A Risk Financing Focus: Physician Group Practices and Integrated Delivery Systems
by Rick Mortimer
HealthCare Professionals' Insurance Services, a division of
R.W. Mortimer & Associates Insurance Agents & Brokers, Inc. Brea, California
The Changing Business of Health Care
The Malpractice Insurance Business
Risk Management for Health Care Provider Organizations
The Role of Insurance Brokers
RISK MANAGEMENT FOR THE HEALTH CARE INDUSTRY
For over 20 years, HealthCare Professionals' Insurance Services (HCP) has
specialized in the development of insurance programs and alternative risk funding
mechanisms for health care providers. HCP has earned recognition as a leader in
the field by keeping pace with the evolutionary changes in the business of
medicine, creating innovative solutions to the problems of managing the
financial risk confronting a new generation of blended health care benefit plans
and provider delivery systems.
HCP shares its perception of the challenges confronting the health care industry
as it moves into a new millennium, by reciting history and focusing on the
changes taking place in the business of medicine. It observes that each change
in the health care delivery system has been accompanied by new theories of tort
liability, which shift the financial burden from individual providers to large
corporations with deeper pockets.
HCP focuses on the historical use of insurance and the traditional role of
insurance brokers to emphasize its position that the new generation of health
care plans and provider systems cannot afford to purchase their property,
casualty, and professional liability insurance in a "business as usual" fashion.
HCP encourages plan managers to add "fee-for-service" insurance brokers to their
teams of outside legal and financial advisors.
By charging for its services on a fee basis, HCP has eliminated the conflict of
interest inherent in commission-based, traditional brokerage houses. By not
relying on insurance carriers' payment of commission as its sole compensation
base, HCP has been able to foster the independence that has brought with it good
working relationships and the respect of underwriters in every segment of the
medical malpractice insurance marketplace, including direct writers and
provider-owned carriers, as well as the traditional commercial markets.
By including HCP on their team of independent advisors, clients are not only able
to take advantage of HCP's existing relationships, its expertise and broad base
of knowledge gained through servicing of the needs of large health care provider
networks and groups, but they also, with rare exceptions, save money in the
please read on.....
Since 1959, R.W. Mortimer & Associates has been helping families and business
owners meet their needs for financial security and peace of mind through the
purchase of insurance. As the company grew, its founders recognized that one of
the keys to its success was the ability to provide a level of professional
expertise and personalized attention and service generally superior to that
offered by its competitors. It also realized it could increase its competitive
edge by catering to the specialized needs of selected industries.
The medical malpractice crisis of 1975-76 presented a unique opportunity to
specialize in the health care industry. The company's principals played a key
role in the formation of a doctor- owned, reciprocal insurance company to fill
the void left when several commercial insurance underwriters ceased writing
medical malpractice insurance policies in California. HealthCare Professionals'
Insurance Services (HCP) was formed to cater to the insurance needs of
physicians, surgeons, and other health care providers and organizations.
During the past 20 years, HCP has earned recognition in the health care industry
as a leader in the creation and implementation of innovative solutions to the
management of financial risk for large group practice health care providers and
other similar organizations. This monologue shares HCP's insight into meeting
the insurance and risk management needs of the changing health care industry, as
it moves into the 21st century.
THE CHANGING BUSINESS OF HEALTH CARE
Prior the mid 1970's, it is estimated that over 90% of all physicians and
surgeons were either in private practice or largely constituents of two- or
three-member partnerships. Personalized care and attention to patients was
emphasized, and house calls were not uncommon, until the malpractice crisis of
The crisis created a public awareness of the economics of the business of
medicine when physicians went on strike to protest the rising cost of malpractice
litigation and insurance. The cost of health care started escalating at rates
which were multiples of the annual rate of inflation, as providers passed their
increased costs of insurance on to their patients, and added charges for
diagnostic tests and examinations many times performed principally to help avoid
accusations of negligence.
Patients were pummeled from two sides by the rising cost of health care. They
were not only forced to pay more for their health insurance, their family budgets
were also effected by new policy exclusions and reduced benefits. Families that
had never before failed to pay their medical bills began to find it difficult, if
not impossible, to meet these obligations.
Doctors and other providers were also caught in a financial squeeze which
threatened their economic positions. The pressure of coping with increased
operating costs, and the expense of keeping pace with technological advances in
their practices were compounded by their inability to collect 100% of their fees.
Providers were faced with two choices: pursue their patients to collect, or
write off their uncollectable receivables as bad debts. Either way, they
recognized that the underlying problems would not be solved. They were forced to
find ways to reduce the cost of their services without sacrificing quality.
