Medical Professional Liability Outlook and Economic Impacts of the Changing Healthcare Environment

1. Medical Professional Liability Outlook and Economic Impacts of the Changing Healthcare Environment Willis Re Annual Healthcare Reinsurance Forum Scottsdale, AZ March 18, 2014 Download at www.iii.org/presentations Robert P. Hartwig, Ph.D., CPCU, President & Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: 212.346.5520  Cell: 917.453.1885  bobh@iii.org  www.iii.org

2. Presentation Outline • The US Healthcare System & the Economy • Employment/Professional Trends in Healthcare • Medical Professional Liability: Performance Overview & Outlook • The Affordable Care Act: Potential Impacts on MPL • Overall P/C Insurance Industry Performance • Investment Overview & Outlook • Tort Trends • Cyber Risk and the Healthcare Industry • Q&A eSlide – P6466 – The Financial Crisis and the Future of the P/C

3. U.S. Health Care Expenditures,1965–2022F $ Billions From 1965 through 2013, US health care expenditures had increased by 69 fold. Population growth over the same period increased by a factor of just 1.6. By 2022, health spending will have increased 119 fold. U.S. health care expenditures have been on a relentless climb for most of the past half century, far outstripping population growth, inflation of GDP growth Sources: Centers for Medicare & Medicaid Services, Office of the Actuary at http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsProjected.html accessed 3/14/14; Insurance Information Institute.

4. National Health Care Expenditures as a Share of GDP, 1965 – 2022F* % of GDP Health care expenditures as a share of GDP rose from 5.8% in 1965 to 18.0% in 2013 and are expected to reach 19.9% of GDP by 2022 2022 19.9% 2010: 17.9% 2000: 13.8% 1990: 12.5% Since 2009, heath expenditures as a % of GDP have flattened out at about 18%--the question is why and will it last? 1980: 9.2% 1965 5.8% Sources: Centers for Medicare & Medicaid Services, Office of the Actuary at http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsProjected.html accessed 3/14/14; Insurance Information Institute.

5. Medical Cost Inflation vs. Overall CPI, 1995 - 2013 Though moderating, medical inflation will continue to exceed inflation in the overall economy Average Annual Growth Average Healthcare: 3.8% Total Nonfarm: 2.4% Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

6. Rate of Health Care Expenditure Increase Compared to Population, CPI and GDP Accelerating business investment will be a potent driver of commercial property and liability insurance exposures and should drive employment and WC payroll exposures as well (with a lag) 1965: $42.0 Bill 2013: $2,914.7 Bill 1965: $719.1 Bill 2013: $16,797.5 Bill 1965: 194.3 Mill 2013: 317.0 Mill Source: Insurance Information Institute research.

7. Employment Trends in the Healthcare Industry Employment Will Grow but Skills, Responsibilities and Risks Will Evolve 7

8. Growth in Health Professions,1991-2013 (Percent Annual Change) Average Annual Growth Average Healthcare: 2.5% Total Nonfarm: 1.0% The U.S. economy lost more than 8 million jobs during the Great Recession, but health sector employment expanded Healthcare employment has continued to grow in good times and bad - including the Great Recession. Sources: Bureau of Labor Statistics, Insurance Information Institute. 8

9. Occupations Ranked by Projected Percentage Growth, 2012-2022F Healthcare professions are expected to grow at 2 to nearly 3 times employment growth overall Source: Bureau of Labor Statistics, Insurance Information Institute.

10. Growth in Healthcare Profession by Skill Level, 2012 – 2022F (Thousands of Jobs) +1.015 Mill +20.3% +697,000 +24.1% +750,000 +30.1% +425,000 +24.0% Source: Bureau of Labor Statistics, Insurance Information Institute. 10

11. Projected Physician Supply and Demand, 2008–2020 A potential large and growing shortage of physicians looms. Estimates suggest a shortage of 91,500 physicians by 2020—a gap 12% gap. Will this be a negative for MPL? 851,300 759,800 Source: American Association of Medical Colleges https://www.aamc.org/advocacy/campaigns_and_coalitions/fixdocshortage/; Insurance Information Institute.

12. Physician Supply and Demand, 2008–2020 A potential large and growing physician gap looms over the next decade, with potential negative impacts on MPL Source: American Association of Medical Colleges https://www.aamc.org/advocacy/campaigns_and_coalitions/fixdocshortage/; Insurance Information Institute.

