session 7 medical malpractice

Session 7

MedicalMedicalMalpracticeMalpractice

Kevin M. [email protected]

Casualty Actuarial Society Loss Reserve SeminarSeptember 14, 20041:00 – 2:30 amLas Vegas, Nevada

mailto:[email protected]

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INTRODUCTION

• Where Are We Now• Why P&C Insurance Companies Fail• Why Medical Malpractice Insurers Fail• Warning Signs• Prevention• Closing Thoughts

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Where Are We Now

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Golden Years

Late 1980s and early 1990s• Favorable reserve development

° Benefit reflected in the current calendar year results

• Lower level of loss trend• High investment yields• Favorable reinsurance pricing• For some, rapid expansion into new markets

5

What Changed

• Loss trends worsening° PIAA data sharing project

• % of 2001 Paid Claims > $1M – 7.9% has doubled since 1997• Indemnity and ALAE payments rising at alarming rates

° Jury Verdict Research – 2001 Average jury award of $3.9 million has tripled since 1994

° Tillinghast-Towers Perrin - tort costs jumped $27.4 billion or 13.3 percent to $233 billion in 2002 (representing 2.23 percent of GDP or $809 per capita). Less than half of the tort costs compensate the victim. Only 1/5th of the tort costs are for economic damages.

° Double digit healthcare inflation° Medical malpractice jury verdicts making the “Top 10” list in

multiple states and nationally (e.g., Lawyers Weekly USA)

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What Changed

• Medical malpractice premium writing capacity down 15%° Impact varies by state and by counties within certain states

• Reinsurance market has hardened° Recent announcements of prior year reserve strengthening° Leveraging effect of severity on excess layers

• Investment returns have declined° A 250 basis point drop in returns equates to a rate increase of

roughly 5 to 10%° For example, compare current yields to 1990’s 3-month yield of

7.5%

• Medical malpractice market is “in crisis” in 20 states according to the AMA (as of September 2003)

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Industry Results

• 2001 industry-wide financial results° Combined ratio of 154% (measures how much of a

premium dollar is dedicated to paying insurance costs of the company in a calendar year)

° Operating ratio of 135% (combined ratio reduced for investment income)

• 2002 industry-wide financial results° Combined ratio of 142%° Operating ratio of 130%

• 2003 industry-wide financial results

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Where Are We In 2004

• Rates approaching adequate levels in many states° Based on year-end earning calls, rates are expected to increase 10

to 25 percent during calendar year 2004

° Down from 20 to 40 percent levels in 2002 and 2003

° Fewer “outlier” states (e.g., 80% rate increases)

• Risk retention levels up (e.g., doubling at year-end 2003)

• Underwriting focus is critical for industry’s survival

• Heavy focus on core states (e.g., ProAssurance/OHIC)

• Targeting combined ratio < 100%

• Continued rating agency pressure

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Tort Reform

Individual State Proposals• Vary dramatically• Key differences

° Cap on non-economic damages

• Dollar amount• Application of caps• Need for constitutional

amendment

° Statute of limitations° Collateral source rule° Limitations on attorney fees° Periodic payments rules

• Key differences (continued)° Bad-faith° Patient Safety° Patient notification (a/k/a “I’m

Sorry” provision)° Certification requirements° Arbitration process° Definition of expert witness° Specialized medical

malpractice judges° Constitutionality

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Tort Reform

Issues• Miscommunication of facts by lawyers, consumer rights

advocates and legislators of the reasons underlying the medical malpractice crisis° Insurers are recouping stock market losses° Insurers are setting rates in collusion (e.g., want to eliminate the

McCarran-Ferguson anti-trust exemption for medical malpractice insurers)

° Insurers are “faking” loss reserves• Difficulty passing reforms

° If passed, watering down of reforms by lawmakers° Some states need constitutional amendment for limitations on

damages to withstand court challenges

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Tort Reform Issues

• Cap on non-economic damages° Hard cap (e.g., $250,000 MICRA cap)

° Soft cap• Florida

• Texas

° “Cap busters”• Florida

• Massachusetts

• Emergency room vs. non-emergency room• Practitioner vs. non-practitioner• Per defendant caps• Per claimant caps• Piercing

• Disfigurement• Death• Vegetative state• Unanimous verdict

RESERVINGIMPACT?

Constitutionality?Phase in of law?

Economic damage ratio?

Trends in policy limits?

