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Session 7 Medical Malpractice

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

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Session 7 Medical Malpractice

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  1. 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

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

  3. Where Are We Now

  4. 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)

  6. 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)

  7. 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

  8. 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

  9. 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 Tort Reform

  10. 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

  11. Tort Reform Issues RESERVING IMPACT? • 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 Constitutionality? Phase in of law? Economic damage ratio? Trends in policy limits? • Disfigurement • Death • Vegetative state • Unanimous verdict

  12. 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

  13. Why P&C InsuranceCompanies Fail

  14. Why Companies Fail – P&C Industry

  15. Why Medical Malpractice Insurers Fail

  16. 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 Medical Malpractice Insolvencies 3-O’s Over-optimism Over-expansion Over-confidence

  17. 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) Medical Malpractice Insolvencies Public Perception of “Reckless under pricing” and Price Competition at any cost

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

  19. 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) The Medical Malpractice “Insolvency” Cycle

  20. 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 • 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) • High investment returns

  21. Reinsurance Subsidization The Medical Malpractice “Insolvency” Cycle

  22. Reinsurance Subsidy – Claims Made Policies

  23. Reinsurance Subsidy – Claims Made Policies

  24. 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

  25. Prior Year Reserve Development The Medical Malpractice “Insolvency” Cycle

  26. Prior Year Reserve Development – Claims Made Policies

  27. Prior Year Reserve Development – Claims Made Policies

  28. Non-Economic Damages The Medical Malpractice “Insolvency” Cycle

  29. 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.

  30. Ratemaking “If only we could see the future” The Medical Malpractice “Insolvency” Cycle

  31. Ratemaking Example Source: 2003 Edition of A.M. Best Aggregates and Averages Actual Industry Claims Made Development

  32. Ratemaking Example IMAGINE IF WE INCLUDED A LOSS TREND SHORTFALL OF 2.0% (e.g., 5% EXP. vs 7% ACT.) Note: Above example simplified for illustrative purposes. Actual ratemaking indication requires adjustments for rate increases, loss trend, tort reform reinsurance costs, classification changes, etc.

  33. Warning Signs

  34. 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)

  35. Warning Signs NOTE: Importance May Vary Depending Upon Company Relationship With State Insurance Department • 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

  36. 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”

  37. 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

  38. Prevention

  39. 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)

  40. Closing Thoughts

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

  42. 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. Global Studies and Examples

  43. 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. Global Studies and Examples Sounds like a good idea to me

  44. 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

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