Self-Insuring Medical Malpractice Can Offer Long-Term Rewards

First, there was too much capacity in the insurance environment. Many companies had excess capacity. Owners, of one form or another, demanded that a return be generated on the capital.

Thus, insurance companies went into lines of coverage they did not understand in order to use excess capacity. Considering the possibilities for using capacity, medical malpractice, both physician and institutional, was appealing.

In long-tail business (business where the time between the collection of premium and the payment of a claim is long), it takes a number of years to truly know if you made money in a given policy year. By the time you find out, it is too late to do anything to fix the problem. The company holds large sums of money for a long period until claims are finally paid.

When there were double-digit returns on investment portfolios, sloppiness in underwriting and claims handling could be covered up by large investment returns on the reserves. But the second factor driving the crisis was ultimately a material decrease in the return on investment portfolios. Many medical malpractice companies never made money on underwriting. They made their money on their banking functions and investments.

During the 10 years preceding the most recent crisis, malpractice companies were also encouraged, most importantly by rating agencies such as A.M. Best, to diversifyto go into other lines of business and to enter other states. This led many malpractice insurers to offer coverages they knew little about in jurisdictions they were unfamiliar with, just to acquire or maintain good ratings.

During the prior "soft" markets, medical malpractice insurance was being sold at cut-rate costs. Doctors, in droves, purchased these policies only to find out that if something appears to be too good to be true, it usually is.

The most recent soft market was no different. Each year an insured had more and more companies wanting its business with broader coverage at lower premiums. While this seemed to be a great opportunity, many insureds got hurt when their insurers went belly-up. The insureds had reported claims, and the state guaranty funds only provided limits of $100,000 to $300,000.

In addition, there was no future coverage, even though doctors and hospitals had paid their premiums. The regulators have closed down many companies in the last five years including big volume insurers like PIE Mutual, Frontier, PHICO and numerous others. Other companies, such as St. Paul and Zurich, decided to leave or greatly reduce their involvement in this line of insurance.

Assuming two companies are managed in a reasonably competent manner, one company cannot sell a malpractice insurance policy for half the price of another company and still be solvent long term. During each soft market, doctors and hospitals have been terribly hurt by their desire to buy cheap insurance. In insurance, more than other purchases, you typically get what you pay for.

During the first crisis, large and multi-location health care institutions found that they could solve their medical malpractice and professional liability insurance problems by forming captive self-insurance companies.

To deal with the crisis, our team created an alliance of hospitals that was able to realize the following benefits of the self-insured concept:

Stabilize premiums over the long term.

Control over which claims should be defended or settled.

Lower premiums or dividends provided.

Make decisions based on needs of hospitals and owners, not shareholders profit motives.

The alliance also had the ability to select hospitals as group members based on exposure and claims history.

This captive insurance company still exists and has provided member institutions with stable premium rates during the various volatile cycles. However, a refinement of the concept was required in the 1980s when, with a hardened market, staff physicians at these institutions had difficulty securing coverage.

At first, the hospital became the "deep pockets" and assumed the liability for malpractice claims. During tough times, institutions traditionally look the other way on requiring insurance for staff privileges.

As the potential for risk increased, however, hospitals turned to us to create a similar model for individually insuring staff physicians.

It quickly became clear that we could solve the problem in the same manner by creating a captive physician insurance company for the 3,000 physicians at their 26 hospitals. Since this was a prevalent problem throughout the nation, we identified three other hospital groups with 80 additional locations and more than 6,000 additional physicians.

The first step was finding a dormant mutual property-casualty company shell, demutualizing it, and turning it into a stock company that would be owned by the four-system hospital group.

The other major issue involved securing licenses in more than 15 states where the hospitals had locations. Each state had different licensing criteria, making it essential for self-insured groups to work closely with professionals who could coordinate administrative, claims and marketing initiatives.

In most cases, when selling a specific type of insurance, such as medical malpractice, it is common to work with local agents whose clients need this line of coverage. This sales approach would not work for us because we were only seeking doctors on staff at specific hospitals. Very few, if any, agents had relationships with clusters of staff physicians. Consequently, we had to go directly to the physicians, which posed an entire new set of challenges.

One major obstacle was dealing with the natural tension that exists between hospital administrators and physicians. In short, physicians do not want to lose their autonomy and independence by having their practices controlled by the administrators.

Our main goal was to get the hospital administrators and physicians to work together and to understand the concept and long-term value of controlling premiums and the possibilities of receiving dividends. It also fostered teamwork because the two parties were working together to oversee the underwriting policies and limit claims.

A typical strategy employed by plaintiffs attorneys involves a divide-and-conquer strategy. With physicians and administrators working together, and with the assistance of our insurance professionals, we were able to agree on a variety of issues, including which doctors would be insured (those with high claims history may not qualify) and which claims should be settled or defended. The plaintiffs bar came to realize that cases we decided to defend would be defended aggressively. Consequently, there were very few frivolous suits.

In establishing this hybrid of a physician-owned medical malpractice insurance company, we also implemented what may have been the first risk management loss prevention training program that addressed issues related to both hospitals and doctors.

As insurance professionals, we had to educate them on minimizing the incidence of claims, including, for example, how to prevent claims, methods for documenting procedures, effective sterile techniques and count procedures for sponges.

The other major benefit was that over a period of time, premiums in this company actually were lowered. In addition, excess capital was returned as dividends. This company still exists today.

Steven L. Salman is chief executive officer of Global Insurance Management Company, the attorney-in-fact managers for the developing Healthcare Underwriters Groups, physician-owned medical malpractice insurance companies in Fort Lauderdale, Fla., and Louisville, Ky.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, May 26, 2003. Copyright 2003 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.