William J McDonough reviews the current status of malpractice risk.

The old expression that `when it rains it pours' is an apt description of the risk financing issues confronting the healthcare field. The current situation, involving a host of insurance risk exposures, presents considerable challenges for a field fraught with financial concerns. To help understand why there is a problem today, and how it can be addressed, some historical information is important.

In the mid 1970s and 1980s, North America experienced a so-called `malpractice insurance crisis'. Traditionally, most observers believed that the hardening and easing of the healthcare professional liability market ebbed and flowed over a seven-year cycle. Thus one would have expected additional `insurance' challenges in the 1990s. Instead, the healthcare field enjoyed relatively easy market access and low insurance premiums both on primary and excess-reinsurance programmes.

With the new millennium has come a major change in the medical malpractice insurance picture. Both the frequency of certain types of malpractice claims and the severity of these events have given rise to marked increases in premiums. (Most experts in the industry suggest that we are facing a `severity' problem in this cycle, not frequency.) Concern about health professional liability has evolved, with nursing homes and medical specialists becoming a focal point of risk exposure. Some malpractice carriers have either gone out of business entirely or they have withdrawn from the marketplace, such as PHICO, Reliance, and most recently,

St Paul. The limits on insurance have contracted and in many cases healthcare organisations (HCOs) have been compelled to absorb larger retentions of risk. In essence, gone are the days of so-called `first dollar coverage' in the malpractice arena.

The US is not the only country facing a malpractice insurance problem. Indeed, to some observers, it is pandemic in nature, impacting many western nations and extending into Japan. With so many nations seeking insurance solutions, the pressure is intense on underwriters and insurance markets. Rather than being a buyer's market, it is a seller's market. Selectivity has increased to the point that those seeking insurance must be able to differentiate themselves to be successful in pursuing traditional malpractice insurance coverage.

Standing alone, the most recent malpractice insurance developments would be a major challenge for healthcare organisations. Unfortunately, the problems are much broader and deeper. As discussed later, major property losses have led to a marked increase in this line of insurance coverage for healthcare facilities. Concerns about the actions or inactions of directors and officers in other areas of endeavour have served to increase premiums for this line of insurance in the healthcare field.

Beyond insurance considerations, other forces are imposing financial pressures on HCOs. Now coming out of the tailspin created by the Balanced Budget Act, many healthcare entities face new unfunded mandates, including HIPAA compliance, clinical trials compliance and the burdens of gearing up for bioterrorism. Many are also faced with professional staffing shortages.

At the same time, consumer groups, unions, and large employer groups are questioning the quality of care provided by healthcare organisations. Demanding greater and greater accountability, they are using `patient safety' as a driver for change. This is seen in the context of the Leap Frog Group, which is using the power of the purchaser to compel how HCOs deliver healthcare services. Thus, they are seeking the introduction of computerised order entry systems for medication, the use of highly trained specialists, called `intensivists' in intensive care units, and the referral of patients to high volume centres with a good track record of treatment outcomes. While it is laudable that purchasers are exhibiting such concern, there are some who ask where the funding will come from to meet these new private sector mandates.

The private sector is not the only source calling for change. The Institute of Medicine (IOM) released a report in 1999, To Err is Human, depicting a crisis in the healthcare field. Suggesting that some 44,000 to 98,000 Americans lose their lives due to medical error, the IOM called for major changes in the healthcare system. This was followed by recommendations from a number of federal agencies and state reforms.

At the moment, the chief financial officers of many HCOs are under tremendous pressure to effect change in order to come up with cost effective and appropriate vehicles to insure against a variety of risks, despite being under the quality spotlight. The answer can be found in innovative risk financing solutions, as well as insurance coverages. In addition, it will require a strong collaboration between the financial and administrative leaders of a healthcare organisation, and those accountable for clinical care. Alternative risk financing is a critical component. The same can be said, however, for fresh thinking about clinical risk management and patient safety initiatives. In this article, the risk financing solutions are addressed. Introduced here is the concept of the `ROI' (return on investment) of patient safety. In other words, patient safety innovations can serve as a way of enhancing the financial picture of the HCOs .

