A New EPOCH

A New EPOCH for the Medical Malpractice Insurer Author: Robert T. Allen Vice President Uni-Ter Underwriting Management Corporation

PRE - 2000

In the mid-1970s, medical malpractice insurers started leaving the marketplace after having to pay multi-million dollar awards. Physicians, hospitals and every other type of healthcare provider were left without coverage. Some states enacted legislation to create joint underwriting associations that were required to "take all comers". In other cases, state medical societies sponsored self-insured programs to protect their members. This period of time has been labeled the "availability crisis."

Ten years after the availability crisis was the "price crisis". Rate levels for malpractice coverage steadily increased between 1975 and 1985. At the same time, healthcare providers were still being hit with multi-million dollar jury awards. Buying anything less than a $1 million policy limit was no longer adequate, but the idea of purchasing high limits was cost prohibitive. As this price crisis continued, it was decided that additional limits must be made available to protect the physicians and other providers. Some states introduced patient compensation funds (PCFs) or risk pools that would provide the excess limits.

During the 1990s, the only crisis to report was a battle between the provider-sponsored companies and the commercial markets. Once loss severity started to level off, commercial stock companies re-entered the medical malpractice arena. At the same time, larger provider groups continued to form alternative risk vehicles. Providers in almost every part of the country had something they had not had in years¦an option.

Ding! Ding! It's now the year 2000 and the fighters (companies) have taken off their gloves. Commercial markets say the physician-owned companies cannot compete with them on a one-stop shopping basis. The doctor mutuals say their provider relationships will carry them through a hardening market. Who will win?

Whether you are a billion-dollar commercial carrier or a smaller provider-owned company, there will be two keys to success in the 21st century: 1) adapt to client changes and 2) deliver multiple products and services. Let's examine events and trends of the '90s in order to understand what to do in the new century.

The '90's - A Decade of Name Changes

The insurance industry's M&A activity of the '90s included several malpractice carriers. Big unions included: ProNational - Physician Protection Trust Fund; Zurich - Truck Insurance Exchange; Frontier Insurance Group - Western Indemnity; HUM - OHIC; Medical Assurance Group - Momedico; FPIC - Physicians Reciprocal Insurers; Medical Group Holdings - Pennsylvania Medical Society Liability Insurance Company and MMI - Unionamerica.

The decade ended with further consolidation and the trend is continuing. At the end of 1999, St. Paul offered $200 million for MMI Companies in a transaction that should close in mid-year 2000. In January 2000 Medical Liability Mutual Insurance Company (MLMIC) and Princeton Insurance Companies announced a plan to merge the two malpractice insurers. Although both of these mega-mergers combine companies with similar underwriting territories, there are definite advantages. St. Paul gains MMI's large hospital underwriting expertise, and MLMIC insureds gain a portfolio of multi-peril and workers' compensation products.

Just as important as the mergers/acquisitions were the new market entrants. In fact, increased competition may have been the leading reason for recent soft pricing. Zurich Insurance Group, Travelers, Chubb Executive Risk, Kemper Insurance Group and Legion Insurance Company each started offering medical professional liability products during the 1990's. In the "milder" medical professional liability market, the new entrants writing risks like social service agencies and bio-tech firms made an equally exhausting list (General Star, Admiral, Royal, etc.). Unfortunately, the market failures of PIC, PIE Mutual and Paradigm were minimized because so many markets were willing to step in their place.

A Decade of "Alternative Risk"

Alternative risk vehicles played an integral part in reshaping (expanding) the malpractice market place. Although their growth slowed in the late-90s, risk retention groups (RRGs), purchasing groups (PGs) and rent-a-captives kept premiums down and put providers in control of their destiny.

Healthcare providers have consistently been one of the leading classes to form risk retention groups. As of 1998, healthcare risks were responsible for 38% of the total RRG premium. According to a report prepared by the Risk Retention Reporter, an alternative risk publication, RRG premiums increased from $250.2M in 1988 to an estimated $790.5M in 1998. RRG insureds increased from 43,337 in 1990 to an estimated 158,844 in 1998. While the number of RRGs for facilities and independent practitioners is relatively equal, we expect the growth in RRGs to be among physicians and other individual providers.

At the end of 1999, PGs reached a 10-year high of 743. PG premiums increased from $575M in 1988 to $1556M in 1993 and are believed to be well over $2B in 1998. PG numbers increased from 377 in 1992 to 743 in 1999. Of the 150 healthcare purchasing groups, 128 programs address the needs of individual practitioners and only 22 PGs that address the liability needs of facilities (HMOs, hospitals, clinics or nursing homes). If we go by these numbers, physicians, dentists and other individual providers should be in a better position to convert into RRGs during a hard market.

What will the future bring for healthcare's alternative risk market? As rates in certain regions harden and providers continue to merge, RRGs and PGs will continue to grow. Some groups will even use these risk vehicles to cover specialized risks such as capitation risk, Medicare/Medicaid Billing E&O and telemedicine.

A Decade of Tough Performance

U.S. RE Corporation compared the financial results of 40 companies that are either mono-line malpractice carriers or carriers where medical professional liability is over 50% of their writings. Statistics for each company were obtained through A.M. Best's Insurance Reports for the periods of 1992 through 1998. The company results in 1992 compared to 1998 were not what one would expect: combined ratios and pure loss ratios are down, policyholders surplus and net written premium are up. With these trends, why has such a negative picture been painted for the past decade?

