Actuary Counters Hunter On Med Mal Insurance Crisis

National Underwriter

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

More importantly, medical malpractice causes of action have changed, making doctors only a portion of the medical professionals universe now exposed to lawsuits.

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

Not only are physicians being sued, but so, too, are "allied healthcare providers" (practitioners other than those with M.D. licenses)--a trend consistent with managed cares philosophy that ancillary 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 malpractice exposure. (Nor is the increasingly adverse experience in nursing home liability included in the paid-loss figuresloss experience that a separate article could be written about.)

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

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

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

Mr. Hunter trends all historical average paid losses per doctor to 2001 cost levels using medical cost inflation indices. After adjusting for medical cost inflationnot medical malpractice cost inflation--he notes that the adjusted paid losses per doctor are stable, while written premiums per doctor are not.

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

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

Turning to the topic of medical malpractice insurers loss reserving practices, Mr. Hunter stated that "insurers jack up reserves as a way to justify price increases." Here is an alternative view of the situation:

Medical malpractice loss reserves were, in hindsight, redundant in the early 1990s because loss-cost trends were actually more favorable than insurers had expected. Resulting reserve takedowns--from 1992 through 1997--and the bull stock market were largely responsible for the success that many medical malpractice insurers enjoyed from 1990 though 1998. The resultant reserve releases and high investment yields subsidized deteriorating accident-year loss ratios to achieve profitable reported loss ratios.

The reserve well, however, ran dry during 1998, according to hindsight reserve estimates implied in a recent Morgan Stanley study on industry reserve deficiency. Given the current bear stock market and a Morgan Stanley estimated reserve deficiency of approximately 25 percent for medical malpractice liability as of year-end 2001, medical malpractice carriers had to raise rates to strengthen balance sheets.

We all know that we are in the hard market part of the insurance underwriting cycle. Cycles are nothing new in a highly competitive corporate America. The equally competitive property-casualty industry is no different.

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

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

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

An analysis of the last truly hard market illustrates this.

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

Actuaries, who are professionally proficient at estimating insurance costs and the inherent risks associated with those costs, do not generate market rates. In fact, the market rates at that time were cut to below marginal cost levels due to aggressive competition to gain market share.

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

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

While smaller firms, initially, have little impact, eventually customer loyalty to the big guys wanesand more firms aggressively seek market share by cutting prices. Market leaders finally react to market pressures or else risk considerable loss in market share. The situation finally results in profit declines for all insurers in the market.

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

But when the reserve well dried up around 1998, and the bear market started to weaken investment earnings, insurers previously engaged in competitive warfare seemed to raise rates in unison because all required balance sheet strengthening. This is notably where consumer activists like Mr. Hunter cried "foul."

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

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

It is a time for patience.

Before we criticize competition as being destructive, lets reconsider its advantages. Competition generates long-term prices that match marginal costs and encourages innovation.

Can the swings of the underwriting cycle be mitigated?

Sure. Regulatory rate laws virtually all dictate the standards that rates shall not be excessive, inadequate, nor unfairly discriminatory. 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 is virtually ignored during the highly competitive soft markets.

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

To conclude, I disagree with Mr. Hunter. There is an explosion in medical malpractice costs due to the changing characteristic of negligence, with lawsuits targeting healthcare providers for non-performance in addition to negligent performance.

While I agree that the current crisis is a consequence of the hardening of property-casualty markets and a function of an economic downturn, it is not due to industry-wide mismanagement.

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

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

Robert F. Wolf is a principal and consulting actuary for Mercer Consulting in Chicago. He also serves as the chair of the Casualty Actuarial 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 serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.