Two solutions emerged: First, solo practice physicians and surgeons began to
cluster into groups organized to relieve them of distracting administrative
chores and to spread the cost of doing business. The group practice concept was
not only designed to reduce the cost of health care, but to offer patients
greater access to a variety of specialists within one office who would tend to
their needs more efficiently.
Secondly, in a parallel move, entrepreneurial physicians planted seeds which
later flowered into health maintenance organizations (HMO), physician hospital
organizations (PHO), and preferred provider organizations (PPO). Later on,
independent practice organizations (IPA) and managed care organizations (MCO)
At the beginning of this decade, politicians moved health care reform to the top
of their list of priorities. Threats of nationalized health care and a universal
payment system have challenged the medical establishment and the health care
industry to bring down the cost of health care or lose the delivery system we
know today. As a result, health care organizations began to proliferate at an
even faster rate.
Wall Street saw the opportunity to make money by supplying the capital to bring
medical and health insurance providers together under one financial umbrella. In
a move towards 24 hour health care, Workers Compensation insurance carriers began
to be included under that umbrella. The public trading of stocks of Managed Care
Organizations (MCO's) has served as a catalyst to move an increasing number of
doctors out of private practice to become employees of wholly- owned subsidiaries
or independent groups managed by physician practice management companies (PPM's)
A recent survey of 2,800 employers conducted by the employee benefit firm of
Foster Higgins found that the number of employees enrolled in HMOs increased from
23% in 1994 to 27% in 1995. Significantly, the average cost to a company for HMO
coverage fell from $3,556 to $3,255 per worker while the national health benefit
costs for business, including all types of insurance, rose from $3,471 to $3,821.
The reductions were achieved by challenging the traditional provider
fee-for-service charges for office visits, tests, treatments or surgery, to a
flat monthly payment based upon the number of individuals enrolled in the HMO,
regardless of the services provided.
According to a Foster Higgins spokesman, employers believe that HMOs have
squeezed everything they can out of doctors, hospitals and other providers and
are concerned that further cost reductions will impact the quality of health care
delivered. To find additional savings, business is now shifting its focus away
from the providers and onto the HMO plans themselves.
The message is clear and presents a challenge to managers of HMOs and similar
group practice models. Employers will not readily accept a compromise that
reduces the quality of health care in return for dollar savings. They understand
that the trade off can mean greater costs in terms of loss of productivity due to
employee illness and disgruntlement. Nor can the health care provider
organization afford the inevitable increase in medical malpractice complaints.
HMO and "systems" managers must concentrate on finding other ways to reduce their
administrative and operating costs if they want to be price competitive and not
adversely effect quality.
THE MALPRACTICE INSURANCE BUSINESS
Prior to the 1975-76 crisis, commercial insurance companies collected an
estimated 80% plus of the premium dollars paid by health care providers for
malpractice insurance. In response to the commercial insurers' demands for
overwhelming premium increases, doctors formed their own mutual and reciprocal
insurance companies and cooperative underwriting facilities. Overnight, the "bed
pan mutuals" (so-called by their commercial carrier competitors) captured the
individual physician and small group market by convincing doctors to replace
their expensive occurrence-type policies with the new claims-made coverage model,
which offered the lure of lower operating overhead of their non-profit status,
which would be passed on in the form of lower rates.
Other than changing to the claims-made policy form, by and large the new
companies carried on the commercial underwriter's practice of catering to the
needs of the individual physicians and surgeons who dominated the health care
market place. When presented with requests for proposals from physician
partnerships and other groupings, some struggled with the concept, and many
continued to issue separate, stand-alone policies to each individual doctor, or
refused the larger clinic opportunities. Carriers who specialized in covering
hospitals and larger clinics avoided extending individual doctor coverage under
their policies to independent physicians and surgeons who had been granted staff
privileges by their hospital and/or clinic policyholders, as they did not view
these physicians as a direct corporate risk.
The changes in the way health care protection is purchased, and the delivery of
care by the accelerated growth of large group practices and managed care
facilities has forced malpractice insurance underwriters to rethink the way they
do business. Policies and services originally designed for individual
practitioners and small groups do not fully meet the needs of providers that
require protection for their corporate interests. Particularly the new demands
for creative financing options for larger numbers of physicians under one buyer.
