How did our Professional Liability Loss Ratio get over 140%?

1. How did our Professional Liability Loss Ratio get over 140%? Prepared For: Midwestern Actuarial Forum Fall 2002 Prepared By: Kevin Conley, FCAS Actuary East Lansing, Michigan September 26, 2002

2. Snapshot of Medical Malpractice Market • National multi-line companies • National uni-specialty companies • Physician & Surgeon medical malpractice companies • Pre-1990 expansionists • One state companies • Post-1990 expansionists

3. APCapital • Began in 1975 as MPMLC • Michigan only • Acquired KY Co. in 1995 and NM Co. in 1997 • First in-house actuary 1996 • Expanded into Ohio, Illinois, Florida, Nevada in mid-to-late 1990’s • IPO in 2000

4. The Extent of the Problem It is estimated that, since 1994: • Over 200 times an insurance company has written over $5 million of medical malpractice premium in a state at an annual ultimate loss ratio over 140% • APCapital has done this 7 times in 4 states • Where does the estimate of 200 come from?

5. The Extent of the Problem Step 1 Estimate industry ultimate loss ratios by accident year Step 2 Estimate loss ratio variance by state by insurer Step 3 Determine the number of insurer/state combinations where written premium > $5M Step 4 Apply a normal distribution to each accident year

6. Industry Med Mal Accident Year Loss Ratios

7. Process States Competition Regulation Legal environment Typical limits of liability Company Operations Marketing Underwriting Claims Actuarial Sources of Loss Ratio Variance

8. Insurers Writing > $5M in Medical Malpractice • 258 in 2001 • 229 in 2000 • 225 in 1999 • St. Paul is counted 32 times in 2001 • California had 18 insurers writing > $5M in 2001

9. Why Did Loss Ratios > 140% Happen? • Excess Capital • Appetite for Growth in New Markets • Change in Underlying Severity Trend • Weak Management • More Sophisticated Buyers

10. Frontier ProAssurance FPIC SCPIE NCRIC MIIX APCapital Why Did Loss Ratios > 140% Happen? 1. Excess Capital • Redundant reserves (e.g., St. Paul) • Calendar year management mentality • In 1990’s, many companies went public:

11. Why Did Loss Ratios > 140% Happen? 2. Appetite for Growth in New Markets • APCapital began expanding outside of Michigan in 1995 • Many peer companies did the same • Enron mentality? • Growth was easiest in large, “troubled” states, e.g., Florida, Ohio, Pennsylvania, and Texas

12. Why Did Loss Ratios > 140% Happen? 3. Change in Underlying Severity Trend • Not as dramatic as often reported • Rhetoric of “runaway juries” and “out-of-control tort system” is overblown • Started in 1996-1997 • First discernable about 2000

13. Change in Underlying Severity APCapital – State X% of Closed Claims > $500,000

14. Change in Underlying Severity APCapital – State X% of Closed Claims > $500,000

15. Change in Underlying Severity APCapital – State X% of Closed Claims > $500,000

16. Change in Underlying Severity Medical Malpractice Trends • No frequency trend • CPI: 1985-2001 3.16% 1991-1999 2.55% • APCapital has used 2.5% to 4.0% in recent years • Competitors now using 3.0% to 7.0% • APCapital now using 4.0% to 7.0%

17. Why Did Loss Ratios > 140% Happen? 4. Weak Management • Small companies often have weak management • Med mal is a “sophisticated” line • Few executives with med mal experience • Doctor-owned, doctor-controlled companies have had trouble achieving pricing adequacy or discipline • APCapital has seen this in acquired companies and books of business

18. Why Did Loss Ratios > 140% Happen? 5. More Sophisticated Buyers • Physician income growth relatively stagnant • Formation of physician groups • More insurers to choose from

19. Why Did Loss Ratios > 140% Happen? How did Actuaries add to the Soft Market? • Optimistic loss development factors • Low-end trend selections • Small profit leads • “Budgeted” expense leads • “Select” less than “Indicated”

20. Where Do We Stand Now? • Many companies left the market • Insolvency • Voluntary choice • Price increases over 2000-2003 period • Some tort reform may happen