Session 7
Medical
Malpractice
Kevin M. Bingham
kbingham@deloitte.com
Casualty Actuarial Society Loss Reserve Seminar
September 14, 2004
1:00 – 2:30 am
Las Vegas, Nevada
INTRODUCTION
•
•
•
•
•
•
Where Are We Now
Why P&C Insurance Companies Fail
Why Medical Malpractice Insurers Fail
Warning Signs
Prevention
Closing Thoughts
2
Where Are We Now
3
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
4
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)
5
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)
6
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
7
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
8
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
9
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
10
Tort Reform Issues
RESERVING
• Cap on non-economic damages
° Hard cap (e.g., $250,000 MICRA cap) IMPACT?
° Soft cap
• Florida
• Texas
° “Cap busters”
• Florida
• Massachusetts
• Emergency room vs. non-emergency room
• Practitioner vs. non-practitioner
• Per defendant caps
• Per claimant caps
Constitutionality?
• Piercing
• Disfigurement
• Death
• Vegetative state
• Unanimous verdict
Phase in of law?
Economic damage
ratio?
Trends in policy
limits?
11
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
12
Why P&C Insurance
Companies Fail
13
Why Companies Fail – P&C
Industry
REASONS FOR INSOLVENCY
1993 - 2002
I.
II
III
IV
V
VI
VII
VIII
IX
X
Deficient loss reserves
Rapid growth
Alleged fraud
Overstated assets
Discounted Operations
Change in business
Reinsurer failure
Catastrophe loss
Unidentified
Impairment of affiliate
51%
10%
3%
2%
8%
3%
0%
3%
17%
3%
100%
X, 3%
IX, 17%
VIII, 3%
VII, 0%
VI, 3%
Note:
218 property/casualty insolvencies
from 1993 to 2002 generated a 10-year
average failure rate of 0.72%.
I., 51%
V, 8%
IV, 2%
III, 3%
II, 10%
Source: A.M. Best Co.
14
Why Medical Malpractice
Insurers Fail
15
Medical Malpractice Insolvencies
• Internal Deloitte “Straw” Poll
°
°
°
°
°
°
°
°
°
°
°
°
°
Pricing inadequacy
3-O’s
Misreading of loss cost trends
Over-optimism
Rapid growth
Over-expansion
Reserve deficiencies
Pressure from external sources to diversify
Over-confidence
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
16
Medical Malpractice Insolvencies
•
PIC Insurance (1998)
°
•
PIE Mutual Insurance Company (1998)
°
•
Pricing inadequacy/ARD/Management/3-O’s
PHICO (2002)
°
•
Pricing inadequacy/Adverse reserve development (ARD)
Public Perception of
“Reckless under pricing”
and Price Competition
at any cost
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)
17
Medical Malpractice Insolvencies
• 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
18
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)
19
CRISIS
Start
CYCLE
Rates
Increase
Adverse
Trends
Identified
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
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
Intense Price
Competition
Market Rates Drop
New Competition Enters
GOLDEN YEARS
Mid 1990’s
•Reinsurance results begin deteriorating
•Loss trends creep up
•Aggressive pricing, rates breakeven (BEFORE PRICING)
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)
20
•High investment returns
The Medical Malpractice
“Insolvency” Cycle
Reinsurance Subsidization
21
Reinsurance Subsidy – Claims
Made Policies
ACCIDENT
YEAR
(1)
TOTAL LOSS AND EXPENSE
INCURRED
DIRECT
AND
ASSUMED
CEDED
NET
(42)
(43)
(44)
TOTAL LOSS AND EXPENSE
INCURRED RATIO
DIRECT
AND
ASSUMED
CEDED
NET
(45)
(46)
(47)
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
3,326,957
3,733,070
4,466,702
4,800,464
5,310,675
5,931,305
6,101,974
6,347,359
6,506,984
6,691,578
690,919
818,805
1,196,734
1,404,808
1,457,061
1,705,709
1,854,272
1,974,896
1,801,862
1,748,636
2,636,038
2,914,265
3,269,968
3,395,656
3,853,614
4,225,596
4,247,702
4,372,463
4,705,122
4,942,942
87.8%
91.3%
104.9%
114.5%
120.0%
132.9%
134.6%
135.7%
121.3%
95.1%
75.9%
78.8%
100.6%
134.3%
129.3%
153.7%
169.3%
151.1%
123.6%
75.7%
91.6%
95.6%
106.6%
108.0%
116.8%
126.0%
123.5%
129.8%
120.4%
104.6%
X-PRIOR
53,217,068
14,653,702
38,563,366
113.6%
116.4%
112.7%
TOT
R
22
Reinsurance Subsidy – Claims
Made Policies
23
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
24
The Medical Malpractice
“Insolvency” Cycle
Prior Year Reserve Development
25
Prior Year Reserve Development –
Claims Made Policies
ACCIDENT
YEAR
2002
NET PRIOR YEAR LOSS & DCC RESERVE DEVELOPMENT
(FAVORABLE)/ADVERSE
NET CALENDAR YEAR CO
ACCIDENT YEAR LR:
1,000,000
ACCIDENT
YEAR
2002
800,000
600,000
400,000
200,000
ULTIMATE
EARNED
INCURRED
PREMIUM LOSS & DCC
4,725,606
4,632,307
98.0%
DEVELOPMENT
ON PRIOR
EARNED
ACCIDENT
PREMIUM
YEARS
4,725,606
824,585
CONTRIBUTION LR:
17.4%
CALENDAR YEAR LR:
115.5%
0
(200,000)
(400,000)
(600,000)
(800,000)
(1,000,000)
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Accident Year
26
Prior Year Reserve Development –
Claims Made Policies
A
NET CALENDAR YEAR CONTRIBUTION RATIO
30.0%
NEGATIVE
CONTRIBUTION
(I.E., INCREASE LR)
20.0%
10.0%
0.0%
NEUTRAL
-10.0%
-20.0%
-30.0%
1993
POSITIVE
CONTRIBUTION
(I.E., DECREASE LR)
1994
1995
1996
1997
1998
Accident Year
1999
2000
2001
2002
27
The Medical Malpractice
“Insolvency” Cycle
Non-Economic Damages
28
Ratemaking and Reserving
• Economic damages
° Lost wages
° Medical expense
° Funeral expense
Quantifiable in the ratemaking
and reserving process from a
claims perspective.
