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

This latest crisis has resulted in a number of long-established insurance companies exiting the medical malpractice market either through voluntary withdrawal or state mandated orders. Those companies that have remained in the market have either instituted significant rate increases, placed moratoriums on new business activity in response to capacity constraints, taken a more restrictive position with respect to underwriting certain risks, or some combination thereof. The result of this activity is that in many markets there are fewer insurance companies providing more restrictive coverage at much higher prices than in the past.

In response, as with the prior two medical liability insurance crises, a number of new medical malpractice insurance vehicles have been formed.

Identification of start-up companies

According to a compilation of 2004 statutory annual statement information, there were nearly 300 insurance companies nationwide that wrote medical malpractice premium. The total amount of direct written medical malpractice premium for these companies approached $12 billion. Of these companies, we identified 90 of them, or nearly one-third, as having begun operations since 2002.

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

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

Market penetration

While the average size of these start-up companies is much smaller than the established market, collectively, they accounted for almost $700 million dollars, or roughly 6 percent of the countrywide market. (The 90 companies wrote direct premiums of $662.6 million, or 6 percent of the $11.8 billion in premiums written by the market as a whole in 2004. The overall market consisted of 295 companies.)

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

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

In reviewing the list of states identified above, it is not surprising that many of these states have been identified as those with some form of market availability issue, whether it be the voluntary withdrawal or financial failure or restriction on new business writings by a major insurer in the state.

Published financial results

The published financial results to date for these start-up medical malpractice insurance companies compare favorably to those of the established medical malpractice specialty insurance companies composite.

We have defined the established medical malpractice specialty insurance companies composite as those companies that write primarily medical malpractice insurance. For 2004, almost 98 percent of their written premiums were for medical malpractice liability coverage. The general profile of these established companies is that they are health care provider-owned and/or governed companies.

For reference, the established-company composite we have developed is characterized as follows: 49 companies with statutory assets 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 or hospital groups. Over half are risk retention groups, and all but one write 70 percent or more of their business in the medical malpractice line (with more roughly three-quarters of them writing medical malpractice exclusively).

With respect to overall underwriting results, the start-up companies' published financial results displayed a 2004 combined ratio approximately 27 points better than the established medical malpractice insurance company composite (Chart C).

This significant disparity in underwriting results becomes smaller once the investment results are considered. The difference between the published operating ratio of the start-up companies and the established medical malpractice insurance company composite is only approximately 9 points for 2004.

The established companies' 18-point advantage on investment results is largely the result of differences in the balance sheet leverage between the two groups of companies. Specifically, the established companies' aggregate balance sheet shows a greater ratio of invested assets to earned premiums, which is expected given the relative immaturity of the start-up companies and hence fewer years worth of reserves for unpaid claim liabilities and the corresponding assets on their balance sheet. In addition, the start-up companies as of year-end 2004 held a significantly greater share of assets in short-term investments and cash, in order to support start-up operating cash flow needs.

Finally, as respects capitalization levels, we have found that the National Association of Insurance Commissioners' risk-based capital ratios for the start-up companies are comparable to those of the established medical malpractice insurance company composite. As of Dec. 31, 2004, the start-up companies' aggregate RBC ratio was approximately 500 percent, whereas the established medical malpractice insurance company composite aggregate RBC ratio was about 445 percent.

It is important to note that all of the financial comparisons shown above have been assembled by referencing each company's published statutory financial statement as of year-end 2004. While we are not commenting on the reasonableness of the published results to date for the start-up companies, it is fair to say that there exists more uncertainty in the results for these start-up companies given the long-tailed nature of the medical malpractice line of business in conjunction with the limited experience of these start-up companies. To the extent that companies ultimately require 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 the early stages of maturation, and as such their premium writing and market share may continue to grow. Although it is difficult to predict how these new companies will affect future medical malpractice insurance market conditions, it is clear that the impact could be significant in many states and perhaps nationally.

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

Ultimately, we expect that a number of these start-up companies will continue to be a significant presence in a certain number of states and at some point in the future become part of the so-called established market. Unfortunately, there are likely to be others that will encounter financial difficulties as a result of failing to maintain one or more of the sound operating principles. These financial difficulties may result in another disruption for the established market to cope with and manage.

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

Flag: Med Mal Toddlers

Chart A: Start-Ups By Year of Commencement

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

Source: Milliman analysis using NAIC Annual Statement Database via 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 six states, these new companies make up more than one-fifth of the med mal market.

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

Flag: Advantage Start-Ups?

Chart C: Combined Ratio After Policyholder Dividends–Calendar Year Results

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

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

Flag: Gap Shrinks

Chart D: Operating Ratio–Calendar Year Results

A significant disparity in results shrinks once investment results are added to underwriting results. The difference between the published operating ratio of the start-up companies and the established medical malpractice insurance company composite was only 9 points for 2004.

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

Special Reports /

The Third Generation: Start-up Medical Malpractice Companies

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