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Cap on Non-economic Damages

• Type of cap and reserving impact (continued)° Massachusetts

• McCullough, Campbell & Lane - Damage Caps (www.mcandl.com/massachusetts.html)

“In a medical malpractice case, the jury is instructed that if it finds the defendant liable, it is not to award the plaintiff more than $500,000 for pain and suffering, loss of companionship, embarrassment, and other items of general damages, unless it determines that there is:

a substantial or permanent loss or impairment of a bodily function or substantial disfigurement, or other special circumstances in the case which warrant a finding that imposition of such a limitation would deprive the plaintiff of just compensation for the injuries sustained.

Mass. Ann. Laws ch. 231, § 60H (Law. Co-op. Supp. 1997). Since this standard can often be met, the cap should not be relied on.”

Makes pricing and reserving easy … No impact

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Why P&C InsuranceCompanies Fail

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Why Companies Fail – P&C IndustryREASONS FOR INSOLVENCY

1993 - 2002

I. Deficient loss reserves 51%II Rapid growth 10%III Alleged fraud 3%IV Overstated assets 2%V Discounted Operations 8%VI Change in business 3%VII Reinsurer failure 0%VIII Catastrophe loss 3%IX Unidentified 17%X Impairment of affiliate 3%

100%

Note:218 property/casualty insolvenciesfrom 1993 to 2002 generated a 10-yearaverage failure rate of 0.72%.

Source: A.M. Best Co.

I., 51%

II, 10%

III, 3%

IV, 2%

V, 8%

VI, 3%

VII, 0%

VIII, 3%

IX, 17%

X, 3%

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Why Medical Malpractice Insurers Fail

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Medical Malpractice Insolvencies

• Internal Deloitte “Straw” Poll° Pricing inadequacy° Misreading of loss cost trends° Rapid growth° Reserve deficiencies° Pressure from external sources to diversify° Poor claims handling° Reinsurance collectability° Loss of reinsurance support° Monoline focus/limited state spread (i.e., lack of diversification)° Management issues° Plaintiff attorney’s with big war chests diversifying from asbestos° Cultivation of “juicy” jurisdictions ripe for large awards° Inadequate Management Reporting Systems

3-O’sOver-optimismOver-expansionOver-confidence

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• PIC Insurance (1998)° Pricing inadequacy/Adverse reserve development (ARD)

• PIE Mutual Insurance Company (1998)° Pricing inadequacy/ARD/Management/3-O’s

• PHICO (2002)° Pricing inadequacy/3-O’s/Significant ARD/Management

• Medical Inter-Insurance Exchange (MIIX) (2002)° 2002 SEC 10K – “Unexpected and unprecedented increases in loss severity during

fiscal 2002, 2001 and 2000 related to prior years’ business”• Approximately $50M in prior year reserve development each year: 2000, 2001, 2002

• Reciprocal of America (ROA) (2003)° Reinsurance collectability° Loss of reinsurance support° Rapid DWP growth (e.g., Alabama from $168,000 in 2000 to $29M in 2001)

Public Perception of“Reckless under pricing”

and Price Competitionat any cost

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• PIE Mutual Insurance Company° Ohio’s largest medical malpractice writer° Liabilities exceed assets by approximately $250 million when shut down° Guarantee Fund (GF) payments as of December 31, 2003 *

• $385 million (#7 on NCIGF’s all time largest P&C insolvency list) Ohio GF payments of $180 million (47%) Pennsylvania GF payments of $72 million (19%) ¼ LAE, ¾ losses and return premium Covers claims up to $300,000 (issue for large awards without cat fund

protection)• $231 million of net expenses ($385 million less $154 million of recoveries)

° Settlements• Law firm - $8.75 million (without admitting guilt)• Accounting firm - $10 million (without admitting guilt)• PIE Executives - $11.5 million (false statements and embezzlement)

Source: Best Review and National Conference of Insurance Guaranty Funds (NCIGF) web site www.ncigf.org

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The Medical Malpractice “Insolvency” Cycle• Ratemaking Assumptions

° Development of premiums

° Development of losses

° Loss trend

° Expenses (e.g., general, commission, brokerage, reinsurance, etc.)

