A recent market analysis has shown that medmal insurers are in a state of crisis, says Robert T Allen.
Two years ago, US RE performed a market analysis of medical malpractice insurers. At the time of the first report, physician mutuals were incurring unprofitable combined ratios and struggling to maintain market share. New products were being developed for emerging risks, and web-based technology was being explored to assist in servicing and underwriting. It's 24 months later and the malpractice industry is in a state of crisis.
In this year's market analysis, US RE provides its malpractice clients with an overview of the traditional insurers, reinsurers and alternative risk vehicles.
State of the `traditional' market
Commercial markets are exiting while provider-owned mutuals are trying to supply adequate capacity to one of the largest service sectors in the US. Reinsurers are perceived as the bad guys who always put themselves in win-win scenarios. Unfortunately, both the reinsurers and insurers can prove that malpractice was a grossly underpriced and underreserved class of business.
Increased claim severity, faster payout patterns and relaxed underwriting standards were all factors that led to the current malpractice market. Juries' hostile responses to the long-term care and managed care industries are driving the escalating jury verdicts. When you couple the claims activity with group discounts, lower attachment points and broader coverage, it is no surprise that the medical malpractice insurance industry's combined ratio rose to 130% in 2000.
With major writers struggling with loss costs and new markets excited about `opportunity' costs, insurance professionals need a map to navigate through the maze of activity created by malpractice writers. Table 1 is a cheat sheet of major events since January 2001.
Medmal results throughout the US are horrific, and the landscape differs from state to state, city to city. St Paul and PHICO insured 40%-60% of the available malpractice market in Delaware, South Dakota and Vermont. Their departures may cause a lot of activity, but these states are not known for claim frequency/severity. It's highly probable that coverage will be replaced, but with premium increases in the 15% range.
The status of malpractice for each state varies as much as the carriers' appetite for various healthcare business segments. In a market where everyone is trying to find that elusive profit, each business segment is being dissected into subspecialties. Not-for-profit vs. for profit, hard-to-place vs. preferred, and chains vs. independents, are examples of the segmentation that occurs on top of classifying by medical specialties. Eventually carriers will find their risk appetite amongst mini-specialties found within the healthcare industry.
Some placements will be easier than others. Long-term care (LTC) facilities will continue to have difficulties and only the smaller, stellar accounts will have more than one option at renewal time. CNA, GuideOne and HUM are still writing this class after years of steadily increasing loss costs. Lexington, American Empire and the London facilities have managed to survive the past two years, but only by writing nursing home risks that are larger and/or have mediocre clinical outcomes. By writing the risks with virtually no options, they have been able to write a book with high retentions and premium rates comparable to hospital liability rates.
The remaining underwriters clearly have ideas of what is an ideal LTC account. Some markets have focused their efforts on assisted living facilities where no employed skilled care is provided. Others feel the better risks are not-for-profit nursing homes, where you can obtain a hefty rate, but the attention to care is supposedly better. Companies like Hartford and Gulf are betting that not-for-profits will generate profits for them, but other markets feel there's no meaningful difference between the loss costs for not-for-profits and the for-profit entities. Almost all underwriters agree that the loss costs for nursing home chains are significantly higher than those for independently-owned homes.
Insurers' appetites, loss trends and state surveys will eventually change how LTC facilities do business. As an example, when national reports concluded that non-profit facilities had better survey outcomes than for-profits, many of the larger for-profit groups began to explore reorganization plans to create not-for-profit entities. When insurance carriers started declining the chains of ten or more locations, many groups started forming multiple holding companies and/or leasing arrangements to give the appearance of a small, independent group. If relief does not come through tort reform, LTC facilities will have no choice but to change their practices and procedures. In doing so, they must restructure in a way that reduces the number of incidents that ultimately lead to loss.
Similar to nursing homes, carriers have identified niches that they believe to be unprofitable/profitable. Members of the Physicians Insurers Association of America (PIAA) continue to underwrite the needs of the many rather than only writing the profitable. On the other hand, the commercial carriers appear to be torn between writing larger groups and non-standard physicians. One thing is certain; very few markets are making money by writing physicians and surgeons.
Poor underwriting results are not limited to the companies that were recently downgraded. US RE examined the 1992-2000 average combined ratios of some of the leading writers of physicians. ISMIE, the leading writer in Illinois, had a nine year combined ratio of 139.4. MICA, Arizona's premier physician insurer tallied a combined ratio of 138.6 and the Tennessee -domiciled State Volunteer Mutual posted a 134.0 ratio.
