The recent medical liability insurance crisis is oftentimesreferred to as the market's third crisis in the past 30 years.

This latest crisis has resulted in a number of long-establishedinsurance companies exiting the medical malpractice market eitherthrough voluntary withdrawal or state mandated orders. Thosecompanies that have remained in the market have either institutedsignificant rate increases, placed moratoriums on new businessactivity in response to capacity constraints, taken a morerestrictive position with respect to underwriting certain risks, orsome combination thereof. The result of this activity is that inmany markets there are fewer insurance companies providing morerestrictive coverage at much higher prices than in the past.

In response, as with the prior two medical liability insurancecrises, a number of new medical malpractice insurance vehicles havebeen formed.

Identification of start-up companies

According to a compilation of 2004 statutory annual statementinformation, there were nearly 300 insurance companies nationwidethat wrote medical malpractice premium. The total amount of directwritten medical malpractice premium for these companies approached$12 billion. Of these companies, we identified 90 of them, ornearly one-third, as having begun operations since 2002.

The screening process we employed was to identify all companiesthat wrote any amount of direct written medical malpractice premiumin 2004 and had a year of commencement of 2002 or subsequent. Wemade one exception to our composite of these start-up companies,which was to exclude one company that began operations in 2002since this company was created by essentially the same managementas a previous company that went into voluntary runoff andsubsequently was placed into rehabilitation by the domiciliaryinsurance department.

Out of these 90 new start-up companies, approximately 85 percentof them commenced operations after 2002 (Chart A).

Market penetration

While the average size of these start-up companies is muchsmaller than the established market, collectively, they accountedfor almost $700 million dollars, or roughly 6 percent of thecountrywide market. (The 90 companies wrote direct premiums of$662.6 million, or 6 percent of the $11.8 billion in premiumswritten by the market as a whole in 2004. The overall marketconsisted of 295 companies.)

Even though on a countrywide basis the aggregate market share ofthese start-up companies may not be significant, on an individualstate level the market penetration of these start-up companies isquite disparate, ranging from 0 percent to over 55 percent.

Chart B illustrates the percent of the market written by thestart-up companies by state for the top 10 states in terms ofmarket penetration. As this chart demonstrates, when discussing thepotential impact of start-up companies in the medical malpracticemarket, it is important to realize that the impact will varygreatly by state.

In reviewing the list of states identified above, it is notsurprising that many of these states have been identified as thosewith some form of market availability issue, whether it be thevoluntary withdrawal or financial failure or restriction on newbusiness writings by a major insurer in the state.

Published financial results

The published financial results to date for these start-upmedical malpractice insurance companies compare favorably to thoseof the established medical malpractice specialty insurancecompanies composite.

We have defined the established medical malpractice specialtyinsurance companies composite as those companies that writeprimarily medical malpractice insurance. For 2004, almost 98percent of their written premiums were for medical malpracticeliability coverage. The general profile of these establishedcompanies is that they are health care provider-owned and/orgoverned companies.

For reference, the established-company composite we havedeveloped is characterized as follows: 49 companies with statutoryassets of $29.1 billion as of Dec. 31, 2004, statutory surplus of$6.6 billion, and 2004 direct written premiums of $6.6 billion.

Many of the start-ups have also been created by doctor orhospital groups. Over half are risk retention groups, and all butone write 70 percent or more of their business in the medicalmalpractice line (with more roughly three-quarters of them writingmedical malpractice exclusively).

With respect to overall underwriting results, the start-upcompanies' published financial results displayed a 2004 combinedratio approximately 27 points better than the established medicalmalpractice insurance company composite (Chart C).

This significant disparity in underwriting results becomessmaller once the investment results are considered. The differencebetween the published operating ratio of the start-up companies andthe established medical malpractice insurance company composite isonly approximately 9 points for 2004.