° Investment income

° Area relativities

° Classification relativities

° ULAE loading

° DD&R loading

° Pricing (e.g., schedule rating, credits)

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RatesIncrease

AdverseTrends

Identified

Intense PriceCompetition

Market Rates DropNew Competition Enters

CRISIS

GOLDEN YEARS

CY

CL

EStart Early 1990’s

•Favorable prior year reserve development attracts new market entrants•Calendar year loss ratios impressive•Operating ratios below 80% •Trends better than originally expected (cushion in rates)•High investment returns

Mid 1990’s•Reinsurance results begin deteriorating•Loss trends creep up•Aggressive pricing, rates breakeven (BEFORE PRICING)

Late 1990’s•Reinsurers getting pounded by leveraging affect of trend on excess layers•Loss trends deteriorating•Favorable prior year reserve development almost gone•Tort reform resurfaces•PIC/PIE insolvent

Early 2000’s•September 11th, Reinsurance market hardens•AMA – 19 states in crisis•Prior year reserve development turns adverse•Loss trends up significantly (e.g., non-economic damages)•Tort reform debate in full swing (nationally and at the state level)•PHICO, MIIX, ROA insolvent•Reduced writing or full/partial moratoriums on business•Low investment returns, equity impairment pressure

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The Medical Malpractice “Insolvency” Cycle

Reinsurance Subsidization

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Reinsurance Subsidy – Claims Made Policies

TOTAL LOSS AND EXPENSE TOTAL LOSS AND EXPENSE TOTAL DCCINCURRED INCURRED RATIO RATIO

DIRECT DIRECTACCIDENT AND AND

YEAR ASSUMED CEDED NET ASSUMED CEDED NET(1) (42) (43) (44) (45) (46) (47)

1993 3,326,957 690,919 2,636,038 87.8% 75.9% 91.6%1994 3,733,070 818,805 2,914,265 91.3% 78.8% 95.6%1995 4,466,702 1,196,734 3,269,968 104.9% 100.6% 106.6%1996 4,800,464 1,404,808 3,395,656 114.5% 134.3% 108.0%1997 5,310,675 1,457,061 3,853,614 120.0% 129.3% 116.8%1998 5,931,305 1,705,709 4,225,596 132.9% 153.7% 126.0%1999 6,101,974 1,854,272 4,247,702 134.6% 169.3% 123.5%2000 6,347,359 1,974,896 4,372,463 135.7% 151.1% 129.8%2001 6,506,984 1,801,862 4,705,122 121.3% 123.6% 120.4%2002 6,691,578 1,748,636 4,942,942 95.1% 75.7% 104.6%

X-PRIOR 53,217,068 14,653,702 38,563,366 113.6% 116.4% 112.7%

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Reinsurance Subsidy – Claims Made Policies

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Reinsurance

• Reinsurance market has hardened• Recent reinsurer announcements of prior year

medical malpractice reserve strengthening• The “free lunch” is over

° Reinsurance rates continue to harden° Shift away from “working layer” attachments

• New definition of what is “working”• Leveraging effect of severity on excess layers• Stricter underwriting requirements• Increase attachment point (e.g., $500K to $1M, $1M to $2M)• Reduce excess layer protection

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Prior Year Reserve Development

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Prior Year Reserve Development – Claims Made Policies

NET PRIOR YEAR LOSS & DCC RESERVE DEVELOPMENT NET CALENDAR YEAR CONTRIBUTION RATIO (FAVORABLE)/ADVERSE

NEUTRAL

POSITIVECONTRIBUTION(I.E., DECREASE LR)(1,000,000)

(800,000)

(600,000)

(400,000)

(200,000)

0

200,000

400,000

600,000

800,000

1,000,000

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Accident Year

ULTIMATEACCIDENT EARNED INCURRED

YEAR PREMIUM LOSS & DCC2002 4,725,606 4,632,307

ACCIDENT YEAR LR: 98.0%

DEVELOPMENTON PRIOR

ACCIDENT EARNED ACCIDENTYEAR PREMIUM YEARS2002 4,725,606 824,585

CONTRIBUTION LR: 17.4%

CALENDAR YEAR LR: 115.5%

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Prior Year Reserve Development – Claims Made Policies

NET CALENDAR YEAR CONTRIBUTION RATIO ACCIDENT YEAR VERSUS CALENDAR YEAR LOSS RATIO

NEGATIVECONTRIBUTION(I.E., INCREASE LR)

NEUTRAL

POSITIVECONTRIBUTION(I.E., DECREASE LR)-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Accident Year

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Non-Economic Damages

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Ratemaking and Reserving

• Economic damages° Lost wages° Medical expense° Funeral expense

• Non-economic damages (a/k/a pain and suffering)° Loss of consortium° Loss of companionship° Disfigurement° Mental anguish

Quantifiable in the ratemaking and reserving process from a claims perspective.