13. 12 Industries for the Next 10 Years: Insurance Solutions Needed Health Care Health Sciences Energy (Traditional) Many industries are poised for growth, though insurers’ ability to capitalize on these industries varies widely Alternative Energy Petrochemical Agriculture Natural Resources Technology (incl. Biotechnology) Light Manufacturing Insourced Manufacturing Export-Oriented Industries Shipping (Rail, Marine, Trucking, Pipelines)

14. Medical Professional Liability Performance Overview 15

15. Medical Professional Liability:4 Major Challenges • Increasing Competition • Price (rate) competition is intensifying • Physicians: More employed by hospitals, large inst. hurts exposure • Self-insurance by hospitals adds to downward pressure • Falling Investment Income • Despite Fed “tapering,” rates remain low • More complete “normalization” will not occur until 2015 • Rising Number of Self-Insured Exposures • Hospitals increasingly self-insure • More use of captives • Legal & Legislative Reform • Tort reform law changes (caps) • Affordable Care Act (“ObamaCare”) • Impacts on practice of defensive medicine • Other: Reserves, Loss Frequency & Severity Trends eSlide – P6466 – The Financial Crisis and the Future of the P/C

16. Medical Errors: Rate of Lethal and Serious Adverse Events Error Rate Sept. 2013 study in the Journal of Patient Health suggests that 210,000 – 400,000+ die each year from preventable medical errors (implies 3rd leading cause of death in US) New study reviewed 4 studies authored since 2008 Source: “A New, Evidence-Based Estimate of Patient Harms Associated with Hospital Care, Journal of Patient Safety, Volume 9, Issue 3 (Sept. 2013) by John T. James, Ph.D. accessed at: http://journals.lww.com/journalpatientsafety/Fulltext/2013/09000/A_New,_Evidence_based_Estimate_of_Patient_Harms.2.aspx 17

17. MPL Statutory Net Income After Tax, 2006 – 2015F Rates and yields will need to improve to reverse the drop in profits ($ Millions) +29.4% +34.0% -12.9% +5.1% -20.1% -11.6% -6.2% -17.0% -10.3% MPL profits peaked in 2010. Falling rates and exposures and lower investment earnings are impacting the bottom line. Source: Conning. eSlide – P6466 – The Financial Crisis and the Future of the P/C

18. Medical Malpractice Combined Ratio vs. All Lines Combined Ratio, 1991-2015F MPL insurers in 2013 paid out an estimated $0.96 in loss and expense for every $1 they earned in premiums The dramatic improvement over the past decade has restored med mal’sviability, though some deterioration has occurred and is expected to continue In 2001, med mal insurers paid out $1.55 for every dollar earned Source: AM Best (1991-2014F); Conning (2015F) Insurance Information Institute.

19. RNW: MPL vs. All P/C Lines, 2003-2012 Since 2005, MPL has outperformed the p/c insurance industry overall by a wide margin (Percent) Average 2003-2012 All P/C Lines: 7.9% MPL: 12.3% Sources: NAIC. 21

20. MPL Combined Ratio and ROE,2006 - 2015F Combined Ratio / GAAP ROE e improved ROEs in 2013 As underwriting results deteriorate, ROEs are have begib to decline Source: Conning; Insurance Information Institute.

21. MPL Statutory Capital & Surplus, 2006 – 2015F Capital is increasing even as premium growth has been negative ($ Millions) +3.7% +4.6% +7.8% +8.0% +0.2% +18.5% +17.7% +22.1% -4.6% Capital and surplus growth in the MPL shows steady growth growth mirroring the overall P/C insurance industry Source: Conning. eSlide – P6466 – The Financial Crisis and the Future of the P/C

22. Change in MPL vs. All Lines P/C Capital & Surplus, 2006-2013E Since 2006, MPL capital and surplus has grown at twice the pace of the p/c insurance industry overall % Change Average 2006-2013E All P/C Lines: 5.2% MPL: 10.6% Source: Insurance Information Institute from A.M. Best and Conning data.

23. P/C Estimated Loss Reserve Deficiency/ (Redundancy), Excl. Statutory Discount Source: A.M. Best, P/C Review/Preview 2014; Insurance Information Institute. *Excluding mortgage and financial guaranty segments.

24. Annual Change in Medical Professional Liability DPW, 2004-2015F % Change Competition and an increasing number of self-insured exposures are weighing on MPL premium growth Source: Conning.

25. Annual Change in Medical Professional Liability Incurred Losses, 2004-2015F % Change Incurred losses have been generally increasing since 2011 after years of sharp declines Source: Conning.

26. Medical Professional Liability: Change inPremium and Incurred Losses, 2006-2015F % Change Mid-2000s: Favorable loss trends precipitated lower prices and falling premium Today: Premium seems to be lagging an increase in losses Source: Insurance Information Institute from A.M. Best and Conning data.