Of the 47 malpractice companies reviewed, there are only three writers of physicians/surgeons which averaged combined ratios under 99% during the period of 1992-2000: Academic Health Professionals Insurance Association (99.3%); Louisiana Medical Mutual (99.1%); and MLMIC (98.0% excluding Princeton and HUM results). It should be noted that there were two writers of medical practitioners which also had results under 99% combined: NCMIC Insurance Company (78.3%); and OMS National a.k.a. National Group (97.9%). In light of the conditional renewals and non-renewals by companies like CNA, Zurich, Clarendon and Fireman's Fund, it's safe to assume there is an equally limited number of commercial markets with less than a 100% combined ratio for physicians.
Recent loss trends amongst some medical specialties are pushing some classes into the `hard-to-place' market. Locum tenens programs have virtually disappeared except for some loss-sensitive business. The staffing agencies have limited control over the physicians' activities, and this results in high claim frequency. Obstetricians have more $1m closed claims than any other physician class. Data gathered by Jury Verdict Research also indicates that obstetric cases have the highest jury awards. On the other hand, catastrophic radiation therapy claims now have a higher average indemnity payment than obstetric claims. According to a 1999 PIAA study, catastrophic radiation therapy closed claims had an indemnity average of $1.6m while obstetrics closed claims had an average of $1.1m. As expected, neurosurgeons and orthopaedic surgeons continue to have high verdicts and settlements. Physicians who staff emergency departments (ED) round out the list of hard physicians. Many ED physicians already have strenuous workloads outside the emergency room. When you couple this with the inherent exposure to misdiagnosis, expect frequency and severity for this class.
Most of the PIAA companies have expanded their products to include managed care liability for small IPAs (Independent Practice Association members) and PHOs (Physician Hospital Organization members). Managed care errors plus omissions (MCO E&O) was an accommodation for physician clients who were expanding into new business ventures. It was never the intent of the PIAAs to offer this product to the `Kaisers' and `Aetnas' of the world. It's been Lexington, Chubb Specialty and TIG Specialty which have been underwriting the larger managed care risks. As the managed care backlash continues, PIAA and commercial markets will all need to carefully monitor this class.
The load roar of Norwood-Dingell patients' rights bill has softened to a steady rumble. The momentum for national patient's rights to sue HMOs was strongest in 1999, which was also the time when MCO E&O rates were skyrocketing at a pace second only to nursing homes. Since Federal action will take years of negotiating, state legislators are taking action to define how and when their constituents can bring HMO suits. Some 40 states have established laws to create independent, administrative review boards to handle allegations of HMO neglect. The question is whether the Employee Retirement Income Security Act (ERISA) will continue to supersede these state laws.
The increased claims activity and uncertainty of losses have made underwriting a roll of the dice. Successful underwriters are constantly monitoring outcomes in Federal district courts and US Courts of Appeal. Higher rates will be applied in those venues that sided with the HMO patient (such as Illinois). Unlike five years ago, underwriters are carefully reviewing how HMOs monitor enrollee satisfaction, set protocols for complaints and how they document eligible benefits.
As with long-term care, the multi-state accounts appear to be the lawyers' preferred targets of litigation. The larger managed care risks will continue to see retentions rise and availability of excess limits will steadily diminish. Many of the managed care products offered by PIAA companies are heavily reinsured (through the London market), and the reinsurers will dictate whether rates/retentions for small risks also increase.
In previous hard markets, hospitals have had problems with insurance availability and affordability. In today's market, carriers are achieving double-digit rate increases in light of the void left by St Paul and PHICO. Higher minimum premiums are being set on excess programs and retentions are being raised in urban and rural venues. Hospitals may face challenges during the next two years, but the other healthcare classes will face greater adversity.
Despite the hardening terms, there appears to be a common theme among the markets: focus resources (capacity) on hospital business. But why are so many markets interested in hospitals? Although there are rumours that larger university hospitals had a hand in the St Paul losses, underwriters are attracted to hospitals' ability to reduce loss through risk management and loss prevention. Many hospital programs are written on an
A-rated basis or on surplus lines paper, which gives underwriters greater flexibility with rates and terms. Lastly, reinsurers which are solely going through rate-on-line exercises will find hospitals to be the big ticket item.
By the end of 2002, we will easily see a shift of over $1bn in malpractice exposures when you consider:
This premium and associated exposures will go to new carriers, in self-insurance, or no insurance.