Highly subjective and difficult to quantify from a reserving and ratemaking perspective.

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Ratemaking

“If only we could see the future”

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Ratemaking ExampleRATEMAKING

1999 RATE INDICATION - CRYSTAL BALL EXAMPLE(000s)

CUMULATIVE NET INCURRED LOSS AND DCC REPORTED AT YEAR END (000s)

EARNEDACCIDENT PREMIUM

YEAR NET 1995 1996 1997 1998 1999 2000 2001 2002(1) (2) (5) (6) (7) (8) (9) (10) (11) (12)

1995 3,068,161 3,377,496 3,372,013 3,331,457 3,246,519 3,112,957 3,070,486 3,053,946 3,053,4121996 3,145,366 XXX 3,320,739 3,310,891 3,202,239 3,190,316 3,093,553 3,109,924 3,152,4361997 3,298,442 XXX XXX 3,524,868 3,462,565 3,495,213 3,495,700 3,563,913 3,629,6871998 3,353,060 XXX XXX XXX 3,524,844 3,577,075 3,710,005 3,874,340 3,987,6681999 3,438,487 XXX XXX XXX XXX 3,409,279 3,627,902 3,925,231 3,999,925

PERCENTINCREASE

ACCIDENT IN ORIGINALYEAR ESTIMATE

1995 -1.9%1996 -1.2%1997 3.8%1998 11.5%1999 17.3%

Source: 2003 Edition of A.M. Best Aggregates and Averages

Actual Industry Claims Made Development

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Ratemaking Example12/31/1999 12/31/2002

PREMIUM CURRENT CURRENT CURRENT PREMIUM CURRENT CURRENT CURRENTACCIDENT AT CURRENT DOLLAR LEVEL LEVEL ACCIDENT AT CURRENT DOLLAR LEVEL LEVEL

YEAR RATE LEVEL ULTIMATE LOSS RATIO LOSS RATIO YEAR RATE LEVEL ULTIMATE LOSS RATIO LOSS RATIO1995 3,068,161 3,112,957 101.5% 1995 3,068,161 3,053,412 99.5%1996 3,145,366 3,190,316 101.4% 1996 3,145,366 3,152,436 100.2%1997 3,298,442 3,495,213 106.0% 106.0% 1997 3,298,442 3,629,687 110.0% 110.0%1998 3,353,060 3,577,075 106.7% 106.7% 1998 3,353,060 3,987,668 118.9% 118.9%1999 3,438,487 3,409,279 99.2% 99.2% 1999 3,438,487 3,999,925 116.3% 116.3%

5 YEAR 3 YEAR 5 YEAR 3 YEARAVERAGE LOSS AND DCC RATIO: 102.9% 103.9% AVERAGE LOSS AND DCC RATIO: 109.0% 115.1%

AO FACTOR: 1.050 1.050 AO FACTOR: 1.050 1.050LOSS AND LAE RATIO: 108.1% 109.1% LOSS AND LAE RATIO: 114.5% 120.9%

EXPECTED LOSS RATIO (ELR): 75.0% 75.0% EXPECTED LOSS RATIO: 75.0% 75.0%RATE INDICATION: 44.1% 45.5% RATE INDICATION: 52.6% 61.1%

SHORTFALL IN INITIAL RATE FILING: 8.5% 15.6%

Note: Above example simplified for illustrative purposes. Actual ratemaking indication requires adjustments for rate increases, loss trend, tort reform reinsurance costs, classification changes, etc.

IMAGINE IF WE INCLUDED A LOSS TREND

SHORTFALL OF 2.0% (e.g., 5% EXP. vs 7% ACT.)