Many underwriters are beginning to recognize that the malpractice exposure can be
more accurately quantified when significant numbers of doctors are required to
conform to defined treatment standards and are paid based upon patient volume
rather than for services rendered. However, with this change has come a trend
towards increasing numbers of medical malpractice cases of failure to diagnose
which could be an out growth of managed care.
Progressive underwriters are willing to gamble their surplus to capture a share
of the premium pool and related services paid by large managed care, group
practice and integrated delivery facilities. Others are more cautious about
taking on large groups of physicians at discounted rates, as losses are growing
disproportionately to historical trends. Not only are commercial carriers
reentering the market, but an increasing number of doctor-owned companies
previously committed to underwriting primarily individual practitioners and small
groups in single states are now willing to innovate and tailor their policies and
services to the specific needs of large groups, hospitals, and integrated
systems. If they do not, they face declining market share to the big commercial
During the past ten years, most group administrators have relied primarily on the
purchase of insurance to finance the business risk associated with malpractice
They have focused on reducing costs through mergers, acquisitions and internal
growth, and by expecting their underwriter to discount the rates charged for
individual medical specialties simply because of the large numbers of doctors
available to insure.
At best, they have given only passing consideration to risk management methods,
such as; loss prevention, mitigation, and risk retention, promoted by their
physician owned and commercial insurers. Even so, this approach has worked well
until most recently.
Between 1988 and 1993 group practices consistently negotiated rates which were up
to 45% below the standard (solo practice) premiums charged by their carriers.
These deep discounts turned the underwriter actuarial tables upside down as time
passed. While the loss experience of solo practitioners and smaller groups
(those paying under $250,000 annual medical malpractice premiums) remained
largely within expected ranges, underwriters began to realize they had
overestimated their ability to quantify and accurately price the exposures of
larger groups. They suffered greater than anticipated losses on their discounted
group accounts before beginning to tighten the underwriting tourniquet to stop
the financial bleeding.
Note: In 1990, 29% of cases arose from failure or delay in diagnosis, and they
represented just 19% of total indemnity. By 1995, these cases comprised 40% of
the total and accounted for 32% of all 1995 indemnity. Average indemnity in
failure to diagnose cases grew from $550,973 in 1990 to $775,123 in 1995. Of the
indemnity awards of more than $1,000,000 only 2 involved diagnostic errors in
1995 compared to 13 in 1994, according to MIEC's 1995 California Large Loss
During the past two years many carriers have been playing catch-up by increasing
premiums for their larger group policyholders, in some cases by as much as 100%.
Faced with intense price- driven competition from reemerging commercial
underwriters, health care CFO's were pressured to find ways to mitigate the
upward move in the cost of insurance. Those seeking to grow by acquisition and
merger can no longer always count on increasing their profits by reducing their
consolidated medical malpractice premiums through size discounts alone. Rather,
they are faced with either: a) absorbing the premium increases, b) moving into
the unfamiliar world of alternative risk financing, c) jumping at temporary price
reductions offered by the vast array of new markets seeking large accounts (often
attached to self-insured retention SIR) or, d) a combination of the various
Many CFO's are, for the first time, embracing the alternative funding mechanisms
which have been used for decades by their counterparts in large industrial
organizations. They are realizing that, in general, first dollar insurance is
the most expensive way to finance risk. Rather than looking solely to insurance
companies for protection, they are implementing loss prevention programs,
exercising greater control over the management of claims, and reducing costs
through a combination of risk retention and the purchase of excess insurance,
among other loss sensitive plans.
RISK MANAGEMENT FOR HEALTH CARE PROVIDER ORGANIZATIONS
The significant changes in the way health care medical liability protection is
purchased and the way health care services are delivered have generated a new
variety of risks that must be addressed by health care providers.
By bringing the services of physicians, hospitals and other health care providers
under the umbrella of one MCO, the separate images of each physician and entity
is merged into one in the public's eye. Regardless of the nature of their
relationship: whether the providers are employees, joint venturers, independent
contractors, or subsidiaries, the whole becomes the sum of its parts. The
creation of large organizations through mergers and acquisitions opens the vault
to withdrawals for settlements of claims not typically experienced by smaller
Claims of negligence are being asserted by patients who would not otherwise
complain had they not been aggravated by the perception of a lack of continuity
of care by attending physicians, prolonged delays in receiving treatment, or long
waits to actually be seen by a physician. Claims triggered by patient hostility
are becoming the norm and increasingly costly for MCO's, as their medical
malpractice underwriter merely passes the costs back to them.
