Actuary Counters Hunter On Med Mal InsuranceCrisis

National Underwriter

Written premiums per doctor do not reflect rate differentials byspecialty. For example, if there is a change in the mix of businessby specialty, the average premium changes. In other words, everytime an obstetrician quits or changes his or her specialty, theaverage premium declines.

More importantly, medical malpractice causes of action havechanged, making doctors only a portion of the medical professionalsuniverse now exposed to lawsuits.

These days, lawsuits not only reflect a philosophy of negligencefor "committed acts," but also a negligence from "omitted acts"philosophy, with failure to diagnose and refusal to treatallegations becoming common. In particular, according to thePhysician Insurers Association of America, the failure to diagnosebreast cancer is now the leading cause of malpractice claims.

Not only are physicians being sued, but so, too, are "alliedhealthcare providers" (practitioners other than those with M.D.licenses)--a trend consistent with managed cares philosophy thatancillary providers be used as much as possible.

This increased exposure is not captured in the "number of doctors"statistic that Mr. Hunter uses to measure medical malpracticeexposure. (Nor is the increasingly adverse experience in nursinghome liability included in the paid-loss figuresloss experiencethat a separate article could be written about.)

If we adjust the denominator of the premium per doctor ratio forthis increased exposure, one can conclude an even more depressedaverage premium than shown in Mr. Hunters exhibit.

Also, the use of paid losses per doctor by Mr. Hunter mismatchesloss dollars with the corresponding premiums that are meant tocover those loss dollars.

Mr. Hunter admits that there is generally a 5-to-10 year lagbetween claim reporting and settlement. In other words, 1995premiums, on the average, are needed to pay 2001 settlements. And2001 premiums pay for 2006 settlements not on the graph.

Mr. Hunter trends all historical average paid losses per doctor to2001 cost levels using medical cost inflation indices. Afteradjusting for medical cost inflationnot medical malpracticecost inflation--he notes that the adjusted paid losses perdoctor are stable, while written premiums per doctor are not.

This is an erroneous statement, as all Mr. Hunter essentially isproving with this assertion is that medical malpractice paymentsper doctor have year-to-year fluctuations at least as large asmedical cost year-to-year fluctuations. By un-adjusting Mr. Huntersstatistics, one can find even more fluctuation in average paid perdoctor statistics than medical cost inflation fluctuations.

There is, indeed, an explosion in medial malpractice claimseverity. According to Jury Verdict Research in Horsham, Pa., themean medical malpractice jury verdict rose from roughly $2 millionin 1993 to more than $3.5 million in 1999.

Turning to the topic of medical malpractice insurers loss reservingpractices, Mr. Hunter stated that "insurers jack up reserves as away to justify price increases." Here is an alternative view of thesituation:

Medical malpractice loss reserves were, in hindsight, redundant inthe early 1990s because loss-cost trends were actually morefavorable than insurers had expected. Resulting reservetakedowns--from 1992 through 1997--and the bull stock market werelargely responsible for the success that many medical malpracticeinsurers enjoyed from 1990 though 1998. The resultant reservereleases and high investment yields subsidized deterioratingaccident-year loss ratios to achieve profitable reported lossratios.

The reserve well, however, ran dry during 1998, according tohindsight reserve estimates implied in a recent Morgan Stanleystudy on industry reserve deficiency. Given the current bear stockmarket and a Morgan Stanley estimated reserve deficiency ofapproximately 25 percent for medical malpractice liability as ofyear-end 2001, medical malpractice carriers had to raise rates tostrengthen balance sheets.

We all know that we are in the hard market part of the insuranceunderwriting cycle. Cycles are nothing new in a highly competitivecorporate America. The equally competitive property-casualtyindustry is no different.

While Economics 101 suggests that prices generally move towards anequilibrium in free markets via the mechanics of supply and demand,the underwriting cycle stems from the fact that the p-c industryis, on the contrary and through no fault of its own, in a constantstate of disequilibrium.

