Risk Management

Hard Times Ahead for Doctors and Carriers

By James F. Holzer, JD
Mr. Holzer is OMIC’s President & CEO.

[Digest, Winter 2001]

The U.S. economy and stock market may be showing signs of renewed vibrancy this quarter, but malpractice insurance carriers are bracing for the worst. Physicians in all specialties are seeing professional liability rates skyrocket for the first time in many years. It’s a grim reminder of when so-called malpractice crises erupted in the past, driving doctors to pay higher premiums, find replacement, and seek shelter behind defensive practice patterns.

Although ophthalmologists are not immune from current adverse developments, their loss experience is better than most other specialties and, in some cases, significantly better on average than all specialties combined. OMIC’s loss experience and financial performance continues to be more favorable than the industry as a whole. Yet claims costs and related expenses require even the most conservative carrier to periodically adjust its price. A few physician-sponsored carriers have been able to keep rate increases well under the 10% this year. OMIC, for example, will adjust its premium by 7.5% for policies issued or renewed after July 1, 2001.

The news unfortunately isn’t as good for other physicians. Double-digit rate hikes are back. Many medical malpractice carriers anticipate or have already instituted premium increases that may well exceed the expected national average of 15%. Commercial (non-provider-owned) carriers seem the hardest hit with planned increases of 50% to 100% in some states. Although the relative rate for an ophthalmologist is less than say for an OB-GYN specialist, some of these large increases may apply across the board to ophthalmologists insured by these companies. One large national carrier, which has slipped from first to fifth place as the leading provider of malpractice insurance, reportedly doubled its premiums for some ophthalmologists in Arizona, Missouri, and Texas and selectively levied a 60% increase for risks in Vermont and 75% in California. Another large national provider of physician professional liability insurance isn’t writing or renewing business at any price in Georgia, sending many of its longtime policyholders and insurance brokers scrambling to find replacement coverage.

Physician-owned or sponsored insurers seem to be faring better. Rate announcements from doctor-owned carries range from no increase to 30% with some 40% to 50% increases in so-called problems states such as West Virginia. Insurance companies there were created by medical societies and governed by physicians mushroomed in the 1970s and 80s in response to capacity and affordability problems during prior hard markets. Collectively, these companies now provide professional liability coverage to nearly two-thirds of the physicians in the U.S. Based on year-end 2000 financial statements, this physician-controlled segment of the insurance industry has generally done better than the medical malpractice industry as a whole., which includes the large commercial stock companies.

Rapidly Deteriorating Market
In a recent study, a leading research analyst for the insurance industry, Conning & Company, warned that the financial condition of the medical malpractice insurance business is rapidly deteriorating with “no margin for negative surprises.” Looking at the industry as a whole, it estimates a huge deficiency in malpractice claims reserves to the tune of a staggering $1.7 billion. This degree of adverse development clearly doesn’t happen overnight. Conning suggests the problem began as early as 1993 when the severity of incidents, accelerating claims payments, and increasing defense costs started to climb. Of particular concern as the rising incidence of claims alleging failure to diagnose and medication-related errors. Ophthalmologists should not be quick to assume that such problems don’t apply to them. A number of OMIC’s largest settlements have related less to the science and practice of ophthalmology and more to general medical problems such as failing to diagnose cancer or failing to adequately track and follow up on urgent care. Clearly, failure to follow some of the most basic risk management principles of general medical practice could have a more crippling effect on overall ophthalmic loss experience nationwide than some of the newer refractive procedures such as LASIK, which to date show only low to moderate claims severity.

What’s causing this deterioration and why does it seem to be occurring so suddenly after years of declining malpractice rates and aggressive competition? For at least the past five years, many medical malpractice carriers have had a voracious appetite for market share. This has had the effect of driving prices down even though combined and operating ratios for the industry as a whole were locked in a steady upward creep. Fortunately, physician-owned/sponsored carriers such as OMIC have been able to maintain more stable and consistent ratios during this period.

Nevertheless, during these “soft market” conditions, the financial results of carriers were propped up by good investment returns, favorable reinsurance deals, and better-than-expected loss results from prior policy years, which allowed companies to reduce their reserves and increase surplus. In the background, however, malpractice claims severity continued to grow. Defense costs kept rising, reserve takedowns on older policy years began to dry up, investment returns started to shrink, but premiums on the most part remained the same. Malpractice carriers were still locked in a battle to gain a shrinking market share. Artificially depressed rates prevailed until the damn burst at year-end 2000.

Loss Ratios Worsen
Every spring, insurance carriers file detailed financial statements showing the results of their operations through December 31 of the previous year. As analyst look at these year-end 2000 statements, a collective picture of the industry began to emerge. Their suspicions during the past 24 months are being confirmed. The approaching “hard market” has finally arrived. Loss ratios, which measure a company’s loss experience in relation to its total book of business, jumped nearly 10 points in one year to approximately 100% for all doctor-owned carriers combined. Analysts expect the numbers to be worse when large independent carriers are included in the mix. (OMIC’s loss ratio in comparison increased only 2.5% to 79.9% at year-end 2000.)

