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Articles
Changing Times - State of the Medical Professional Liability Market
After more than a dozen years of unabated softening in the insurance market, the first signs of a shift in
underwriting philosophy emerged in late 1999 as some segments of the market found the floor on the pricing of their
products. During the final quarter of 2000, the shift that began in 1999 materialized in earnest.
As in most market shifts, the trend began in the reinsurance marketplace and then naturally spread to the primary
market. Unlike the market that transformed dramatically upon the almost overnight erosion of capacity in the
mid-1980s, today's insurance/reinsurance market is well capitalized, but is earning far too little on that capital.
Consequently, as 2000 drew to a close, we witnessed a market correction that appeared to be seeking equilibrium,
not revenge. The current shift, rather than being nearly across the board in previous cycles, is more dramatic or
less dramatic, depending on the segment of the market.
The key difference between this market firming and the radical hardening of the market in the last cycle of more
than a decade ago, is capacity. The prolonged halcyon period in the economy of the 1990s removed the cyclicality of
investment results that would otherwise have rippled through the insurance industry. In previous cycles, slowing
results in investment income had been a warning bell signaling the need for more disciplined under-writing. Absent
that wake-up call, insurers continued to liberalize their underwriting, offering greater coverage at increasingly
lower rates. Higher investment returns gave insurers both the incentive to seek market share and a greater cushion
to tolerate poorer underwriting results in that process.
Now the pressures of underwriting losses have severely stretched the financial tolerances of the industry. This
time, however, the balloon is not bursting; instead, the pressure is being valved out. Thanks to a sustaining
economy, underwriting losses have not single-handedly threatened the financial viability of most insurers' ongoing
operations. As long as the economy remains strong, rather than over-reacting, insurers and reinsurers can seek to
rectify their underwriting losses in a "market correction" as opposed to a "market panic." If, however, the economy
should slow down in 2001, it could have a significant impact on the industry's underwriting position.
Although the economy remained strong in 1999 and 2000, stress in the Medical Professional Liability (MPL)
marketplace is becoming apparent. Several factors have contributed to the pressure being felt by MPL insurers.
MPL insurers enjoyed a strong capital position during most of the 1990s, largely the result of the bullish stock
market. While the economy is still strong, growth in equities markets has been slower in recent years. Many MPL
insurers are heavily invested in equities, relying on investment yields to offset underwriting losses. If unable
to rely on strong market performance, insurers must focus on improving their underwriting results.
Disparity in Calendar Year vs. Accident Year Losses
A widely accepted indicator of underwriting results is the combined ratio- the sum of an insurer's calendar year
loss ratio and its expense ratio. For the last several years, the MPL combined ratio has been in the range of 110%
to 115% percent. In the current economic environment, many companies can be profitable at a 115% combined ratio.
However, in order to truly gauge its underwriting results, a company must account for losses and exposures on an accident year, not a calendar
year basis. This means that losses are attributed to the policy year in which they occurred. Unfortunately, the MPL
accident year combined ratio is currently indicated at between 135% and 140%, instead of the more manageable
calendar year combined of 100% to 115%.
Reserve releases - reducing loss reserves when it is known they will not be needed to pay claims- allow insurers to
offset lower prices and continue to report operating profits. In the 1990s, reserve development had a positive
impact on calendar year combined ratios, as companies were able to reduce their estimates of future loss payouts on
prior years' claims. Many MPL insurers were able to rely on reserve releases to offset the negative effects of
geographic growth, especially when such growth was accomplished through reduced prices and liberal underwriting.
Aggressive pricing will eventually erode an insurer's loss reserves, putting more emphasis on profit margins.
Industry Based on preliminary information received from insurers, A.M. Best estimates the medical professional
liability combined ratio for 1999 will be 131.5%, compared to a combined U.S industry ratio of slightly more than
107%. Combined ratios in 1998 were 115.7% MPL vs. 105.6% for the remainder of the industry. While it is typical for
the MPL combined to exceed that of other industry players, the gap is widening.
Increasing Claim Severity
While claim frequency has remained steady for the past several years, claim severity has surfaced as the most
troubling issue facing the MPL marketplace. The latest PIAA Claim Trend Analysis shows that in the five-year period
between 1994 and 1999, the average medical professional indemnity payment increased 38%. Jury Verdict Research's
1999 study shows the median medical professional award as increasing 100% over a seven-year period, with a 60% jump
in the two years from 1996 to 1998.
Not included in this study are twelve jury verdicts in 1999 and 2000 in the city of Philadelphia totaling more than
$258 million, an average of more than $20 million per verdict returned. Three Texas awards in the same time period
totaled $167.5 million. In June of last year, a Cook County jury awarded a record $55 million to a woman who
suffered brain damage in a Chicago-area hospital. And the state of Ohio recorded a $17 million medical malpractice
verdict in 1999, its largest award ever. While many judgments are reduced on appeal, it goes without saying that
awards such as these raise the floor for many cases that may or may not end up in front of a jury.
