Robert T. Allen puts the US medical malpractice market under the spotlight.
It is safe to say the soft market of the 1990s is over. Today, most classes of healthcare risks are facing premium rate increases of 5% to 10%. Some classes, like nursing homes, are seeing increases in the range of 50% to 500%. For any impending crisis, it appears insureds have a host of options: commercial markets, bedpan mutuals, residual markets (joint underwriting associations), risk retention groups, rent-a-captives, and so on. But even with so many types of insurers, sound underwriting and reinsurance will continue to dictate future pricing.
Insurance rating agencies have had their hands full with medical malpractice carriers. Medical Inter-Insurance Exchange (MIIX) and PHICO (1999's sixth and seventh largest malpractice writers) were both downgraded during the past year. The two companies watched their written premiums grow at exponential rates but now they need to slow down and fine-tune their underwriting. Frontier Group's financial woes and subsequent downgradings were allegedly due to inferior physician business. Reliance was also downgraded but it is unlikely that its relatively small healthcare book was the reason for the company's downfall.
In addition to these markets, some of the state-run facilities have had their share of financial hardships. The Pennsylvania Patient Compensation Fund (PCF) continues to alter retentions and surcharges to reduce its alleged shortfall of $2bn. The South Carolina PCF is also experiencing financial difficulties. According to a January 2000 Legislative Audit Council report, South Carolina's PCF is under-funded and government officials are considering whether they should disband it. New York's Medical Malpractice Insurance Association (MMIA) has had its dissolution delayed until 30 June 2001. The primary reason for the hold-up is a dispute over ‘who' will pay $373m to complete MMIA's loss portfolio transfer. The National Association of Independent Insurers filed suit in the Supreme Court of New York to ensure that the state government and not insurers pay to dissolve the fund.
Nevertheless, the past few years have not been a picture of absolute gloom. The release of reserve redundancies in conjunction with strong investment income enabled quite a few malpractice writers to perform well. The improved loss development fuelled companies' ability to offer dividends and in turn, they retained their market share.
Reinsurers were not immune to the rough waters faced by the primary insurers. Domestic and European reinsurers have faced consecutive years of combined ratios above 110% and these reinsurers will now dictate market conditions for the $6bn malpractice market.
While reinsurers are not looking for extreme rate increases to recoup years of losses, they are dictating more restrictive terms for their participation. As an example, most reinsurers will not support fronted programmes or programmes in which the reinsurer is the only party at risk. Most domestic reinsurers are looking for the issuing carrier to maintain at least 20% to 25% on a quota share basis or a minimum attachment point of $250,000 for specific excess. If the issuing carrier is not willing or able to retain meaningful risk, the policyholders or the MGA must have ‘skin in the game'. This position on risk taking has already had an impact on MGA-driven business and will be felt by the small mutuals at renewal.
The insurance industry's M&A activity of the 1990s included several malpractice carriers. Big unions included: ProNational – Physician Protection Trust Fund; Zurich – Truck Insurance Exchange; Frontier Insurance Group – Western Indemnity; HUM – OHIC; Medical Assurance Group – Momedico; FPIC – Physicians Reciprocal Insurers; Medical Group Holdings – Pennsylvania Medical Society Liability Insurance Company; and MMI – Unionamerica.
The trend toward consolidation has continued unabated. The St Paul – MMI acquisition and the Medical Liability Mutual Insurance Co (MLMIC) – Princeton Insurance Co merger were completed last year and the proposed Medical Assurance – Professionals Group merger is expected to be completed later this year, though it has met with some regulatory hurdles. These malpractice mega-mergers combine companies with similar underwriting territories and, therefore, reduce the number of options in their regions.
Just as important as last year's mergers and acquisitions were the new market entrants. In fact, increased competition may have been the leading reason for recent soft pricing. Zurich Insurance Group, Travelers, Chubb Executive Risk, Kemper Insurance Group and Legion Insurance Co each started offering medical professional liability products during the 1990s. In the ‘milder' medical professional liability market, the new entrants writing risks like social service agencies, nursing homes and biotech firms made an equally exhausting list (General Star, Admiral, Caliber One, Royal, etc.). Unfortunately, the departures of PIC, PIE Mutual and Paradigm were minimised because so many markets were willing to step into their place.
Reinsurers also played M&A musical chairs during the 1990s but the primary carriers have relatively the same number of options. General Reinsurance Corp, Employers Reinsurance Corp, Munich Re, CNA Re, Hannover and underwriters at Lloyd's of London have consistently reinsured US malpractice writers during the past 25 years. Two newer exceptions would be Swiss Re and Gerling Global. The Doctors Company (TDC) and SCPIE each created reinsurance divisions, but their success appears to be with non-healthcare opportunities.
Capacity has not shrunk for this line of business, but reinsurers are showing signs of selling their capacity at the appropriate price. Although reinsurers have a limited appetite for first dollar business, there has not been a withdrawal of capacity when the price is right. Reinsurance buyers ranging from the commercial markets to the bedpan mutuals will pass their increased reinsurance costs onto their insureds at renewal.
