Medical Professional Liability for Physicians– Current Actuarial Challenges

1. Medical Professional Liability for Physicians– Current Actuarial Challenges Midwestern Actuarial ForumSeptember 24, 2003Kevin Dyke, FCAS, MAAAAmerican Physicians Assurance Corporation

2. Topics to be Covered • Company Background • Coverage overview • Tort reform • Capacity Shrinking • Retention • Frequency/severity trends • Investment income • Occurrence coverage • Free tail (DD&R) pricing and reserving

3. American Physicians At a Glance • Founded in 1975 as Michigan Physicians • 19th largest medical professional liability insurance provider in U.S.* • Headquartered in East Lansing, MI • Focused on solo practitioners and small physician groups • A- rated by AM Best and S&P • Completed IPO in December 2000 • American Physicians Assurance Corporation is a subsidiary of APCapital (NASDAQ: ACAP) *Source: Thomson Financial/OneSource

4. Coverage Overview • Coverage variations • Occurrence • Claims made • Tail • Hybrid products (e.g. Prepaid tail) • Physicians rated by class, territory, specialty, number/types of procedures • Death Disability and Retirement • Free coverage in event of above • Vesting periods for retirement

5. Tort Reform • Pending or enacted legislation at both the federal and state levels. • Benchmark is California’s MICRA reforms • Key is $250,000 cap on non-economic damages • Average premiums are lower in California than in other states • Common provisions • Limiting non-economic damages • Statutes of limitations/repose • Caps on attorney fees • Pitfalls • Many attempts at previous tort reform have been overturned by the courts as unconstitutional. • Need to monitor conservative/liberal tendencies of courts.

6. Tort Reform (cont) • Quantifying tort reform • Ask the experts (claims) • Select lower trend factors • Rate selection < Rate indication • Adjust step factors - earlier steps will be affected more than others • Wait for results to emerge • Courts have overturned tort reform in the past • Ohio is on it s 3rd attempt at tort reform.

7. Carriers exiting markets (some by choice) St. Paul exited line in 2001. American Physicians exited Florida in 2002 MIIX, PHICO, PIE, Legion, Frontier, Reliance Some new capital entering market RRGs being formed by physician groups and hospitals Insurance companies being formed in KY, FL, NV Actuarial challenges Who picks up the pieces? Existing carriers already facing capacity constraints due to rate increases Prior acts coverage on insolvent/exiting markets Capacity Shrinking

8. Rate Changes Impacting Retention • Carriers out in front of rate changes may suffer from retention woes • Most research and modeling for personal lines companies • Actuarial needs to monitor retention to ensure mix of business not materially changing • May also want to develop diagnostic tests on new and renewal business (e.g. frequency)

9. Physicians Loss Trends • Conning and Co. trends • Frequency flat or declining • Severity increasing 50% from 1997-2001 • American Physicians average trends vary by state and policy limit • Frequency trend is flat • Michigan requires only 200K/600K limits. Severity trends are modest (3-4%) • Patient compensation funds limit severity trend to direct writer (e.g. IN, NM) • States with $1M/$3M limits have trends in the 6-8% range • Need to monitor on both a traditional coverage year basis and on a calendar (settlement) year basis

10. Investment Income • Tort reform opponents say stock market losses have led to insurer losses • Quite the reverse – insurers invested in bonds at higher interest rates and have achieved greater returns than stock market • Pricing considerations • Monitor investment yields net of capital gains • Rising cash positions • Need about 4% additional rate for every 100 basis points reduction in interest rate.

11. Peer Investment Returns Only fixed income investments are considered. Source: Thomson Financial OneSource, Internal analysis

12. Cash Position Growing… Source: Thomson Financial OneSource, Internal analysis

13. Occurrence coverage • During the soft market, carriers were offering both occurrence and claims made products • Industry wide, occurrence represents 25-30% of total med mal premium. • Often pricing on occurrence products were less than 5% above the mature claims made rate • Now, carriers are scaling back their occurrence offerings.

14. Why not occurrence? • Both frequency and severity unknown for years • Years pass before a difficult risk and can be identified • Longer investment horizon -> more investment income but greater interest rate risk

15. Occurrence Challenges (cont) • Difficulty in predicting ultimate losses  more uncertainty in the company loss reserves • Development methods highly leveraged in loss development factor • Claims made 12 months – ultimate: less than 2.0 • Occurrence 12 months – ultimate: greater than 7.0 • Frequency/severity approaches highly dependent on ultimate severity • Carriers have traditionally understated severity • Hypothesis: Less incentive for doctor to report claims under occurrence than under claims made

16. Do doctors report more slowly on occurrence covers?

17. Contrast with claims made…

18. Lag Observations • Medical malpractice claims have a long tail. Reporting can occur 15-20 years following the incident (e.g. birth related). • Average settlement lags longer than report lags • Physicians under occurrence policies report slightly later than those under claims made policies • But…the gap is narrowing in recent years.

19. DD&R Coverage • Provides “free” coverage for claims reported after a physician dies, becomes disabled, or retires. • Free tail at retirement typically requires a vesting period (e.g. 5 years). • Cost of coverage typically included as an expense in calculating the target loss ratio (commonly 5%). • Cost vary by entry age but fairness considerations dictate a flat charge to all physicians

20. DD&R Reserve • NAIC requires companies to maintain a reserve for the promised future benefits. • Actuarial calculation of DD&R reserve ( PV of future benefits – PV of future premiums ) • Assumptions required for • Retention • Premium trend • Loss cost trend • Mortality, morbidity, retirement • Similar to a pension funding model

21. DD&R Reserve (cont) • Actuarial considerations • Declining retention  less insureds are vested for retirement benefits • Age of doctors displaced by existing markets  older doctors require higher accruals • Early retirement • Be careful using % of unearned premium to accrue DD&R reserve  Rate increases will increase the adequacy of the UPR