Plaintiff lawyers are cashing in on new theories of tort liability which may hold
MCO's vicariously accountable for the overt acts, or the negligence of their
providers. Failure to properly select or deselect panel providers or monitor
their performance is becoming more common as causes of action. Allegations of
failure or refusal to provide, or pay for, experimental or otherwise
controversial treatment for life-threatening maladies are resulting in million
dollar settlements. Few are covered for claims arising out of physicians'
medical liability by conventional medical malpractice insurance policies. New
insurance products are developing and are becoming more readily available for
handling the growing exposures of this burgeoning industry.
While claims of malpractice are generally understood, large MCO's are confronted
by an array of other kinds of risk. Examples of these include: Workers
Compensation claims, claims against directors and officers for malfeasance and
antitrust violations, claims alleging discrimination in the credentialing of
providers, violations of various state and federal statutes and regulations
governing employment practices (including ERISA), and assumption of claims-made
prior-acts a.k.a. tail exposure of acquired providers.
The realization that some losses can be predicted with reasonable accuracy and
budgeted for as a routine cost of doing business enables management to rethink
how it uses insurance to control the cost of risk.
An analogy helps to illustrate the point of buying first dollar insurance
coverage. Every retail shop owner knows that the loss of merchandise to
shoplifters is part of the regular cost of doing business. Some ask their
insurance broker if they can purchase a shoplifting policy. Although the answer
is no, the creative broker will ask how much the owner expects to lose, mark up
the result by 25%, and quote a premium. Rather than pay 25% more than their
expected losses, merchants add projected shoplifting losses to their inventory
costs, and mark up their prices accordingly.
Unlike the shoplifting losses in the foregoing analogy, the reasonably
predictable cost of malpractice, miscellaneous liability, workers compensation,
and health care benefit plans are already included in the premiums paid by MCO's
to the insurers. Rather than pay the "mark- up", it is possible for MCO's to
obtain premium reductions larger than the cost of their expected losses by
agreeing to retain large portions of their predictable losses. But a word of
caution is required:
Insurance; an ingenious modern game of chance in which the player is permitted to
enjoy the comfortable conviction that he is beating the man who keeps the table.
CFO's must not be lulled into a false sense of security by thinking they can
always beat the cost game through the use of deductibles and risk retention. The
decision-making process is complex, and it goes beyond the simple calculation of
premium credits based upon deductible amounts retained.
The decision process starts with charting the organizational structure and its
obligations to providers, and the development of a risk profile. The decision to
use deductibles and risk retention to reduce costs should not be made until the
CFO understands the MCO's obligations, has become comfortable with the accuracy
of the loss predictions, is clear on who is going to administer the routine
claims, has quantified the variable costs of claims administration, and has
determined the maximum amount of accumulated claims payments the MCO can absorb
in any given year. Because more than one type of insurance may be involved,
extreme care must be taken to integrate the deductible and retention limits of
separate coverages and treat them as though they were one. In addition, the
client should, with the assistance of its Broker/Consultant, pick the retention
amounts itself, rather than rely solely on the reinsurer to select the
attachment points. These should be set with an eye to the client's profitability
and comfort zone, not those of the reinsurer.
Deductibles and retentions are typically "self-funded". Claims that fall under
the assumed amounts are generally paid out of cash flow. Larger organizations
may find it advantageous to consider alternative ways to fund their risks. The
formation of a captive insurance company, participation in a captive pool, the
use of a rent-a-captive, reinsurance, and other methods must be considered, as
well as the business and tax advantages or disadvantages of each.
Three Risk Management Terms to be Familiar With:
encompasses the avoidance or elimination of risk and risk reduction
through loss control. Loss control reduces the probability that loss will occur
and also reduces the magnitude of losses that do occur. Risk control, however,
only addresses a portion of the risk management process and is not a complete
solution in itself.
involves various techniques to pay for losses that occur in spite
of risk control tech- niques that are utilized. It involves assumption of risk
and risk transfer. Assumption or retention of risk, either wholly or partially
means that the risk is borne or financed internally.
can mean either a contractual transfer of risk or transfer through
the purchase of insurance
THE ROLE OF INSURANCE BROKERS
Despite what most insurance agents would have you believe, the purchase of
insurance is relatively uncomplicated. Most individuals and business managers
know it is prudent to buy insurance to protect their assets. Because many
buyers look upon insurance as a necessary evil and a mere commodity, they
generally look upon agents and brokers as little more than shopping services to
find the best price for the type of policy wanted. They place little value on
the agent's or broker's services because insurance companies pay them commissions
for bringing the buyer to them and servicing the business once placed.