Alternative risk market
When speaking of the ‘alternative risk market' for the healthcare industry, we are not speaking of bond products and use of the capital markets. In fact, it's unlikely that capital markets will play any role in helping healthcare providers stabilise the cost of risk financing. For the purposes of this discussion, alternative risk refers to captive-related insurance mechanisms.
Alternative risk vehicles played an integral part in reshaping – expanding – the malpractice marketplace. Although their growth slowed in the late 1990s, risk retention groups (RRGs), purchasing groups (PGs) and rent-a-captives kept premiums down and put healthcare providers in control of their own destinies.
Healthcare providers have consistently been one of the leading classes to form. While the current number of RRGs for facilities and independent practitioners is relatively equal, we should expect the growth in RRGs to be among physicians and other individual providers.
Unfortunately, RRGs and single parent captives will not work for all classes of business. A prime example is the long-term care industry. While liability rates for this class are through the roof in some states, risk assumption cannot be the sole solution. In the following sections, we will look at some of the reasons why we have not seen a wave of nursing home RRGs during the past few years.
What will the future bring for healthcare's alternative risk market? As rates in certain regions harden and providers continue to merge, RRGs and PGs will continue to grow. Some groups will even use these risk vehicles to cover specialised risk such as capitation risk and Medicare/Medicaid Billing E&O. Again, this alternative will not suit the needs of all healthcare providers.
Physicians and medical facilities flocked to residual markets or joint underwriting associations (JUAs) during the 1970s crisis. Most of these JUAs have seen their state market share percentages drop into single digits, though the question is whether their market share will rise or fall during the next two to three years.
The Texas Department of Insurance expanded the underwriting authority of its JUA to include not-for-profit nursing homes, a move that has been viewed as ‘symbolic' by many facilities. A facility with a mediocre to below average survey could expect to pay as much as $3,000 to $4,000 per bed through the Texas JUA. These rates only contemplate medical professional liability, so a home would have to purchase general liability on a stand-alone basis. With rates comparable to the commercial market, the JUA cannot be perceived as the answer to the Texas nursing home crisis.
Managed care liability coverage is rarely offered through JUAs and/or patient compensation funds. The continued push toward state legislation as well as a federal Patients' Bill of Rights (the Norwood-Dingell bill) has led to rate increases in the managed care errors & omissions arena. In addition to rising rates, deductibles are being raised and caps on punitive damages are once again in fashion. Since managed care entities usually ‘administer' rather than ‘provide' medical services, they are not perceived as having a medical malpractice exposure. With this in mind, it may be some time before malpractice JUAs provide support for this hardening class of business.
Hard-to-place physicians have had huge shifts in premium pricing and availability. Malpractice carriers are re-evaluating their definition of non-standard physicians and we should expect doubled submission activity into underwriting units like the Bernard Warschaw/PULIC programme for hard-to-place physicians. Since the rate increases on physician business have not been anywhere near those experienced by nursing homes or HMOs, a viable market should remain for all types of physicians without forming new residual markets.
There does not appear to be a need for increased JUA activity during the initial stages of this hardening market. Healthcare liability risks have evolved rapidly in comparison to the products offered through JUAs and PCFs, so the current underwriting facilities are not equipped to handle all classes of healthcare. Unless state insurance departments are willing to make drastic changes to their malpractice facilities, we do not expect residual markets to be the solution for providers in the course of the next couple of years.
Markets vs bedpan mutuals
During the 1990s, commercial carriers went in and out of the malpractice market and the increased competition kept risks underpriced. The strength of the commercial markets was their ability to offer ancillary lines of coverage, and their multi-state licensing enabled them to write the larger provider groups. At the same time, many of the so-called bedpan mutuals saw their writings grow by only single digit percentages. Some introduced workers' compensation and provider excess products in order to address their clients' insurance needs, a few formed rent-a-captive units and some even merged or formed alliances to tackle the large risks. As rates harden and providers look for a cost-effective solution, it will be curious to see whether the bedpan mutuals or the commercial markets will be the preferred insurer.
If the provider-owned companies continue sound underwriting practices, explore emerging risks and are willing to deliver new products and services to their clients, they will be on equal footing with their commercial counterparts. Many of the specialty companies are adequately capitalised to offer new lines of coverage and alternative risk services. For those which are not financially sound, relationships can be developed with reinsurers and/or MGAs to supply the necessary coverage or service.
The commercial markets like St Paul, CNA and AIG already have the ability to underwrite every line of coverage for healthcare insureds. They can require insureds to place their non-volatile lines of business with them in order to maintain their professional liability insurance. The commercial markets clearly have more weapons in their arsenal, but relationships may be the driving force during the next few years.
Despite all of the attempts to push insurance transactions on-line, the insurance industry still relies on people skills. Medical malpractice will probably be the last line of insurance to go the way of the internet. Whether a physician is explaining her history of substance abuse or an underwriting manager is outlining goals to his reinsurer, the one-on-one relationship is critical.
The direct relationships between the provider-owned companies and their insureds is the elusive weapon that PIAA companies can use as the market hardens. There are long-term goals that are shared through these relationships and there's a sense of trust between the two parties.
