What's Happening to the Cost and Quality of Medical Malpractice Insurance?

by Rick Mortimer

Published in Cost and Quality Journal - March 1998

What a difference a generation makes! In 1975 physicians and other health care providers were hard pressed to find any underwriter willing to sell them medical malpractice insurance protection at any price. Now, over 60 insurance companies and trust funds are offering many say, bargain basement prices to capture a share of a market that has consolidated the buying decisions of thousands of doctors into a relative handful of corporate managed care and health maintenance organizations. Whether you make the buying decisions for your own practice or rely upon the CFO of your MCO, HMO, PPO, IPA, or other group organization, beware! Although professional liability underwriters as a group are capital rich, many are struggling to survive. Don't be seduced by the perfume of low premiums with out doing your homework. You may be left with the stench of claims unpaid by an insolvent underwriter.

To understand what's happening, let's look back 23 years. The malpractice insurance crisis of 1975-76 was triggered by El Nino type floods of red ink that washed away the underwriting profits of commercial underwriters who handled 95% of the physician medical malpractice risk. The crisis started in California and swept across the country when Travelers Insurance Company and other leading underwriters abandoned the market as the rising tide of claims frequency and severity threatened their solvency. A few companies, including Signal Imperial and Glacier General tried in vain to weather the storm. Despite 400% plus increases in premiums, they were washed into oblivion.

The business of medicine was different then. By and large, doctors either practiced alone or in small loosely structured clusters. Throughout the country, they relied upon the clout of their local medical societies to keep malpractice premiums low by sponsoring commercial underwriters that were willing to issue their policies to member doctors at below market rates. As a result, the markets in many states were controlled by one or two insurance companies. When they abandoned the market or increased prices 400%, doctors only had one option. So, they formed their own "not for profit" mutual and reciprocal insurance companies and trust funds which collectively were tagged as "bed pan mutuals." California set the paradigm for the rest of the country.

Five insurance companies were formed in California within two years (1975-77). Three were sponsored by medical societies and two by entrepreneurial spirited physicians. In addition, one co-op trust that pooled it's members' risk on an assessment basis was formed. All were capitalized by contributions made by their policyholders and trust members. In return most contributors received a non-interest bearing Contribution Certificate which included terms similar to a subordinated debenture.

The "bed pans" filled the void and reduced prices by only offering policies that cover "claims made" during the term of their policies. Because the carriers were generally unwilling to provide protection for "prior acts", they effectively started with a clean slate. By refusing to provide "occurrence" type protection that allows claims to be submitted years after the policies expire, they also minimized the uncertainties of the "long tail" exposure that villainized the commercial underwriters. Instead of looking into the crystal ball to estimate the amount of premium they needed to collect in one year to pay claims reported long after the policy expiration, the move to claims made allowed underwriters to base their rates only on the claims they expect to receive during each policy year. They were able to gradually increase their premiums upon the renewal of each policy based upon a retroactive date rather than prospective analysis of claims frequency and severity over an unlimited future. Although the rating process eliminates long tail considerations, claims made rates become comparable to occurrence form rates within five to seven years. As a result of the combination of the adoption of the claims made policy form and the underwriters' non-profit status, the bed pans arrived into the early 90's with little competition within the boundaries of their respective societal territories. Along the way, many accumulated tremendous amounts of surplus.

Ironically, as the result of the companies' financial success, over 20 new capital rich carriers are now aggressively competing for a share of California market. Significantly, the shift from solo and small group practices to large managed care organizations has exerted extreme pressure on the doctor owned companies. Although the increasing number of commercial underwriters is keeping prices low, a nine year up-ward trend in claims frequency and severity is increasing the pressure on them to raise rates. Despite many of the insurers' CEO's call for higher rates, medical malpractice insurance continues to be a good buy, and in many cases a great buy for the larger IPA, MCO and physician group organizations. The scenario is the same throughout most of the country.

In the face of intense competition and a decreasing pool of prospective customers, the questions are; How will underwriters survive without increasing rates? How can they increase rates without loosing market share?

Two of two largest California doctor owned reciprocals, SCPIE and Doctors' Company, believe they are answering the questions by converting to publicly owned capital stock companies. Consider SCPIE's strategy.

After going public, SCPIE embarked on a national expansion campaign. One of its first moves was to acquire Fremont Indemnity's book of medical malpractice policyholders. Fremont got deep into the malpractice business by acquiring the policyholders of Physicians and Surgeons Insurance Exchange of California (PSIE) in 1984. To down play the significance of rate increases levied in 1997, SCPIE announced in its December 3, 1997 edition of its news letter, MEDIGRAM that "despite the rate increase in 1997 actual premiums will be comparable with those paid eight years ago. Factoring in inflation with consumer price index, physician premiums in 1997 correlate to those paid in 1984".

While its early, it appears SCPIE's attempt to get their policyholders to stay put and pay higher premiums in the heat of heightened competition is working. Even though its rates for many specialties are higher than some in southern California, its policyholders continue to support their once non profit, now publicly traded insurance company, buying quality over bottom dollar price.

SCPIE's story of how a small doctor owned reciprocal insurance company has grown into a local dominate player now expanding nationally is being watched closely by the 40 or so remaining doctor owned carriers across the country. It will be survival of the fittest. As the smaller companies feel the pain of the loss of market share and eroding profits, they will go the way of PSIE and look to SCPIE, Doctors' Company, CNA, St. Paul, MMI or other prominent malpractice underwriters to bail them out.

On the heals of nearly a half dozen medical malpractice company failures in the last 24 months, now more than ever, physicians must balance quality with cost when purchasing malpractice insurance in this increasingly volatile marketplace.

Rick Mortimer is co-owner and Executive Vice President of HealthCare Professionals' Insurance Services. He has specialized in insurance and alternative funding mechanisms for the health care industry for over 20 years and is responsible for the daily management of HCP.