A number of societal factors seem to be driving the alarming rise in claim severity, including the managed care
backlash, an increasing public desensitization to large numbers, and increased focus by the media on large
malpractice awards. Factors during trial that contribute to excessive awards include more creative plaintiff
attorneys with more money to spend on preparing the case; more convincing plaintiff experts; detailed damages
presentations that often go undisputed by defense counsel; cases made difficult to defend due to altered or missing
medical records or poor documentation; and finger pointing among defendants.
In addition, the 1999 Institutes of Medicine (IOM) report brought medical errors to the attention of the public.
IOM reported that more people die each year from medical errors than from highway accidents, breast cancer or AIDS,
with estimates between 44,000 and 98,000 annually. The public has begun to more strongly question the quality of
medical care they or their loved ones receive, believing that someone must always be to blame in the event of a
poor outcome. Beginning on July 1, 2001, the Joint Commission on Accreditation of Healthcare Organizations (JCAHO)
safety and medication-error standard will require hospitals to inform patients and their families whenever results
of care differ significantly from anticipated outcomes. Time will tell the impact, if any, of this standard on
future claim severity.
There has been no significant medical malpractice tort reform for a number of years, and damage caps continue to be
challenged in several states. Caps were challenged most recently in California (the damage cap held) and Nebraska
(a trial court struck down Nebraska's $1.25 million cap in June of 2000; the case is currently under appeal).
Continuing erosion of the Employee Retirement Income Security Act (ERISA) preemption for managed care organizations
and creative allegations by plaintiff attorneys also contribute to the potential that a provider or organization
will experience a severe medical malpractice or managed care liability jury award.
Loss Adjustment Expense as an Increasing Percentage of Claim Costs
According to Best's Aggregates and Averages, the ratio of MPL loss adjustment expense to loss has increased from
30% in 1992 to 38% in 1998. While the PIAA reported an increase in indemnity payments of nearly 48% over the past
decade, its members' average defense costs nearly doubled. As MPL cases become more difficult to investigate and
defend, additional pressure is mounting on already strained combined ratios.
A Changing Reinsurance Market
Wayne deNazarie, Managing Director-Healthcare, Aon Reinsurance, verifies a firming in the MPL reinsurance
marketplace, as frequency continues and severity loss trends move upwards. However, Mr. DeNazarie reports strong
and stable reinsurance remains for most MPL insurers, and the vast majority of PIAA companies have been able to
maintain their long-standing relationships in the domestic and European reinsurance markets. While capacity is not
yet a problem, the hardening of reinsurance prices will have a significant impact on pricing in the primary
insurance market.
The MPL market has definitely entered a phase of more disciplined underwriting and pricing. This discipline has
taken different forms, depending on the market segment.
Physician Professional Liability
Over the past 36 months, there have been a number of carrier mergers in response to the need for additional
capital. Other carriers have simply failed?- most notably PIE in Ohio and PIC in Pennsylvania. The majority of
physician insurers are experiencing underwriting losses. Publicly traded PIAA companies have been particularly
hit with pressure on earnings and deflated stock prices. Larger commercial insurers have been forced to reexamine
their position on this line of business as their loss ratios and pure rate inadequacies have steadily grown. Some
insurers have completely withdrawn from certain areas of the market (such as specific states or classes of business),
while others have substantially increased pricing and adjusted rates in certain classes. Many carriers are now
willing to lose business rather than compete by lowering prices any further. Single-state insurers have been more
likely to hold the line on rate increases, but may also be more vulnerable financially as they have no other
business that can shore up deteriorating results.
Financial strength of a carrier is increasingly important as this market changes, and those carriers who are not
strategically or financially positioned may run into difficulties over the next several months.
The PIAA 1998 Claim Trend Analysis reports that 64.3% of medical malpractice claims originate in the acute care
setting. Many members of the public believe that hospitals are responsible for the actions of all medical
professionals who practice on the premises, regardless of whether or not they are employees. Hospitals and
integrated delivery systems continue to be the defendants with the deepest pockets in most malpractice cases, and
often remain the sole defendant in severe-injury cases after other parties have tendered their limits. As the
number of catastrophic verdicts grows in an increasing number of venues, costs of investigating and preparing cases
for trial are growing dramatically, along with settlement values. Carriers agree that their ability to manage claim
severity in this litigation climate is severely compromised.
Insurers are responding to increasing severity trends and combined ratios by raising both premiums and
policyholders' retentions. Some coverage enhancements are being withdrawn at program renewal, and multi-year
programs are generally unavailable. Underwriters are being more selective in entertaining new risks. While a few
minor players have withdrawn from the market, capacity is still plentiful. However, some carriers reduced limits
on selected renewals in the fourth quarter of 2000.