Other ratios that analyst use to measure an insurer’s operating performance also worsened during the past year. The combined ratio, which measures a company’s overall underwriting profitability before investment returns, climbed to 125% for the provider-sponsored carriers and 134% for the entire industry. However, after factoring gains on investments, carriers still showed relatively acceptable (albeit increasing) operating ratios. An operating ratio of less than 100 indicates acceptable financial health for a carrier because it is still able to show a profit from its core business. The average operating ratio for all doctor-owned carriers combined was 95.6% at year-end 2000. (OMIC reported a combined ratio of 119.3% and a favorable operating ratio of 91%.)

More Ominous Signs for Some Carriers
Unfortunately, we are now starting to see a number of long-standing carriers having difficulty even measuring up to the average. Data from financial filings for year-end 2000 indicate that between one-quarter and one-third of provider-sponsored medical malpractice carriers may show an operating ratio of greater than 100% and could report negative operating cash flow. A handful of companies may even show operating ratios in excess of 120%. A number of large independent commercial carriers also are facing significant challenges. The health care unit of one of the leading national medical liability carriers reported a year-end 2000 combined ratio of almost 130% and a fourth quarter combined ratio of nearly 160%. A large hospital association carrier reported a combined ratio last year of 200% as well as receiving two rating downgrades by A.M. Best Company in as many years.

Even if an improving U.S. economy turns Wall Street bullish again, it’s clear that it will take more than higher returns on investments to reverse the deterioration of some segments of the medical malpractice insurance industry. Insurance carriers will have to invoke a number of tough and unpopular remedies to exorcise the demons of the hard market of 2001. Here’s what ophthalmologists and doctors in all specialties can expect:

• Higher malpractice premiums for the near future. The size of increases will vary by carrier and depend on an individual company’s financial performance and overall profitability. OMIC anticipates a more modest fluctuation in its rates compared to the industry because it has historically kept rates a level sufficient to support its ability to pay claims over the long term.
• Tougher underwriting and cancellations of policies that carriers deem unprofitable. Some carriers appear to be engaged in wholesale cancellation of policies based primarily on geography, claims history, and scope of practice. Some uninsured ophthalmologists have called OMIC with stories of physicians being dropped because they were doing refractive surgery or had just one claim. OMIC plans to continue underwriting physicians in the same prudent manner it has in the past, relying on its historical success of selecting insureds who ultimately contribute to loss results that are consistently better than the industry.
• Fewer discounts and lower dividends. Cash-strapped carriers may become less generous with premium discounts to raise much needed revenue. Last year, the surplus of all companies combined fell for the first time in recent history. Shrinking surplus and smaller or nonexistent reserve takedowns could mean lower dividend payouts in the future. OMIC’s surplus did not decrease last year and was maintained as the same conservative level as the previous year. OMIC also is continuing its cooperative ventures with a dozen state and subspecialty societies and provides a special 10% premium discount for participating in cosponsored risk management programs. As in the past, dividends will be determined each year based on annual performance results.
• Claims costs will continue to increase unless controls are employed. Despite the cyclical nature of insurance markets and litigation, claims severity will continue to grow unabated unless doctors and carriers employ proven measures to stem the tide.
  • Tort Reform — First and foremost, efforts to bolster state tort reform initiatives are critical to keeping claims indemnity under control. According to Jury Verdict Research, jury awards in malpractice cases jumped 7% in 1999, raising the median award to $800,000. During previous, “medical malpractice crises,” the most common factor associated with markedly improved loss experience was the existence of strong tort reform measures with an effective cap on noneconomic damages (pain and suffering).
  • Risk Management — Despite the temptation to reduce costs by cutting back on operational expenses, such as risk management, carriers instead need to provide more resources for these activities. OMIC will continue to make its ophthalmic-specific risk management activities available to policyholders and members of the American Academy of Ophthalmology and anticipates extending these activities through the Internet and other means.

Why Some Carriers Can Withstand a Hard Market
Perhaps the silver lining in this hard market is that physicians and their professional liability carriers have been down this road before. What we’ve learned from previous hard markets is that such a condition is not so much a malpractice crisis as it is a cycle. Fortunately, cycles turn, but their duration can clearly be impacted by how quickly and how well we respond. Physicians who didn’t chase some of those irresistibly cheap rates in the past and stayed with a strong and reasonably priced insurer are now in a better position to ride out the hard market with their current carrier. Companies that previously engaged in predatory pricing tactics to gain market share may now have to play “catch-up” by significantly boosting rates to meet the future demands of rising claims. Others, such as OMIC and those physician-sponsored carriers that remained focused on their original mission and purpose, are likely to successfully ride out the current storm as well as provide opportunities to those doctors now forced to search for a new carrier that can better support their long-term insurance needs.

In the future, adverse market cycles might be broken if some carriers choose to learn from the past and resist the temptation to feed their egos and corporate appetite for market domination and growth at any cost.