The preferred malpractice insurer will be the one that builds relationships with its clients and does not look at the hard market as an opportunity to take advantage of insureds.
There has been an endless number of articles that address the skyrocketing liability rates for nursing homes. Some have said that the Medicare/Medicaid reimbursement rates have led to the poor performance of nursing homes. Others note that the limited supply of certified nurses' aides (CNAs) is the reason for the claims against facilities. Some of the entrepreneurs have suggested forming RRGs for state healthcare associations. Then there are those who have simply said that nursing homes are uninsurable due to the loss severity. With so many insurers and reinsurers seeing nursing home liability as the number one concern, it would be appropriate to discuss some of the myths and realities surrounding this class of business.
Myth: Nursing homes are all financially insolvent due to inadequate Medicare/Medicaid reimbursement.
Several underwriters have concluded that nursing homes are poor risks because they cannot afford to focus on quality of care issues. The same underwriters would have everyone believe that the trend of nursing homes filing for bankruptcy applies to both big and small homes. These and other financial setbacks are all due to federal and state funding. The reality is that there is a host of nursing homes that have learned to deal with the prospective payment system (PPS) and they are running profitably. It's not surprising that the same profitable homes are not carrying debt on their balance sheets from acquiring other facilities. In short, there are homes with sound financial management and this financial responsibility carries over into other parts of their operations.
Myth: CNAs are the reason for the incidents that occur in nursing homes.
It is true that the CNAs have the most hands-on contact with the residents. It is also true that CNAs do not have the same training as registered nurses (RNs). It can be said that higher turnover occurs in the CNA position than in any other found within a nursing home. With all of these issues it is understandable that CNAs are charged with the rise in loss activity. The truth is that senior management is the key to reducing loss; the CNA simply helps management reach its stated goals.
While CNAs are an integral part of a home's operations, they do not develop the practices and procedures that assure quality of care and services. Two key individuals in nursing homes hand down instructions; the administrator and the director of nursing (DON). If the administrator and DON implement superior procedures (and there are methods to confirm compliance), then the chance for loss will be reduced.
Myth: Nursing homes can form RRGs to solve the crisis.
In states like Florida, Texas, Arkansas, Alabama and California, retail brokers/consultants have suggested that the remedy to high premiums is a risk retention group. These consultants have gathered loss information, talked with reinsurers and earned consulting fees without answering their clients' tough questions: what are the cost reimbursement implications of premium versus capital? How is a home going to afford the first year's premium as well as the initial capital contribution? What claims procedures will be implemented in order to keep losses to a minimum? What clinical and administrative protocols should be followed by insureds to minimise loss?
Whether it is a broker, consultant or underwriter, the only way these questions can be answered is by having in-depth knowledge of a home's financial mechanics and its clinical practices.
Myth: Nursing homes are uninsurable.
We have a crisis for nursing home liability because we have inexperienced underwriters and dynamic underwriting has been replaced by opportunistic underwriting. This statement applies to both the insurance and reinsurance communities. These industries have become lazy in that they are not willing to truly learn about the exposures we insure or reinsure. Fortunately, there is a select number of underwriters who have taken the time to analyse their clients risk so the ‘uninsurable' can be insured.
Young professionals who have not experienced a hard market are managing the day-to-day underwriting of risk. As market conditions change, their knee-jerk reaction is to avoid risk rather than underwrite risk. ‘Avoiding' risk is done in one of two ways: cease writing a tough class or charge premiums so exorbitant that there is no chance of a high loss ratio. Taking either of these approaches ruins any hope for a long-term relationship.
Relationships can be established and nursing homes can be insured, but only when the two parties understand the other's business and goals. It is the responsibility of the primary carrier as well as the reinsurer to know more than catch phrases like ‘Chapter 400' and ‘pressure sores' to explain the reason for losses. We must understand why legislation like Chapter 400 was originally enacted and what is the physiology behind pressure sores. As specialists, we must know all aspects of our clients' operations if we are going to help them through this crisis.
What should we expect during the next 24 months? We will see commercial carriers target even fewer classes of healthcare risks and focus their resources on providers that have historically performed well for them. The big dollars surrounding nursing home liability will continue to entice carriers to ‘dabble' in underwriting nursing homes, but there will not be enough interest to stabilise rates. And it is unlikely we will see more than one new carrier writing medical malpractice.
Reinsurers will require even new carriers to assume meaningful risk. As a novice, it is unlikely that a new market will be agreeable to assuming the first $250,000 of loss. In addition to risk taking, reinsurers will push for modest rate increases and insured providers will feel the effects.
The provider-owned mutuals will need to continue efforts toward offering ancillary lines of coverage. At the same time, they need to utilise their strong relationships in order to retain their most profitable business.
Cultivating relationships with their reinsurers will be equally as important so they can keep increases to a minimum.
Finally, underwriters will be carefully watching the US legislators during the next two years. Healthcare data requirements (from HIPAA of 1996 and subsequent proposed rules), open access to the National Practitioners Data Bank, a Patients' Bill of Rights for HMO enrollees and some type of tort reform for nursing homes are all on legislators' to-do list and each will have rate implications for different sectors of the healthcare industry.