As soon as the St Paul exit was announced, new capacity began to trickle back into the malpractice market. Caliber-One, a surplus lines carrier, announced its intentions to build a medical portfolio of smaller facility business as well as hard-to-place physician business. General Star Indemnity, a GeneralCologne Re company, will also offer surplus lines coverage for `hard-to-place' physician business. It appears that BeaconOne Professional Partners, a subsidiary of the White Mountains Insurance Group, will focus on creating a book of business similar to that of Chubb Executive Risk (most of the staff is from Chubb's healthcare practice). ACE USA, the latest entrant, will use staff previously from CNA Healthpro to grow a healthcare book.
Today's chaos has prompted some reinsurers to add medical malpractice to their list of products. WR Berkley Group has hired Dominic Senese (ex-CNA Re) and it has formed a dedicated unit, Berkley Medical Excess, to handle this line of business. Endurance Specialty has hired Judy Hart to head its hospital liability initiative. Bermuda facilities such as Allied World Assurance Co (AWAC) and Arch Re also have business plans that lend themselves to supporting malpractice during the next year. Arch's hiring of Steve Nelson (ex-AIG and ex-St Paul) could also put them in a position to underwrite malpractice on a primary basis.
The new capacity has not been limited to a handful of surplus lines carriers and reinsurers. We must also consider the activity that has occurred with joint underwriting associations (JUAs). The Texas JUA expanded its operations to include certain nursing home classes. Unfortunately, the base rates for nursing home professional liability are too cost prohibitive for most facilities and the Texas JUA does not offer commercial general liability (an integral piece of the loss picture).
The Medical Liability Association of Nevada was targeted to begin its underwriting on 15 April 2002. Each insurer authorised to transact casualty insurance business is a member of the association. The implementation of this program was supported by a 2002 Nevada marketplace analysis, which showed $15m of the $33m in physician premiums being non-renewed during the course of the next year. Fortunately for the remaining markets, the emergency regulation that created this JUA clearly states that this program will not be in direct competition of the voluntary market.
The authority of the Board of Risk & Insurance Management (BRIM) in West Virginia was recently broadened to cover all healthcare classes. Marsh USA provides the administration of this program which offers coverage to those providers that cannot obtain insurance through carriers licensed in West Virginia. The BRIM program also mandates that the healthcare provider accepts any patient whose health coverage is provided through a state health insurance program, including Medicaid. A few years ago there appeared to be no need for these state malpractice programs, but failing results across several carriers have made them an inevitability.
In West Virginia and in Florida, we have witnessed the use of government funds to facilitate the creation of provider-owned companies. In West Virginia, HB 601 includes guidelines for the creation of a physician-owned insurance company. If a physician mutual is formed that complies with Article 20F, a portion of the initial capital may be provided by direction of the WV Legislature. In Florida, a special waiver was granted to members of the LTC RRG Inc Medicaid-eligible policyholders of this Florida-domiciled risk retention group (RRG) are able to have their capital contributions reimbursed as if they were liability premiums. Uni-Ter Underwriting Management Corp, the RRG's underwriting manager, was instrumental in having the Florida legislators pursue this waiver from the Health Care Financing Administration (HCFA), and it appears future provider-owned companies will follow suit.
Newfound capacity through state-sponsored vehicles is going to be critical, especially with the dwindling reinsurance support. According to the Reinsurance Association of America, polled reinsurers reported an aggregate combined ratio of 142.2%. These results include companies that are known for supporting malpractice writers: American Re-insurance Co (148.3%); CNA Re (247.8%); Employers Reinsurance Corp (131.4%); General Re (175.2%); Transatlantic Re (116.0%); and Swiss Re (141.4%). Although these combined ratios contemplate more than just malpractice losses, healthcare writers should expect their reinsurers to continue tightening their terms. It should be noted that reinsurers from the London market are also experiencing hardships and the January 1 renewals clearly showed reduced capacity available from London. With Berkley Medical Excess and Endurance Specialty as the only proactive new reinsurers, their impact on rate stabilisation will be diminimus.
"It's déjà vu all over again." Some classes are having difficulty buying excess limits while other groups are having trouble buying any limit of coverage. Where will all of this premium be placed?
Higher rates and fewer options will eventually drive healthcare entities into the alternative risk market. Healthcare entities have an infinite number of alternatives in comparison to the last hard market. Risk purchasing groups, rent-a-captives, trusts, single parent captives, risk retention groups and offshore group captives are just some of the available risk vehicles.
Risk purchasing groups (RPGs) are conglomerates of homogeneous insureds which purchase liability insurance from traditional carriers. Most healthcare RPGs are formed to provide individual practitioners (e.g. physicians, chiropractors or nurses) with discounted professional liability insurance. Unlike most of the alternative risk vehicles, RPGs are not risk-bearing entities. On the other hand, carriers often issue dividends to RPGs' members for good loss experience. Since the carrier is taking all of the risk, RPGs inevitably see rate increases/restricted coverage during a hardening market.
