claims is not broken out by state, and the NAIC only began collecting data measuring case severity in 2000.
Furthermore, assuming insurers actually track their losses to identify the amount of payments attributable to settlements versus judgments, and non-economic damages versus economic damages, this data is not provided to the NAIC or state insurance departments. The GAO fittingly observed that comprehensive information is vital to effectively study losses and for a better understanding of the causes of increased premium rates.
In fact, the only recommendation made in the GAO report is to have Congress consider encouraging the NAIC and state insurance regulators to identify and collect additional data necessary to evaluate the frequency, severity, and causes of losses on medical malpractice claims.
The General Accounting Office recently completed an extensive study of the medical malpractice insurance industry and the factors that have caused premium rates to increase. The study found this business line to be unprofitable mainly on account of a persistent upward trend in claims costs. Due to its thoroughness and the lack of bias of its authors, the GAO report should be the basis for discussion on issues effecting medical malpractice insurance, including tort reform. The only action the GAO recommends is a implementing a better process for gathering data necessary to evaluate the medical malpractice market.
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