This article describes the current status of market conditions in a number of key areas. It provides insights into alternatives to the traditional approach of relying on insurance as the primary resource for risk transfer. It then describes how identified patient safety innovations can actually help to drive financial solutions.

Market review: medical malpractice/professional liability
Most risk management consultants and brokerage consultants would agree that property, professional liability and general liability and financial coverages, such as directors' and officers' insurance, are causing the most headaches for buyers and risk consultants alike. The following reviews are based on market response and recent renewal results programs for healthcare facilities. (Note: Chubb has purchased the renewal rights for IRI's book of sponsored HCO property business.)

The issue of terrorism insurance remains difficult, complex and continuously changing for the healthcare industry. Following September 11, there was a general contraction of terrorism coverage for many classes of property risks, most notably for the larger HCO exposures. Brokerage consultants continue to work closely with the insurance industry and the appropriate government entities to solve this issue. For HCOs, special attention must be afforded questions regarding bioterrorism and the resulting business interruption possible if an anthrax outbreak were to occur, with closure to areas of a hospital - for instance the emergency department.

There are currently markets that will write terrorism as a stand-alone coverage - but for HCOs the costs may be prohibitive - as well as options to `buy back' this cover with the HCO's current property underwriter. Again, this option may support the inherent cost benefit analysis so common in healthcare settings today - appropriately so. Contingency planning will be key in these situations where the risk cannot be transferred to a market/underwriter.

A closer look
In general, the healthcare professional liability market is in very poor condition. Combined ratios are in the area of 130% to 140%, although the performance of individual carriers depends upon a number of variables, such as jurisdiction, client type (within their book of business) and reserving practices. The emphasis on medical error reduction, patient safety initiatives and media coverage has driven closer scrutiny of the industry by both underwriters and consumers. Severity, as mentioned previously, continues to escalate and frequency in diagnostic error (for example, failure to diagnose breast cancer) is worrisome.

For the most part, long-term care, managed care and larger urban institutional risks have been subject to greater rate increases than physician business and rural hospitals. Industry loss experience is highly dependent upon geographic region, with the most extreme market conditions to be found in the urban areas of Pennsylvania, Illinois, Texas, Florida, and Ohio. Though with 1 April and 1 July renewals fast approaching, many other states will be added to the `tough' placement list.

Approximately one-third of the healthcare insurance market has either withdrawn or become financially impaired. Reduced capacity, higher retentions and standard coverages are prevalent in today's marketplace, and terrorism exclusions as well as mould exclusions are now required in many circumstances.


Acute care hospitals
Two main factors have contributed to the high rate increases for acute care hospitals:

  • l the client's position within the market cycle turn, whether it be 1 October 2001; 1 January 2002; 1 April 2002; 1 July 2002; or 1 January 2003 - in trying to hold onto business, some markets may have refrained from imposing price increases this past year. This `benefit' of continued low rates, out of line with the rest of the market, is now producing much greater comparative increases than expected for some HCO insureds, particularly for those forced to seek a new carrier. This result has contributed to huge surprises for many HCO chief financial officers and risk managers as they compare budgets to actuals for risk financing; and

  • excess placement versus primary coverage - there has been an increase in the severity of losses surpassing the typical `working layers' of excess placements, leading carriers to offer reduced limits at significantly higher rates. HCO insureds receiving smaller price increases generally have seen rising retentions in their primary programmes, along with reduced limits, and/or new markets to fill out capacity needs. Many HCO insureds have chosen to keep premium increases down by reducing their limits, despite ever-higher jury verdicts in medical malpractice cases.

    Physician groups
    Rates for physician professional liability coverage continued to escalate at January renewals, especially on the excess/umbrella layers. In addition, retentions were often doubled or worse, even as excess limits declined by 50% to 100%, and limits that had been set on a `per physician' basis, without a policy aggregate, were changed to shared limits with aggregate policy caps.