Healthcare RPGs typically are managed/underwritten by managing general agents (MGAs). MGA compensation has historically been determined as a percentage of written premium, regardless of the underwriting results. MGA programs were often structured with carriers acting as pure fronts, or the carrier procured quota-share reinsurance. Reinsurers and insurers alike are withdrawing from MGA-driven business where the underwriter (i.e. the MGA) is not assuming meaningful risk. More importantly, there is virtually no reinsurance capacity for medical malpractice. With this in mind, new RPGs will slowly form unless the issuing carrier handles all underwriting functions or the MGA is willing to take risk.
Trust funds are sometimes described as the dinosaurs of alternative risk. Not-for-profit or 501(c) trusts have been formed for lines of business ranging from physicians' malpractice to nursing homes workers' compensation. Insurance trusts can be used as a risk transfer vehicle for a single hospital or a group of hospitals. Excess of loss reinsurance can be purchased to reduce the exposure of the trust to catastrophic claims, and the expenses associated with self-insurance trusts are usually lower than those of traditional insurance plans. In short, trusts can operate very much like a small insurance carrier.
Unfortunately, trust structures have limitations that make them less attractive than their alternative risk counterparts. As an example, a hospital trust for professional liability cannot offer coverage for its unemployed (or voluntary attending) physicians. There are geographic limitations which prevent trust pools from expanding into new states. Very few trusts are reviewed by AM Best's or other rating agencies, so the financial stability of the trust is often questioned by prospective insureds. Most importantly, the idea of an assessable policy sends most healthcare facilities seeking other alternatives where they are not impacted by the loss experience of other facilities.
Rent-a-captives have become very popular for large, individual risks. Rent-a-captive programs can be structured as protected cells where a policyholder's liabilities are segregated from impacting the financials of the rent-a-captive or the captive's other policyholders. In addition to financial stability, their popularity has been driven by the fact that they usually require less capital to operate than a single-parent captive. They are easily accessible through large stock companies as well as many of the physician-owned mutual companies (PRI, AP Capital, ProAssurance and NCRIC have rent-a-captive facilities available for their larger clients). Through the use of a domestic issuing carrier, the insured's rent-a-captive program can continue to show admitted paper with claims managed by local professionals.
Although rent-a-captives can be structured to address the self-insurance needs of smaller facilities/groups, they often have significant premium requirements. Most malpractice carriers with rent-a-captive facilities will not consider a risk unless the insured generates at least $500,000 in premium (commercial carriers have even higher premium thresholds). The availability of aggregate stop loss protection is also limiting the use of rent-a-captive cells. Stop loss coverage caps the aggregate retained losses of the captive cell and it is imperative that each rent-a-captive cell is adequately secured with reinsurance and/or some type of financial guarantee. Sometimes the issuing carrier will provide the aggregate stop loss for the rent-a-captive cell, but availability of adequate reinsurance is going to be a stumbling block during the next year.
Group captives in the form of risk retention groups (RRGs) have steadily grown since the mid-1980s. Growth slowed during the soft market, but a greater number of specialty groups will start reviewing RRGs as an insurance alternative. RRGs afford the greatest flexibility in state filing requirements which allows them to quickly operate in new states. For classes that are experiencing adversity throughout the US (such as nursing homes), the RRG model can help attract a geographically diverse membership.
On the other hand, group captives domiciled offshore do not have the same flexibility as risk retention groups. Depending upon the product that is offered, offshore captives usually require a fronting carrier to satisfy state malpractice requirements. It should be noted that group captives formed onshore do not have this flexibility unless they are formed under the federal guidelines of the Liability Risk Retention Act.
The risk-bearing alternatives (risk retention groups, trust funds, etc) might not be the best medicine for this hardening market, especially for individual practitioners. In states where medical malpractice/professional liability is mandatory, there are often rules regarding the type of insurance that is purchased. If a Pennsylvania physician decides he/she wants to self-insure your malpractice, there are stringent funding requirements for a trust fund. If a New York neurosurgeon wants to join a newly formed RRG, the surgeon must see whether the Insurance Department deems it as an authorised insurer for malpractice. Aside from the regulatory issues, risk-bearing programs require capital contributions. This additional charge may make these alternative risk vehicles cost-prohibitive.
