In looking at medical professional liability financial results, some people might say that pigs are indeed airborne.
Many industry observers expect overall 2008 property-casualty underwriting and investment performance to reflect significantly deteriorating results– separately and combined. In fact, insurance analysts at A.M. Best expect something approaching a 10 percent decline in surplus.
For its part, the medical professional liability line should be expected to share in some aspects of the deteriorating investment results, but early signals are that expectations for deteriorating underwriting results may not be realized.
It may seem odd to discuss medical professional liability as though it could have its own underwriting and investment results but, in substantial measure, it can. Because so much of the coverage is provided by companies that specialize in the business or by captives and self-insured programs, we can review both of these drivers of financial outcomes–something that can’t be done easily for most other lines of business.
In addition, medical liability coverage, because of its longer-than-average payout duration and the impact investment income has on its financial results and pricing, can be more significantly affected by the financial environment than other lines of business.
So, when do the pigs get involved and why are they flying?
Over the last 30 years or so, the expectation and reality for this coverage has been to lose money on underwriting and make it up on the predictable investment income. Today, however–and here come the pigs–lower investment returns have driven many insurers to price to make an underwriting profit.
Further, the underwriting results seem more stable than investment results over the last few years and, in several instances, they are covering investment losses–the reverse of the long-term history for this coverage.
UNDERWRITING IS KEY
From an underwriting standpoint, we began 2008 after two years of net combined ratios under 100, including an approximate 85 combined ratio for 2007. (Editor’s Note: The industry aggregate combined ratios for the med mal line were 90.6 in 2006 and 84.7 in 2008, according to results compiled by Highline Data, the data affiliate of National Underwriter.)
These are record lows.
In over 30 years of reporting medical professional liability as a separate line of business, combined ratios have been below 100 in only four other calendar years.
Preliminary summaries of 2008 annual statement data would suggest a potential further reduction in the combined ratio for 2008 of perhaps 3 to 5 points. These results are being driven by continued better-than-expected outcomes on prior-year losses, which have produced favorable reserve development in the current calendar year and which occur coincidental with the building momentum of downward pricing adjustments.
Although this is still a difficult claim environment, the favorable development reflects the fact that more is now known about changing circumstances as a result of tort reform legislation in some jurisdictions and the debate about it in others.
A few observations on this point:
o Lower claim frequency, an important factor in the improved results of the last few years, appears to have bottomed out and, in some jurisdictions, may be increasing slightly.
o There are reduced concerns about the likelihood that lower claim frequency could result in claims being of higher quality and therefore costing more because more claims close with indemnity payments. While more time is needed to fully resolve this concern, current results are benefiting from what is known so far.
o Claim severity levels appear to have stabilized coincidental with the timing of the tort reform actions and debate. The better-than-expected severity is making a contribution to improved results.
o Costs of defending claims, on the other hand, appear to be increasing more rapidly than claim payments. This development, however, has not outrun the positive developments.
INVESTMENT INCOME DROPS!
It’s clear that 2008 investment results will not be as favorable as prior years. The pre-tax investment gain from insurance operations (excluding investment income on surplus) was in the 17-18 percent range as a percentage of net earned premiums for the last two years–fairly good results despite the lower interest rate environment and weak equity returns.
Again, based on preliminary statement data, it is a good bet 2008 results will be half or less than the 2006/2007 results.
The poorer investment results come in two flavors–the “not-so-good tasting” and the “awful tasting.”
In the first category are the much lower interest rates available on fixed income instruments. New cash flows, maturing assets or reinvestment of interest income on existing assets all are being put into a market with very low yields.
The second category is the realized losses on sales of assets, particularly equities. Additionally, in a fairly new subcategory of “awful,” the impact of being forced to write-off nonperforming assets or to write-down assets whose values have fallen under certain circumstances (e.g., value fallen by some percentage for a specified period of time) or due to some other variation of mark-to-market. All of these combine to produce a lower and more volatile investment income contribution to operating results.
These results are reasonably visible for medical professional liability specialty carriers because they must report their financial results in statutory annual statement detail. They may be less visible for other entities funding for med mal exposures, like specialty captives and self-insured programs–many of which discount funded amounts to reflect expectations of investment earnings between the time of an event, report and disposition of a claim.
These entities will be dealing with the issue of funding more dollars to cover the reduction in future investment return expectations and the already realized losses to current funded amounts.
In summary, it is business “unusual.” Expectations of the economic drivers have been turned upside down. Who would have thought 2008 underwriting results would outperform, and even carry, investment results?
Clear the flight pattern, the pigs are airborne!
So what’s next?
Well, we should not have expected that frequency would continue to decline indefinitely–and it definitely has not. The big question from this perspective is whether it will stabilize or move back up. If it goes up, will it be to longer term historic levels or somewhere between current lower levels and higher historic levels?
Claim severity trends have been modest over the last several years and one might reasonably ask whether that will continue. A low economic inflationary environment has helped, but given the current circumstances, will that continue as well?
A potentially constraining factor is the predominant $1 million limit on physician-purchased insurance, but one might expect an increasing number of excess of policy limit claim awards as a consequence.
Regarding defense costs, while insurers and self-insurers struggle with managing the increasing costs of defending claims, these efforts must be balanced with the obligation to provide an appropriate defense and the tradeoff between money spent on indemnity and expense.
In addition, we should keep a watchful eye on enacted tort reforms to see whether they withstand court challenges. There have already been challenges in a few jurisdictions. With the change in the political landscape, some would argue there is a greater likelihood of tort legislation being overturned.
On the investment side, it is not clear that all the bad news has been identified and recorded. The stock market movements in the first quarter, along with the continuing downward pressure on other assets, may require further write-downs of assets during 2009. If true, this will set the stage for another year of poor investment results.
Finally, and least understood, is the impact a national health care program might have on coverage.
Stay tuned; the pigs will have to land sometime!
James D. Hurley is a consulting actuary for Towers Perrin in Atlanta, Ga. He is also an Associate of the Casualty Actuarial Society and a Member of the American Academy of Actuaries. He may be reached at email@example.com.