Long Term Care
Providers of long term care, specifically nursing homes, were the first to see availability and affordability
problems with liability coverage. Increases in frequency and severity of claims in this industry have outpaced
those of other providers. In recent years, residents in nursing facilities have experienced increased levels of
acuity. A contributing factor to long term care loss deterioration has been the increased emphasis on litigation
in states with broad residents' rights legislation. Non-economic and punitive damage caps that apply to medical
malpractice or other personal injury awards may not apply to claims falling under residents' rights acts. Often,
attorney fees are not tied to award amounts, making it particularly lucrative for attorneys to run up sizeable fees
when pursuing these cases.
Unlike other healthcare industry segments, long term care liability is clearly in crisis. The few insurers that
remain in this market have taken an extremely conservative approach, with rate increases of several hundred percent
on some renewals. Retentions have also increased significantly for this market segment, and many insurers have
changed to claims-made coverage, at little or no discount from occurrence rates.
Managed care loss experience continues to be closely tracked by the marketplace. Rates for this coverage have
typically been lower than in other industry segments, and both frequency and severity of claims have increased
as this industry continues to suffer the effects of a public backlash against its business practices.
The United States Supreme Court decision in Pegram vs. Herdrich, upholding the right of Managed Care Organizations
(MCOs) to offer financial incentives to physicians to hold down costs, was considered a major win by the industry.
The decision, however, also created a new category of lawsuit involving mixed-eligibility and treatment decisions.
In the past, claims for injury from negligent treatment could be brought against providers in state court, while
claims for eligibility decisions made by the MCO were remanded to federal court under ERISA. For cases falling
into this new category, there may be no ERISA preemption, allowing lawsuits against the MCO to be brought in state
court.
At the beginning of this year, the status of several class action lawsuits against MCOs alleging violation of the
Racketeer Influenced and Corrupt Organizations (RICO) law is still unknown. In August 2000, the decision to dismiss
one such suit against Aetna U.S. Healthcare was upheld in federal court. Most remaining cases have been
consolidated before a single federal judge in Miami, who will determine whether the suits can survive defendants'
preliminary.
In June 2000, a federal appellate court upheld a Texas law that lets patients sue MCOs for malpractice for injury
claimed as a result of an organization's utilization review process. Several other states have passed similar laws.
While federal patients' rights legislation efforts have been unsuccessful to date, experts predict the ERISA
preemption will not continue to survive. If the right of members to sue their health plans in state court becomes
law, the insurance marketplace will be watching closely, ready to respond if the floodgates of litigation are
opened. A market in which there were few players to begin with could quickly erode.
We expect that the MPL marketplace will continue to harden throughout 2001, as carriers seek rate increases, and
capacity is withdrawn from some areas. The renewal process for healthcare providers should be one of careful
planning and negotiation. Larger organizations should be prepared to assume more risk as carriers seek to smooth
the effects of more frequent catastrophic awards and return to underwriting profitability. And finally, providers
should be vigilant in their pursuit of relationships with insurers who have the financial stability to be there
when it matters most- when it comes time to pay a claim.
While conducting research for "Changing Times-State of the Medical Professional Liability Market," the Aon
Healthcare Alliance Market Council interviewed key executives from Aon's major medical professional liability
carriers. Following are some of their observations:
"There are definitely indications that the prolonged soft market for medical professional liability is at an end.
The high number of carrier failures, consolidations, and withdrawals/retrenchments in the past two years is a
telling sign of the relative inadequacy of recent price levels for this product line."
"Claims severity (particularly at the catastrophic level) has increased dramatically in recent years. As juries
continue to show no reluctance to award higher and higher judgments, the plaintiff's bar is becoming less inclined
to consider reasonable settlement."
"We have definitely seen an increase in the average severity of malpractice claims, especially in the large account
arena and, to a lesser degree, in the physicians' and surgeons' book of business. Rate increases are planned in
these two areas to more accurately reflect these emerging trends, and to also reflect increases being requested
by reinsurance markets for their capacity support."
"The marketplace is moving into a state of more equal balance between buyer and seller, with resultant improving
terms for underwriters. There is movement in all sectors and it's very hard, excluding long term care, to predict
which segment will be most affected."
"Change will be seen more in the physicians' arena this year, and very dramatically. We are seeing in our small
group physicians' book, and to some extent, the larger groups, a remarkable increase in frequency and some
severity. We are also noticing an earlier development pattern. There may be some very difficult times ahead for
certain physician specialties that are going through changes; e.g., neurology. We have seen an upturn in severity
for allegations such as failure to diagnose and failure to prevent stroke. These market positions are affecting the
specialties at the same time that physicians are being squeezed from the commercial side."
"The industry should expect to begin to see a flight to quality. The role for specialty insurers will become
increasingly diminished because larger risks can't take the chance of placing their programs with companies with
questionable financials."
"The tendency of markets to deviate heavily from filed, increased limits factors is coming to an end, as excess
premiums have proven woefully inadequate. Present pricing structures cannot support the dramatic upswing in
severity the market has experienced since the mid-1990s."
"Reprinted with permission from Aon Healthcare Alliance Healthline, February 2001, Vol. VIII, No.
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