Managed care and government programs have had an obvious impact on healthcare financials. Available funds for capital contributions are not a problem exclusive to individual practitioners. In fact, the HealthCare Financing Administration (now known as the Centers for Medicare & Medicaid Services) has very specific rules in which Medicare/Medicaid-eligible facilities must comply. These rules are spelled out under the Provider Reimbursement Manual (PRM). Reimbursement and potentially a provider's Medicare/Medicaid eligibility can be affected unless the provider complies with rules related to prudent insurance purchases, self-insurance requirements and retention levels.The PRM also addresses where capital contributions to self-insurance programs are not considered a reimbursable expense item. With this in mind, providers must be extremely careful when participating in risk programs that may require additional capital assessments.
Alternative risk vehicles will also find capital in the form of reinsurance an impediment during the next year. There is virtually no quota-share reinsurance available for primary programs. Reinsurers such as Employers Reinsurance Corp, Transatlantic Re and Munich-American Risk Partners continue to offer excess of loss reinsurance to RRGs, group and single parent captives, but aggregate stop loss protection is a commodity limited to preferred risks. This is worrisome because new captives will not get off the ground unless they can cap their aggregate exposure. The only option alternative risk facilities may have is to set conservative premium-surplus ratios (1:1 to 2:1) and offer insureds a low limit product that does not require reinsurance.
Success during stress
The next 18-24 months will be difficult for all involved parties - the reinsurer, the insurer and the healthcare provider. Some reinsurance underwriters will feel pressure to support programs that see the highest priority in rates and little concern on risk selection. Some PIAA companies will try to maintain existing rates and market share, despite increased reinsurance costs and higher claim severity. Many providers (and their insurance consultants) will seek premium reductions through the use of alternative risk vehicles. Reinsurers, insurers and providers alike must be careful in the strategies they implement during this malpractice crisis.
At a certain point, exorbitant reinsurance rates become too much for insurers and their policyholders to absorb. If reinsurers are going to be successful, it will not be through focusing on rate and abandoning underwriting. Reinsurers' success cannot be based upon writing one class (e.g. hospitals) and declining all other classes (e.g. nursing homes and doctors). First, reinsurers must understand how and where losses occurred from their reinsureds. Once trends are identified, they must share this information with their clients to help them fine-tune their underwriting techniques. Through modest increases, product diversity and renewed underwriting discipline, long-term profitability can be achieved.
Provider-owned companies run the risk of under-pricing insureds when trends justify rate increases. Determining premiums solely by a risk's ability to pay is not a worthwhile venture. Similarly, for companies which are opportunistic, risk selection based solely upon an insured's ability to pay does not result in profits. The best way to offer insureds rate stability is to consistently charge for expected loss costs plus expenses. Anything less will result in huge rate swings. Policyholders may appreciate under-priced coverage while it's available, but they are never understanding when the company has to repeatedly request 15%+ rate increases.
When healthcare providers see the incumbent carrier's renewal terms, they will be tempted to find the cheapest market or self-insure their risk. Buyer beware. Buying cost-effective coverage from a financially unstable company can ultimately be expensive. If a company goes into liquidation, costs from unpaid claims and/or tail coverage can make a provider's `cost- effective' program two or three times more expensive than the incumbent's terms. Insurance buyers also need to be wary of group, alternative risk programs where policies are assessable or members' losses are not segregated. As the number of malpractice writers continues to decline, maintaining relationships with stable carriers is imperative... even if their rates are higher than their competitors'.
No one needs a crystal ball to see that higher rates will be maintained during the next two years. While the insurance industry as a whole may have excess capital, the amount allocated to medical malpractice is dwindling. The new reinsurers have very specific targets for eligible risks and profitability; they will not be the end-all solution for the market. And as long as jury verdicts and settlements continue this severity trend, another wave of additional capacity will not come any time in the near future.
Unlike previous hard markets, healthcare providers have an arsenal of alternative risk vehicles to retain loss and reduce costs. Unfortunately, reinsurers' appetite for aggregate stop loss and providers' restricted use of and access to capital will make many risk-bearing vehicles difficult to get off the ground.
This hard market will not disappear overnight. It will not go away because of ignorant capacity coming into the market, nor will it end by a mass exodus to captive facilities. State-specific crises will diminish through a combination of stringent underwriting, equitable risk sharing and tort reform. Once these are put into practice, the market will return to a place of normalcy.
By Robert T Allen
Robert T Allen, is assistant vice-president at US RE Corp. Over the last 11 years he has specialised in underwriting, reinsurance, and broking professional liability for the health care industry. During the past year, Robert has been the underwriting manager of Uni-Ter's Nursing Home Liability Program and he is currently dedicated to the development of medical malpractice reinsurance opportunities.