Med Mal Market Healthy, Prognosis Cautiously Optimistic Despite Downturn

The prognosis for the financial health of medical malpractice insurers seems cautiously optimistic, despite continuing economic uncertainty and a range of challenging underwriting conditions.

No company or sector has been unaffected by the economic downturn which saw U.S. stock markets lose 28 percent of their value in the second half of 2008. Medical malpractice insurers are seeing the implications along with the property-casualty insurance market.

The p-c market as a whole incurred investment losses of approximately $25 billion in the third quarter of 2008, and an additional $35 billion in the fourth quarter. On a percentage basis, these figures translate into an overall loss of 4.1 percent of the average surplus for the third quarter, and another 5.9 percent of the average surplus for the fourth quarter.

The declines contributed to total investment losses for all of 2008 of approximately $80 billion, or 13 percent of the average surplus for the year. This compares to a net capital gain of $17 billion, 2.8 percent of the average surplus, in calendar year 2007.

These 2008 investment results, coupled with a lackluster operating performance, resulted in the entire p-c industry reporting a total reduction in capital of $66 billion.

Med mal insurers were no exception to the trend and generally replicated the entire p-c industry's investment losses as a percentage of surplus in the second half of the year.

In total, 227 med mal insurers reported investment losses of $490 million in the third quarter, which amounted to 3.9 percent of the average surplus for the quarter–a percentage drop very similar to the 4.1 percent of surplus figure for the entire p-c industry.

The same group of med mal insurers had $770 million in investment losses in the fourth quarter, or 6.3 percent of the average surplus for the quarter, compared to 5.9 percent for the industry.

(See accompanying text box for information on how med mal insurers were identified for this comparison.)

Med mal groups which invested heavily in equities or failed financial services institutions were among the biggest losers. Others, with a narrower investment mix with lower exposure to equities and a stronger risk position, performed better.

Overall, the med mal sector continued to report positive operating results, which provided a net increase in capital of $174 million in 2008.

While current results may be troubling, they need to be taken in historical context.

Med mal insurers have a long track record of safe and prudent investing which has enabled them to build up the strong asset base essential to providing consistency and continuity of cover in a market characterized by complex long-tail claims.

The capital and surplus built up in the past few years mean that many med mal insurers have the reserves to withstand the current economic crisis and are therefore in a strong position to continue with ongoing operations.

This strength will be needed in the years to come not only due to reduced investment income but also because underwriting challenges in this sector are not getting any less complex.

UNDERWRITING CHALLENGES

The population in the United States is aging. By 2025, the percentage of the population over the age of 65 will have increased from 12.7 percent to 18.2 percent, according to the U.S. Census bureau, which is putting an increased burden on health care systems. At the same time, expectations of patients of every age are increasing.

Well-informed and affluent consumers expect to be offered a choice of therapeutic approaches and access to new and expensive medicines. This makes the process of care much more complex, raises costs and places much higher demands on practitioners.

In these conditions, the likelihood of failure or perceived shortfall in standards is all the more acute, opening the door to a greater volume, and value, of claims.

At the same time, underwriters are aware that the practitioner base is changing. As pension plans fail to deliver, care professionals may remain in practice past normal or intended retirement ages, and the recently retired may look for opportunities to rejoin the workforce to top up their finances.

This presents an interesting challenge for underwriters. While individuals in the older-age category by definition have many years of experience, it is also possible they will be less knowledgeable with regard to new therapies, surgical techniques or clinical approaches.

CLAIMS PATTERN MAY CHANGE

Two other factors complicating the underwriting picture are rising unemployment and declining fee income for lawyers.

During these challenging economic times, unemployed patients have more time and incentives to contemplate whether or not they received the best medical care and to investigate the potential to generate income from speculative med mal claims.

Likewise, lawyers who are feeling the pinch because of the economic downturn may be persuaded to take on weaker cases in a bid to boost fees.

While such concerns have yet to translate into increased claims, they nevertheless add to underwriting uncertainty and are likely to remain on the radar while difficult economic conditions persist.

RE DEMAND INCREASES

Given the financial losses of the last six months, increasing underwriting complexity and a potential rise in claims, it seems likely the primary carriers that need to reload their balance sheets may turn increasingly to reinsurers for support.

Although reinsurers are unlikely to walk away from a sector in which strong relationships have been built up over many years, they nevertheless face an urgent business imperative to rebuild their own balance sheets, which means they have to deploy their capital to maximize results. As long as other markets, such as property catastrophe, continue to support higher rates, med mal insurers will need to keep close to their reinsurers to maintain continued support from their capital.

Excellent data, well thought-through business plans, adequate primary rates, excellent claims performance and a stable reserving policy are the strong cards insurers will need to play in order to get the most out of their reinsurance relationships.

The med mal insurance sector is one which has performed well over many years. We see no reason why it should not continue to do so in 2009 and beyond.

Although this is a difficult market, we believe that medical reinsurance capacity is unlikely to reduce in 2009 and that prices will remain stable through the rest of the year. However, companies will need to demonstrate that their operations are being managed with care and prudence if they are to maintain the same level of support from reinsurers in what may be difficult times ahead.

Although not recession proof nor immune from the current financial crisis, it appears the medical malpractice sector has positioned its collective balance sheet well to meet the current financial crisis. History suggests that this segment, along with supporting reinsurance markets, will adapt to the new underwriting and claims challenges that may arise in the future.

Tony Hill and R. Ray Pate Jr are both senior executives in the BMS Group Healthcare team. Tony is a director of BMS Intermediaries Ltd based in London and may be reached at tony.hill@bmsgroup.com. Ray is an executive vice president of BMS Intermediaries Inc based in Birmingham, Ala., and may be reached at ray.pate@bmsgroup.com.