However, those few MCO's that have risk management professionals on staff
regularly rely on the advice and services of a knowledgeable independent broker.
The challenge is to find a Broker with a working knowledge of the health care
industry, with hands-on experience in dealing with the risks faced by health care
providers, and who is schooled in the art of risk financing- not merely with the
purchase of insurance. Only a handful of Brokers in the United States are able
to meet these criteria with any consistency.
Alternative Markets Cannot be Ignored
Before the 1975-76 crisis, most doctors, hospitals, and other health care
providers relied upon the leadership of their medical societies and associations
to select the carrier and designated sales agent. As a result, their "sponsored"
programs effectively stifled competition for their business, and created
quasi-monopolies for the bidders (carriers and agent) who won their endorsement.
Although the formation of doctor-owned companies appeared initially to increase
competition, most were founded around the nucleus of the members of local medical
societies and, therefore, catered specifically to the needs of the individual
practitioners. Few would allow agents or brokers to sell their policies. Only
recently have some of these companies revamped their operating premise. They
have entered the group practice arena and have been forced to play catch-up with
their commercial competitors who lost the physician market 20 years ago while
maintaining control of the larger risk market. They are under pressure to
acquire the knowledge of risk management techniques and alternative funding
mechanisms necessary if they are to capture a representative share of the large
health care provider market. Many are relying on qualified brokers for help.
The typical insurance agent is not equipped to deal with the complexities of the
business risks confronting large health care providers. Even many who have the
requisite skills cannot be relied upon to place their client' needs above their
own interests. Why? Because there is an inherent conflict of interest in the
way most brokers do business: on a strict commission basis.
Most brokers break their client's premiums into two parts: part one is paid to
the carrier, part two is kept by the broker as a commission for services
rendered. The buyer seldom knows the breakdown of these two parts.
The dilemma facing the commission-oriented broker is that they must cater to the
carrier's needs while trying to serve the client at the same time. Because the
carrier dictates the underwriting conditions and sets the rates for the broker's
commissions, it is unusual for these brokers to approach any direct writing
carrier, including the bed pan mutuals, because as a rule direct writers price
their policies net of commissions.
Traditional brokers are caught between the proverbial rock and a hard place: the
better job they do for their client in reducing costs, the less they get paid.
Therefore, like Diogenes searching for an honest man, CFO's should take the
advice of a commission-only broker with caution. The physicians' medical
malpractice insurance marketplace is much larger than traditional-large
commercial commission paying markets.
THE ALTERNATIVE: HEALTHCARE PROFESSIONALS' INSURANCE SERVICES (HCP)
R.W. Mortimer has taken a leadership role in changing the way insurance agents
and brokers do business by establishing a specialized health care division.
HCP's principals made a commitment to professionalism by structuring this
division's compensation on the basis of value of the advice given and the
Rather than provide the "shopping service" typically offered by brokers who
utilize only commission-based markets, and by adopting a fee-for-service
strategy, HCP positioned itself to become a vital member of its client's team of
independent management advisors. HCP expects to make a significant contribution
to its client's financial success by serving shoulder-to-shoulder with their
attorneys, accountants, actuaries, and risk management team to employ the latest
risk financing techniques and seek out cost reduction opportunities wherever
available for its client.
HCP's function is to help its client evaluate their exposures to loss and to
structure financing plans designed to fit their specific needs. Even those
clients with risk management departments already in place can benefit from the
services provided by HCP. Importantly, HCP never has to factor its own financial
needs into any proposal it presents to its client.
Because HCP presents itself as a member of its client's team of independent
management advisors, it is able to open doors to insurance carriers overlooked
by, or not otherwise available to, commission brokers. Due to its ongoing
dealings in the underwriting marketplace, it has developed a working relationship
with virtually all of the leading medical malpractice underwriters. HCP has
earned an impeccable reputation for integrity and technical competence that risk
managers can use to their advantage.
HCP's principals and staff of qualified service representatives recognizes it
cannot be all things to all people. That is why HCP does not hesitate to consult
with other experts in their respective fields. HCP assumes the role of
coordinator and assembles and monitors the team of actuaries, claims
investigators, loss and quality control technicians, captive managers, (if
necessary) and other experts to complement the services it provides. The same
concept applies to the selection of an insurance carrier and the placement and
service of the insurance piece. HCP's broad and unbiased knowledge of the many
insurance carriers and products results in a wider variety of options from which
HCP's clients are able to chose and is unique to professional medical malpractice