27. Medical Professional Liability, RNWBy State, Average 2003-2012 Top 25 States and DC Source: NAIC; Insurance Information Institute.

28. Medical Professional Liability RNWBy State, Average 2003-2012 Bottom 25 States Source: NAIC; Insurance Information Institute

29. Medical Professional Liability, RNWBy State, 2012 Top 25 States and DC Source: NAIC; Insurance Information Institute.

30. Medical Professional Liability RNWBy State, 2012 Bottom 25 States Source: NAIC; Insurance Information Institute

31. Medical Professional Liability, RNWBy State, 2003 Top 27 States and US Source: NAIC; Insurance Information Institute.

32. Medical Professional Liability RNWBy State, 2003 Bottom 24 States and DC Source: NAIC; Insurance Information Institute OK -202.5

33. The Affordable Care Act and Medical Professional Liability A Summary of Potential Impacts 52

34. Potential Impacts of the ACA on Medical Professional Liability Source: Insurance Information Institute research. 53

35. Number of People Signed Up for Health Care Under the ACA, Oct. 1 – March 1 UPDATE HHS announced that enrollment as of 3/16 now exceeds 5 million As of March 1, 4.2 million people have signed up for coverage under the ACA since enrollment opened on Oct. 1, 2013 759,800 Source: Centers for Medicare and Medicaid as of March 7, 2014: http://aspe.hhs.gov/health/reports/2014/MarketPlaceEnrollment/Mar2014/ib_2014mar_enrollment.pdf

36. Projected Number of People with No Health Insurance, 2013—2022* By 2018 the number of people under age 65 without insurance is expected to drop by 25 million (~45%) Millions The projected decline in the uninsured population is very sensitive to the enrollment rate under the Affordable Care Act *Under age 65. Sources: Centers for Medicare & Medicaid Services, Office of the Actuary at http://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsProjected.html accessed 3/14/14; Insurance Information Institute. 55 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

37. P/C Insurance Industry Financial Overview 2013: Best Year in the Post-Crisis Era 56

38. P/C Net Income After Taxes1991–2013:Q3 ($ Millions) Net income is up substantially (+54.7%) from 2012:Q3 $27.8B • 2005 ROE*= 9.6% • 2006 ROE = 12.7% • 2007 ROE = 10.9% • 2008 ROE = 0.1% • 2009 ROE = 5.0% • 2010 ROE = 6.6% • 2011 ROAS1 = 3.5% • 2012 ROAS1 = 5.9% • 2013:9M ROAS1 = 9.5% 2013:9M ROAS was 9.5% • ROE figures are GAAP; 1Return on avg. surplus. Excluding Mortgage & Financial Guaranty insurers yields a 8.9% ROAS through 2013:Q3, 6.2% ROAS in 2012, 4.7% ROAS for 2011, 7.6% for 2010 and 7.4% for 2009. • Sources: A.M. Best, ISO, Insurance Information Institute

39. Net Premium Growth: Annual Change, 1971—2013:Q3 (Percent) 1975-78 1984-87 2000-03 Net Written Premiums Fell 0.7% in 2007 (First Decline Since 1943) by 2.0% in 2008, and 4.2% in 2009, the First 3-Year Decline Since 1930-33. 2013:9M = 4.2% 2012 growth was +4.3% Shaded areas denote “hard market” periods Sources: A.M. Best (historical and forecast), ISO, Insurance Information Institute. eSlide – P6466 – The Financial Crisis and the Future of the P/C

40. Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2013:Q3* History suggests next ROE peak will be in 2016-2017 ROE 1977:19.0% 1987:17.3% 2006:12.7% 10 Years 1997:11.6% 2013:Q3 8.9% 10 Years 9 Years 2011: 4.7% 1984: 1.8% 1975: 2.4% 1992: 4.5% 2001: -1.2% *Profitability = P/C insurer ROEs. 2011-13 figures are estimates based on ROAS data. Note: Data for 2008-2013 exclude mortgage and financial guaranty insurers. Source: Insurance Information Institute; NAIC, ISO, A.M. Best.

41. A 100 Combined Ratio Isn’t What ItOnce Was: Investment Impact on ROEs A combined ratio of about 100 generates an ROE of ~7.0% in 2012, ~7.5% ROE in 2009/10,10% in 2005 and 16% in 1979 Combined Ratio / ROE Lower CATs are improved ROEs in 2013 Combined Ratios Must Be Lower in Today’s DepressedInvestment Environment to Generate Risk Appropriate ROEs * 2008 -2013 figures are return on average surplus and exclude mortgage and financial guaranty insurers. 2013:9M combined ratio including M&FG insurers is 95.8; 2012 =103.2, 2011 = 108.1, ROAS = 3.5%. Source: Insurance Information Institute from A.M. Best and ISO Verisk Analytics data.