Unlike other industries, the costs for insurers generally becomeknown subsequent to the collection of revenue, in contrast to thewidget manufacturer that manages its revenue as a function of themarginal cost of producing that next widget.

Actuarial ratemaking is a moving target and, in the meantime, themarket is competitive. The p-c market is relatively easy to enter,lacks significant market concentration, and is one in which it isrelatively difficult to monitor competitor prices. These factorsdrive the underwriting cycle.

An analysis of the last truly hard market illustrates this.

Rates were below marginal costs between 1983 and 1985, primarily asa result of expanding tort laws in commercial liability exposures.Actuaries analyzing required rates and corresponding loss reserveswere in no way surprised by the resultant increasing loss-costtrends.

Actuaries, who are professionally proficient at estimatinginsurance costs and the inherent risks associated with those costs,do not generate market rates. In fact, the market rates at thattime were cut to below marginal cost levels due to aggressivecompetition to gain market share.

The subsequent rise in rates during 1985-86 started the most recentprofitable phase of the underwriting cycle, until now.

Profitable peaks of the underwriting cycle increase incentives forsmall firms to aggressively seek market share and for new firms toenter the industry to join the profitable bandwagon. As insurancedemand is relatively inelastic, the only way to increase marketshare is to take away from other carriers via price-cutting.

While smaller firms, initially, have little impact, eventuallycustomer loyalty to the big guys wanesand more firms aggressivelyseek market share by cutting prices. Market leaders finally reactto market pressures or else risk considerable loss in market share.The situation finally results in profit declines for all insurersin the market.

The combination of a bull stock market economy and reserveredundancies from the early 1990s prolonged the downward spiral ofthe last decade. As rates fell below marginal costs, the redundantloss reserves were released to offset inadequate rates.

But when the reserve well dried up around 1998, and the bear marketstarted to weaken investment earnings, insurers previously engagedin competitive warfare seemed to raise rates in unison because allrequired balance sheet strengthening. This is notably whereconsumer activists like Mr. Hunter cried "foul."

The bottom line is that there is no collusion here, noindustry-wide mismanagement. There are no intercompany agreements,no gentlemans agreements, and no compacts--just good old Americanapple-pie, free-enterprise competition.

We are at a time now when profits are rising, and should continueto rise. Balance sheets will strengthen. And the cycle will startanew with competition for market share that will inure to thebenefit of insurance consumers.

It is a time for patience.

Before we criticize competition as being destructive, letsreconsider its advantages. Competition generates long-term pricesthat match marginal costs and encourages innovation.

Can the swings of the underwriting cycle be mitigated?

Sure. Regulatory rate laws virtually all dictate the standards thatrates shall not be excessive, inadequate, nor unfairlydiscriminatory. An emphasis on the first and last standards,lobbied by consumer groups, always prevails during a hard market.But the standard dictating that rates should not be inadequate isvirtually ignored during the highly competitive soft markets.

To mitigate underwriting cycle swings, attention is needed at bothends of the cycle. Speaking from the standpoint of a consumer,advocates should welcome competition. The 1990s brought cheap ratesto many.

To conclude, I disagree with Mr. Hunter. There is an explosion inmedical malpractice costs due to the changing characteristic ofnegligence, with lawsuits targeting healthcare providers fornon-performance in addition to negligent performance.

While I agree that the current crisis is a consequence of thehardening of property-casualty markets and a function of aneconomic downturn, it is not due to industry-widemismanagement.

Let the companies strengthen their balance sheets so that themedical malpractice players can compete again.

Consumer advocates are to be commended for the work they do for thebenefit of consumer America. To truly mitigate price swings,however, they must speak out during cycle troughs as well as cyclepeaks.

Robert F. Wolf is a principal and consulting actuary for MercerConsulting in Chicago. He also serves as the chair of the CasualtyActuarial Societys Media Relations Committee.

Reproduced from National Underwriter Property &Casualty/Risk & Benefits Management Edition, November 11, 2002.Copyright 2002 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.