    Primary market capacity has dropped significantly overall and is often unavailable for certain specialties (for example, emergency medicine, OB/GYN). Little or no excess capacity is available either. Excess markets, threatened by increasing claims severity, are no longer writing stand-alone coverage for this class. The withdrawal of most of the national commercial carriers from the physician malpractice business makes multi-state programmes increasingly difficult to assemble.

    Long-term care institutions
    Good risks generally experienced price hikes of 50% or less on primary professional liability renewals. However, this typically came with limits lowered by as much as two-thirds. Also, in many cases, these price increases came on top of relatively large increases in January 2001 renewals.

    Rates continue to be driven upwards by:

  • ongoing concerns over large court awards, demands and settlements;

  • continued financial pressure from changes in Medicare/Medicaid reimbursements, staffing costs and risk management needs;

  • the reduction in available capacity for malpractice liability; and

  • as noted above, a long term care risk's position within the market cycle turn.

    Additional notes on capacity trends

    Market failures, withdrawals, and consolidations
    The failure of some companies offering this line of coverage - for example, PHICO, Reliance and Frontier - has affected the marketplace significantly. The most notable departure from the medical malpractice landscape is The St Paul, which had long been committed to the healthcare industry but which, with adverse results, chose to exit this line of business in late 2001. Failures, withdrawals and the consolidation of several regional carriers have combined to produce a less competitive marketplace with fewer commercial alternatives.

    Restrictions on capacity
    Primary carriers still expressing a commitment to the healthcare industry remain wary and have generally reduced the capacity they are willing to commit to any one risk, in some cases halving previous maximums or worse.

    Due to the lag time in the reporting of claims (up to three years or more), reinsurers are now being hit severely for past years' losses. In response, most reinsurers are cutting back on limits provided and the price for the capacity that is being offered has increased substantially. Both self-insured healthcare organisations and med mal carriers, such as members of the PIAA, are being hit as well - reinsurers are pulling back on offerings based on performance in the past few years.

    Changes in insurance coverage

    Acute care hospitals and physician groups
    Carriers are insisting on the use of their policy forms and narrowing the scope of their coverages.

    Claims reporting
    Carriers are imposing specific conditions on the reporting of excess losses and potential excess losses. Settlement offers that may affect excess carriers need to be reported in a highly detailed fashion to ensure that no conflicts arise from late notice.

    Tail/extended reporting period (ERP) provisions
    Until recently, many policies had specific provisions for options that would extend reporting periods. When triggered, these provisions allowed HCO insureds to evaluate the financial ramifications of tail options at a fixed cost while simultaneously locking into place a self-insured retention on all incurred-but-not-reported losses. Most carriers are now either refusing to commit to a pre-determined cost for ERP or establishing parameters that protect them while offering a lesser benefit to insureds.

    Terrorism exclusions
    Many January 2002 renewals contained new policy language on terrorism developed by the Insurance Service Office and endorsed by the National Association of Insurance Commissioners. The current language is not industry-specific, raising many questions about the appropriateness of applying these provisions to healthcare HCO insureds. HCO professional liability buyers must work with their brokerage consultants to determine if this type of exclusion could possibility exclude a medical malpractice claim where the event leading to the claim originated from a patient who was being treated at the HCO after an anthrax exposure at another location, for instance.

    Increased deductible levels and self-insured retentions
    Deductibles for HCO insureds for this line of coverage are definitely on the rise. Very few insureds with first-dollar coverage still exist. In many cases, deductibles are increasing so much that they are being converted to self-insured retentions (which carriers prefer as a matter of risk-sharing). Medical malpractice loss development and increased actuarial analysis have combined to put upward pressure on self-insured retentions, i.e. the marketplace is forcing higher risk retentions on many facilities.

    Collateralisation for retentions
    Carriers are becoming more stringent in requiring collateralisation for even small retentions at levels close to the aggregate retention amount. Required levels of collateralisation are also rising as would be expected with other market indicators.