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Warning Signs

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Warning Signs

• Obvious under pricing° “If it looks to good to be true, it probably is.”° Med mal has a long tail, so the death spiral can emerge quickly with

enough years of under pricing (e.g., late 1990’s)• Rapid expansion/new market entrant with a national claims handling

focus (i.e., don’t know the market or case precedents)• “Piggy Back” rate filing syndrome• Captives cherry picking the best risks (i.e., focused risk management,

loss control, etc.)• Heavy reliance on reinsurance

° Net written premium to gross written premium° Significant reinsurance recoverables (Schedule F)

• Schedule F Penalty• A.M. Best rating of largest reinsurers

° Reinsurance recoverables in dispute (Notes to AS)

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Warning Signs

• Statistics° Risk Based Capital (RBC) Ratios

• RBC Ratio < 3x’s Authorized Control Level (ACL) Company Action Level = 2 x ACL Regulatory Action Level = 1.5 x ACL Authorized Control Level = 1.0 x ACL Mandatory Control Level = 0.7 x ACL

° Leverage Ratios• Loss reserves to surplus > 3.00 (caveat 2.00 ratio)• Net written premium to surplus > 1.00 (caveat 1.25 ratio)

° NAIC IRIS Ratios

NOTE: Importance MayVary Depending Upon

Company Relationship With State Insurance Department

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Warning Signs

• Management Discussion & Analysis (MD&A)° Company overview° Financial highlights, position and metrics (e.g., combined ratio)° Loss reserve development and discounting if applicable° Reinsurance issues including retention changes and recoverability

• Notes to Annual Statement° Note 22 on Reinsurance

• 2002 ROA Note 22.D Uncollectible Reinsurance (TOO LATE) $126.7 million unsecured reinsurance recoverables from First

Virginia Reinsurance “FVR’s legal representatives have advised the Company that

FVR has minimal assets available to pay unsecured reinsurance recoverables”

NOTE: Some Are MoreUseful Than Others.

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Warning Signs

• Listen to public company quarterly earning calls° FPIC Insurance (FPIC)

° American Physicians Capital (ACAP)

° NCRIC Group (NCRI)

° ProAssurance (PRA)

° SCPIE Holdings (SKP)

• GAAP 10Q/10K

•Major items•Tort Reform Updates•Frequency Trends•Severity Trends•Competitive Landscape•Investor Q&A

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Prevention

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Prevention

• Know your market° ProAssurance Chairman & CEO Dr. A. Derrill Crowe said it best

during his January 26th NY Society of Security Analyst Insurance Conference presentation:

• “Know the difference between a venue in Houston and a venue in Alabama.”

• Underwriting, underwriting, underwriting° Know when to walk away° Monitor credit use/abuse

• Set conservative reserves• Stick to your specialty

° There are plenty of companies willing to write other lines of business if you get the urge (e.g., workers compensation)

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Closing Thoughts

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“Medication errors and malpractice is not just a United State problem, it is a global

problem.”

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Global Studies and Examples

• England's National Patient Safety Agency (NPSA)° Study found that more than 40% of medication errors in children

were due to the patients receiving the wrong doses of drugs.° Nearly one in five of the mistakes were preparation errors° The NPSA reviewed newspaper stories on medication errors

affecting children from 1993-2000. • The articles reported on 84 errors

Affected 1,147 children, of whom 30 died. 32 involved an incorrect dose, leading to 12 deaths. One error involved 857 children who received the wrong dose of

a tuberculosis vaccination. Nine of the 84 dosage errors were the result of a misplaced decimal point, causing five patient deaths.

In one case, a premature baby was given 100 times the correct dose of morphine.

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Global Studies and Examples

• Sydney Australia° Pat Skinner, 69, had part of her colon removed at Sydney's St.

George Hospital and received a clean bill of health from her doctors following the surgery.

° But for 18 months after the operation, Skinner consistently experience bad stomach and back pain that doctors told her was normal following that procedure.

° Doctors finally ordered an x-ray and found a 6.8-inch pair of surgical scissors in her stomach.

° St. George's Chief Executive Officer David Pearce said the hospital has since modified surgery guidelines and now requires staff to complete a full inventory of all surgical items.

Sounds like a good idea to me

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We Are on The Right Track

• National Patient Safety Foundation (www.npsf.org)

• JCAHO Environment of Care (www.jcaho.org)° Environment of Care° National Patient Safety Goals (2005 goals now available)° Root Cause Analysis

• Medical associations (e.g., American Medical Association - www.ama-assn.org)

• The Leapfrog Group (www.leapfroggroup.org)

• State patient safety organizations (e.g., Virginia - www.vipcs.org)

• Advancements in computerized physician order entry (CPOE) systems

• Safety books (e.g., “The Satisfied Patient” – James W. Saxton)

• Legislative action

session 7 medical malpractice

Documents