42. P/C Insurance Industry Combined Ratio, 2001–2013:Q3* Higher CAT Losses, Shrinking Reserve Releases, Toll of Soft Market Relatively Low CAT Losses, Reserve Releases As Recently as 2001, Insurers Paid Out Nearly $1.16 for Every $1 in Earned Premiums Heavy Use of Reinsurance Lowered Net Losses Relatively Low CAT Losses, Reserve Releases Avg. CAT Losses, More Reserve Releases Sandy Impacts Best Combined Ratio Since 1949 (87.6) Cyclical Deterioration Lower CAT Losses * Excludes Mortgage & Financial Guaranty insurers 2008--2012. Including M&FG, 2008=105.1, 2009=100.7, 2010=102.4, 2011=108.1; 2012:=103.2; 2013:Q3 = 95.8. Sources: A.M. Best, ISO. eSlide – P6466 – The Financial Crisis and the Future of the P/C

43. P/C Reserve Development, 1992–2015E Note: 2005 reserve development excludes a $6 billion loss portfolio transfer between American Re and Munich Re. Including this transaction, total prior year adverse development in 2005 was $7 billion. The data from 2000 and subsequent years excludes development from financial guaranty and mortgage insurance. Sources: A.M. Best, ISO, Barclays Research (estimates).

44. Policyholder Surplus, 2006:Q4–2013:Q3 Drop due to near-record 2011 CAT losses ($ Billions) 2007:Q3Pre-Crisis Peak Surplus as of 9/30/13 stood at a record high $624.4B The industry now has $1 of surplus for every $0.78 of NPW,close to the strongest claims-paying status in its history. 2010:Q1 data includes $22.5B of paid-in capital from a holding company parent for one insurer’s investment in a non-insurance business . The P/C insurance industry entered 2014in very strong financial condition. Sources: ISO, A.M .Best. 63 12/01/09 - 9pm eSlide – P6466 – The Financial Crisis and the Future of the P/C

45. Financial Strength & Underwriting History Suggests that MPL, Like Other Long-Tailed Lines Is Much More Difficult to Underwrite 64

46. P/C Insurer Impairments, 1969–2012 Impairments among P/C insurers remain infrequent The Number of Impairments Varies Significantly Over the P/C Insurance Cycle, With Peaks Occurring Well into Hard Markets Source: A.M. Best Special Report “Pace of P/C Impairments Slowed in 2012; Auto Writers, RRGs Continued to Struggle,” June 2013; Insurance Information Institute.

47. P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2012 2012 impairment rate was 0.69%, down from 1.11% in 2011; the rate is lower than the 0.82% average since 1969 Impairment Rates Are Highly Correlated With Underwriting Performance and Reached Record Lows in 2007; Recent Increase Was Associated Primarily With Mortgage and Financial Guaranty Insurers and Not Representative of the Industry Overall Source: A.M. Best; Insurance Information Institute

48. Reasons for US P/C Insurer Impairments, 1969–2012 Historically, Deficient Loss Reserves and Inadequate Pricing AreBy Far the Leading Cause of P-C Insurer Impairments. Investment and Catastrophe Losses Play a Much Smaller Role Reinsurance Failure Sig. Change in Business Misc. Investment Problems (Overstatement of Assets) Deficient Loss Reserves/Inadequate Pricing Affiliate Impairment Catastrophe Losses Alleged Fraud Rapid Growth Source: A.M. Best Special Report “Pace of P/C Impairments Slowed in 2012; Auto Writers, RRGs Continued to Struggle,” June 2013; Insurance Information Institute.

49. Top 10 Lines of Business for US P/C Impaired Insurers, 2000–2012 Medical Professional Liability Accounts for Only About 2% of Industry DPW but 6.7% of Insurer Impairments Other Title Surety Workers Comp Med Mal Other Liability Pvt. Passenger Auto Commercial Auto Liability Commercial Multiperil Homeowners Source: A.M. Best Special Report “Pace of P/C Impairments Slowed in 2012; Auto Writers, RRGs Continued to Struggle,” June 2013; Insurance Information Institute. .

50. INVESTMENTS: THE NEW REALITY The Challenge of Low Investment Yields Is a Critical Issue for MPL Insurers Is Relief in Sight? 69