Med Mal: The Pain Before The Gain

Meanwhile, the shock waves are being felt far and wide, putting all med mal players–insureds, providers, courts, regulators and lawmakers–on notice that the past cannot be a model for the future. The year 2002 should be a pivotal one for the medical malpractice sector of the property-casualty industry.

Looking back, years of recognition of redundant reserves, fantastic equity and fixed income investment returns, cheap reinsurance, geographic growth initiatives, flat medical care costs, and seemingly benign liability loss trends prompted highly competitive pricing conditions for the med mal product.

Some time in the waning two or three years of the millennium, everything went into reverse: redundancies were depleted, prospective investment returns dropped, reinsurance rates began an upward creep, medical inflation resumed, and loss severities started rising.

While these conditions could be cited for nearly every p-c carrier, the long loss tail of the Medical Malpractice product compounds the impact of this reversal by the multiple accident years involved.

To date, nothing has changed with regard to these conditions, and loss severities are accelerating. One study, by Jury Verdict Research of Horsham, Pa., shows that median jury awards rose at a compound annual rate of 15 percent from 1995 to 2000, and 43 percent from 1999 to 2000.

The St. Pauls position in the sector was, in no uncertain terms, a major one. Using 2000 data, the company possessed a 9 percent nationwide market share– seemingly small in the aggregate. Yet an unraveling of the data reveals that The St. Paul was a top-two medical malpractice provider in 25 states nationally.

Given its national scope and penetration within certain states, The St. Pauls pullout is nothing short of seismic to the sector. One could suggest that this is reminiscent of the mass insurer exodus from southeast coastal exposures after Hurricane Andrew and the earthquake insurance crisis in California after the Northridge quake.

Perhaps more appropriately though, this is akin to the announcement by Berkshire-Hathaway of its Unicover-related losses through its own Cologne Life Re subsidiary in 1999. Such an "outing," relatively small in its financial impact to Berkshire, altogether busted the mass retrocessional hijinks then going on in the workers compensation sector.

Indeed St. Paul has prompted a similar reckoning in med mal. Given the adverse severity trends and general financial position of most medical malpractice carriers today, St. Pauls timing was deft–if not for itself, then for the med mal industry on the whole.

Now, "post-St. Paul," not a week goes by without news of another state legislative or regulatory body now intending to study their own medical malpractice situation.

Pennsylvania is currently the most storied situation. The state has been plagued by the collective impact of the insolvency of PHICO Insurance, poor underwriting results of the state-run Medical Professional Liability Catastrophe Loss Fund, and announced market departures by major players.

In response, a comprehensive reform bill was crafted after long negotiations between trial lawyers, doctors, hospitals and insurers. The bill attempts to halt the escalating costs of medical malpractice premiums for doctors and hospitals with measures aimed at improving patient safety, privatizing the state's Medical Professional Catastrophe Loss Fund over six years, and implementing medical tort reform.

To be sure, analyses from all quarters will come forth to predict this bills ultimate impact. In the meantime, we can be sure that private market insurers will be cautious to return to the scarred Pennsylvania marketplace, letting time define their compass and pace.

Beyond Pennsylvania, there is a rising din of concern among medical care providers, regulators and legislators regarding the escalating costs of medical malpractice insurance.

Most recently, the Washington State Insurance Commissioner has begun a rule-making process to help providers secure med mal coverages after a major clinic was nearly forced to close due to its inability to secure renewal coverages. Weve recently seen further examples of doctor and regulator unrest in Nevada, Texas, West Virginia and New Jersey. No doubt other states will follow.

On the other side of the equation, we estimate that the national medical malpractice sector is underreserved by $3.0-to-$3.5 billion, which equates to a 15 percent deficiency on $21 billion in aggregate med mal reserves.

Certainly, some carriers possess more than their share of this deficiency, as others are less exposed. I admit this is but a truism. Yet it is a notable one if one thinks about the notion that markets are made at the margin, and how destabilizing one additional troubled carrier can be to its incumbent marketplace.

This point is further brought home by this important statistic: the median market share maintained by the top two med mal writers within a state totals 59.2 percent, on average. In short, on average, the top two players in any state share more than half of a states medical malpractice business. This chunky state-by-state market share picture makes for some potentially volatile situations, given any incremental signs of financial stress by a participant.

What about the carriers themselves?

The good news for them is that medical malpractice rates have risen at rates well into double-digit levels in 2001 and 2002. Stories abound of doctors and hospitals whose rates have increased several-fold, if there is any coverage available at all. Carriers are reducing writings in both core and non-core states, increasing deductibles, and non-renewing troubled accounts.

Despite these market rate increases, we do not have high hopes for carrier profitability levels in the short term. For now, any rate relief realized by carriers will likely–and promptly–be put back into reserves; mere rate increases on current accident years are not enough to back fill long reserve tails.

Meanwhile, hospitals and physicians are escalating their cries of outrage, staging walkouts and threatening to leave their practices outright. Further carrier insolvencies should also occur. Thus, the din of dissatisfaction on provider and consumer fronts should only escalate in 2002.

Actual tort reform traction by state is spotty at best. So far, Pennsylvania (by virtue of some very severe troubles) stands alone as having tangible reforms on the table–the effectiveness of which may take some time to realize, if at all.

Certainly, other states may well follow suit on the tort reform front in 2002 and 2003. Expected further signs of stress by certain carriers will help this trend. Interestingly, while several states still have rather benign medical malpractice conditions, the industry-wide repricing now underway will only increase dissatisfaction among their constituent medical care providers and prompt additional regulatory and legislative inquiries.

In summary, though the Medical Malpractice business is a state-by-state proposition, the wholesale reversal of fortune among carriers exacerbated by the exit of one of the nations largest players leaves few rocks unturned.

In my view, the outlook is for further pain on all medical malpractice fronts, denoted by continued increases in loss severity and nationwide rate increases. This situation is only exacerbated by a dearth of bullets in the chamber (i.e. reserve redundancies) possessed by carriers.

Everyone is nearing the boiling point. We are not yet at the crisis levels as occurred to the sector in the mid-1970s when tort reforms spread throughout the country and spawned the creation of numerous physician-owned carriers. But we are getting there.

We will look back on 2002 as an important turning point in the medical malpractice sector–and a painful one at that.

Blair Sanford is a managing director and equity research analyst in the San Francisco office of Cochran, Caronia Securities, and has over ten years experience as an analyst in the property-casualty insurance and related services sectors. Cochran, Caronia & Co. is a leading full service investment bank exclusively serving the insurance and insurance services industries.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, May 6, 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.