• Non-economic damages (a/k/a pain and suffering)
°
°
°
°
Loss of consortium
Loss of companionship
Disfigurement
Mental anguish
Highly subjective and difficult
to quantify from a reserving
and ratemaking perspective.
29
The Medical Malpractice
“Insolvency” Cycle
Ratemaking
“If only we could see the future”
30
Ratemaking Example
RATEMAKING
1999 RATE INDICATION - CRYSTAL BALL EXAMPLE
(000s)
CUMULATIVE NET INCURRED LOSS AND DCC REPORTED AT YEAR END (000s)
ACCIDENT
YEAR
(1)
EARNED
PREMIUM
NET
(2)
1995
(5)
1996
(6)
1997
(7)
1998
(8)
1999
(9)
2000
(10)
2001
(11)
2002
(12)
1995
1996
1997
1998
1999
3,068,161
3,145,366
3,298,442
3,353,060
3,438,487
3,377,496
XXX
XXX
XXX
XXX
3,372,013
3,320,739
XXX
XXX
XXX
3,331,457
3,310,891
3,524,868
XXX
XXX
3,246,519
3,202,239
3,462,565
3,524,844
XXX
3,112,957
3,190,316
3,495,213
3,577,075
3,409,279
3,070,486
3,093,553
3,495,700
3,710,005
3,627,902
3,053,946
3,109,924
3,563,913
3,874,340
3,925,231
3,053,412
3,152,436
3,629,687
3,987,668
3,999,925
PERCENT
INCREASE
ACCIDENT IN ORIGINAL
YEAR
ESTIMATE
Source: 2003 Edition of A.M. Best
Aggregates and Averages
Actual Industry Claims Made Development
1995
1996
1997
1998
1999
-1.9%
-1.2%
3.8%
11.5%
17.3%
31
Ratemaking Example
12/31/1999
12/31/2002
PREMIUM
CURRENT
CURRENT
CURRENT
PREMIUM
CURRENT
CURRENT
CURRENT
ACCIDENT 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 RATIO
1995
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%
AVERAGE LOSS AND DCC RATIO:
AO FACTOR:
LOSS AND LAE RATIO:
EXPECTED LOSS RATIO (ELR):
RATE INDICATION:
5 YEAR
102.9%
1.050
108.1%
75.0%
44.1%
3 YEAR
103.9%
1.050
109.1%
75.0%
45.5%
AVERAGE LOSS AND DCC RATIO:
AO FACTOR:
LOSS AND LAE RATIO:
EXPECTED LOSS RATIO:
RATE INDICATION:
5 YEAR
109.0%
1.050
114.5%
75.0%
52.6%
3 YEAR
115.1%
1.050
120.9%
75.0%
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.)
32
Warning Signs
33
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)
34
Warning Signs
• Statistics
NOTE: Importance May
Vary Depending Upon
Company Relationship With
State Insurance Department
° 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
35
Warning Signs
NOTE: Some Are More
Useful Than Others.
• 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”
36
Warning Signs
• Listen to public company quarterly earning calls
°
°
°
°
°
FPIC Insurance (FPIC)
American Physicians Capital (ACAP)
NCRIC Group (NCRI)
ProAssurance (PRA)
SCPIE Holdings (SKP)
•Major items
•Tort Reform Updates
•Frequency Trends
•Severity Trends
•Competitive Landscape
•Investor Q&A
• GAAP 10Q/10K
37
Prevention
38
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)
39
Closing Thoughts
40
“Medication errors and malpractice is
not just a United State problem, it is a
global problem.”
41
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.
42
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
43
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
44