    Risk management
    Carriers are requiring that risk management measures be taken, which may include the purchase of services over and above the cost of insurance. Specifically underwriters are looking for current information on patient safety initiatives at the HCO, representation of medical error reduction strategies and evidenced based loss prevention measures taken based on loss data.

    Long-term care institutions- much of the `narrowing' of coverage offerings seen in the scope of medical professional liability coverage for hospitals and physician groups has already become standard for the long-term care industry. Some of the `narrowing' seen recently includes:

  • shorter ERP term - ERP provisions are generally not given at policy inception any more. Terms of only one to two years have become standard for this class of business;

  • reduced limits and increased/unaggregated deductibles - carriers are generally not offering per location limits. Aggregated limits and unaggregated deductibles are more prevalent. Deductibles are doubling and tripling. Many carriers now have minimum deductibles of at least $25,000. Quotes are being offered with deductible options running up to $500,000;

  • limited coverages - coverage specifications are not negotiable as carriers adhere strictly to forms and conditions. The punitive damages exclusion is usually mandatory. Sexual abuse and molestation coverage is difficult to get or, if available, the coverage is often sub-limited;

  • occurrence coverage - the few remaining occurrence markets are moving HCO insureds to claims-made coverage;

  • retrodate inception - carriers are far less willing to pick up retroactive dates and, if they do, the charge is hefty. More often, the retroactive date will be the date of policy inception;

  • mandatory risk management - some carriers are including a mandatory `risk management fee' of up to $50,000, depending on the client's size and risk profile; and

  • responses to the crisis - ROI for patient safety.

    For many years, clinical healthcare risk managers have advocated changes in processes and systems that would reduce or eliminate many expensive loss exposures. Some have involved changes in physician plant, such as moving archival record systems from flood prone basements to safer locations and placing auxiliary and backup generators in areas not exposed to potential storm damage.

    Other changes have been more of a patient care-related nature: enhanced credentialling systems, continuous competency readiness to assure staff are capable of providing requisite service and use of innovative technologies such as pulse oximetry monitoring.

    Innovations can carry a hefty price tag. When put in the mix with competing demands for expenditures, some risk management recommendations may not be given much notice. Now, however, the situation may have begun to change. The current insurance landscape and the demand for patient safety have coalesced, leading to the idea that the investment in patient safety solutions may actually have a positive ROI that can be used or leveraged far beyond clinical care considerations.

    Studies completed for the Leap Frog Group demonstrate that there are likely to be substantial financial savings from patient safety. Other studies, involving changes in treatment practices in the emergency department and computerised assisted interpretation of acute ischemic heart disease demonstrate the concept of the `ROI in patient safety.'

    The benefits go well beyond the numbers on the bottom line of a spreadsheet. That a healthcare facility does not incur adverse publicity from patient safety problems means that it can maintain and grow its market share. It can use its `patient safety' programme to satisfy the demands of health plans demanding such activity as the basis for negotiating a contract. It may also serve to satisfy the demands of underwriters seeking demonstrable proof that the healthcare facility has a plan in place for loss control, loss prevention and error reduction.

    The idea of the ROI of patient safety presents a new opportunity for harnessing the power of clinical risk management with financial management of the healthcare organisation. It presents the opportunity for using new tools to pinpoint which processes or systems need change, the potential cost for systems modification, and the measurable financial outcomes in terms of patient safety. A concept long recognised in industry, it means leveraging clinical information to maximise financial forecasting for the healthcare organisation. As part of the solutions considered in the context of alternate risk financing, it is an approach that merits active consideration.

    Although current market conditions are grim, there are practical, attractive solutions available that involve innovations in risk financing. These approaches can be enhanced by building on the idea of the `return on investment' in patient safety. Tying clinical healthcare risk management data and solutions to new risk financing vehicles provides a potent tool to the chief financial officer in driving systemic change for improving the overall financial picture of the organisation.

    By William J McDonough

    William J McDonough is senior vice president and national practice leader, healthcare risk for Marsh, based in Boston, Massachusetts.