The established companies' 18-point advantage on investmentresults is largely the result of differences in the balance sheetleverage between the two groups of companies. Specifically, theestablished companies' aggregate balance sheet shows a greaterratio of invested assets to earned premiums, which is expectedgiven the relative immaturity of the start-up companies and hencefewer years worth of reserves for unpaid claim liabilities and thecorresponding assets on their balance sheet. In addition, thestart-up companies as of year-end 2004 held a significantly greatershare of assets in short-term investments and cash, in order tosupport start-up operating cash flow needs.

Finally, as respects capitalization levels, we have found thatthe National Association of Insurance Commissioners' risk-basedcapital ratios for the start-up companies are comparable to thoseof the established medical malpractice insurance company composite.As of Dec. 31, 2004, the start-up companies' aggregate RBC ratiowas approximately 500 percent, whereas the established medicalmalpractice insurance company composite aggregate RBC ratio wasabout 445 percent.

It is important to note that all of the financial comparisonsshown above have been assembled by referencing each company'spublished statutory financial statement as of year-end 2004. Whilewe are not commenting on the reasonableness of the publishedresults to date for the start-up companies, it is fair to say thatthere exists more uncertainty in the results for these start-upcompanies given the long-tailed nature of the medical malpracticeline of business in conjunction with the limited experience ofthese start-up companies. To the extent that companies ultimatelyrequire changes to their year-end 2004 loss reserve estimates,future earnings and capitalization levels will be impacted.

Future impact on med mal market

These start-up companies, by their very definition, are in theearly stages of maturation, and as such their premium writing andmarket share may continue to grow. Although it is difficult topredict how these new companies will affect future medicalmalpractice insurance market conditions, it is clear that theimpact could be significant in many states and perhapsnationally.

While the published results to date are solid in the aggregate,it is the long-term results that are most important. This long-termsuccess will depend on their ability to maintain sound operatingprinciples, which include efficient operations, realistic anddisciplined pricing targets, discriminate underwriting, effectiveclaims handling, and stable reserving practices.

Ultimately, we expect that a number of these start-up companieswill continue to be a significant presence in a certain number ofstates and at some point in the future become part of the so-calledestablished market. Unfortunately, there are likely to be othersthat will encounter financial difficulties as a result of failingto maintain one or more of the sound operating principles. Thesefinancial difficulties may result in another disruption for theestablished market to cope with and manage.

Chad C. Karls, FCAS, MAAA, is a principal and consulting actuaryfor Milliman Inc. in the Milwaukee office. Charles W. Mitchell,FCAS, MAAA, is an actuary for Milliman, also in the Milwaukeeoffice.

Flag: Med Mal Toddlers

Chart A: Start-Ups By Year of Commencement

Out of 90 new med mal start-up companies, roughly 85 percent areless than three years old.

Source: Milliman analysis using NAIC Annual Statement Databasevia National Underwriter Insurance Data Services/Highline Data

Flag: Market Penetration

Chart B: Start-Up Market Share By State

The impact of start-up companies varies greatly by state. In sixstates, these new companies make up more than one-fifth of the medmal market.

Source: Milliman analysis using NAIC Annual Statement Databasevia National Underwriter Insurance Data Services/Highline Data

Flag: Advantage Start-Ups?

Chart C: Combined Ratio After Policyholder Dividends–CalendarYear Results

The 2004 combined ratio for start-up companies' was roughly 27points better than the overall combined ratio for established medmal insurers.

Source: Milliman analysis using NAIC Annual Statement Databasevia National Underwriter Insurance Data Services/Highline Data

Flag: Gap Shrinks

Chart D: Operating Ratio–Calendar Year Results

A significant disparity in results shrinks once investmentresults are added to underwriting results. The difference betweenthe published operating ratio of the start-up companies and theestablished medical malpractice insurance company composite wasonly 9 points for 2004.

Source: Milliman analysis using NAIC Annual Statement Databasevia National Underwriter Insurance Data Services/Highline Data