As would be expected, there were those who had favorable underwriting results and those who did not. The release of reserve redundancies in conjunction with growth in investment income was often the reason for performing well. The better than expected loss development in previous accident years also fueled some companies' ability to offer dividends and in turn, they retained their market share.

There are, however, some underlying themes that could lead one to imagine a less favorable future. Some industry professionals have predicted that the reserve redundancies experienced by the provider mutuals will not continue at recent levels and eventually the mutuals will be less competitive.

The average combined ratio of the reviewed companies rose from 101.4 in 1997 to 107.4 in 1998. A.M. Best's Medical Malpractice Industry Composite rose from 98.1 to 110.5 during the same period. As a critical measure of underwriting performance, these figures could indicate the beginning of this class's deterioration.

Although net written premiums are up, they were bought with a price. Of the 40 companies, only eleven (11) averaged double-digit growth from year to year. Of the eleven (11), six (6) companies had growth without acquiring or partnering with other markets: Academic Health Professionals, Community Blood Centers, RRG, HANYS Insurance Company, Medical Inter-Insurance Exchange, NCRIC and Ophthalmic Mutual Insurance Company (OMIC), RRG. Seventy-two percent of the companies either lacked the capital to support illusionary growth or they simply did not offer a commodity product that interested new buyers.

(1) Merger, acquisition or market partnership occurred between 1992 to 1998.

Profitable growth was difficult to realize during the 1990s. The few who did realize profitability and significant growth (Academic Health Professionals, Community Blood Centers, FPIC and OMIC) were a mixed bag of markets. They are not solely writers of individual providers nor are they exclusive to being mono-line writers.

For the past few years, these companies have stuck to their sound underwriting practices and offered a niche product in order to reach their goals. In the future, they will need to identify untraditional sources of business and be willing to deliver new products and services in order to compete with the growing number of medical malpractice insurers. The following section will examine developments in state-controlled facilities, emerging risks and underwriting practices and then explore how these changes can result in new business opportunities.

YEAR 2000+

In the New Epoch: A Decline in Residual Markets and Patient Compensation Funds

The conversion of the Massachusetts JUA into a thriving mutual company (ProMutual) is an example of where mutual and commercial insurers are able to accommodate all types of providers. With so many companies fighting for the same $6 billion in premium, you would imagine that JUAs and other state-sponsored facilities would be a thing of the past. They still exist but their need has been questioned.

There are ten (10) states with active residual markets (or JUA's) for medical malpractice: Florida, Kansas, Minnesota, New Hampshire, New York, Pennsylvania, Rhode Island, South Carolina, Texas and Wisconsin. Most of these JUA's have seen their state market share percentages drop into single digits. South Carolina is the only JUA that underwrites a controlling share of its state's malpractice premium.

The JUAs' decline in market share is due to several factors. Carriers have been willing to underwrite the "high-risk" physicians and facilities that traditionally were covered by markets of last resort. The predictability of future loss and the continued long-tail nature of the business make even the loss-driven business relatively attractive. Managed care entities (independent practitioner associations, preferred providers organizations, etc.) have the purchasing power necessary to negotiate malpractice programs that cover all of their contracting providers, including the bad ones. When you couple these factors with the overcapitalization of the insurance industry, it raises questions whether there is a need for any JUA.

The price crisis of the 1980's drove many physicians and healthcare facilities to purchase low limits of coverage. State-controlled facilities, known as Patient Compensation Funds (PCFs), were created to offer all licensed "healthcare providers" excess limits at 'affordable rates'. There are eight (8) states with active PCFs: Indiana, Kansas, Louisiana, Nebraska, New Mexico, Pennsylvania, South Carolina and Wisconsin (see Exhibit ?). In addition to these general PCFs, some states have created compensation funds specific to birth-related neurological injuries.

Some PCFs have experienced financial hardships. It was proposed that the Pennsylvania PCF would cease writing business, settle all outstanding claims and dissolve the operations. The need for altering coverage terms and possibly dissolving the facility was brought about by an alleged shortfall of $2 billion. The South Carolina PCF is also experiencing financial difficulties. According to a January 2000 Legislative Audit Council report, South Carolina's PCF is underfunded and government officials are considering whether they should disband it. With almost 80 percent of South Carolina's doctors participating in this facility, it is frightening to imagine this PCF running at a deficit somewhere between $30 - $100 million. Fortunately, the insurance industry could easily assume the limits offered by South Carolina and the nation's other PCFs. If current trends continue, we would expect most states to reduce their participation in PCFs and voluntary markets to provide the additional limits at cost-effective rates. Since the JUA market is such a small percentage of the total malpractice market, we expect states to also depopulate these facilities.

1996 MEDICAL MALPRACTICE JUA MARKET SHARES DIRECT PREMIUMS WRITTEN (dollar amounts in millions)

State Private Market JUA Market Total Market JUA Market Share Florida $393.9 $1.9 $395.8 0.5% Kansas 39.6 0.7 40.4 1.8% Minnesota 45.1 0.2 45.3 0.4% New Hampshire 20.2 5.1 25.3 20.3% New York 783.4 38.7 822.1 4.7% Pennsylvania 200.8 1.2 202.0 0.6% Rhode Island 19.8 5.3 25.1 20.9% South Carolina 10.7 12.3 23.0 53.4% Texas 287.8 4.7 292.5 1.6% Wisconsin 64.2 2.7 66.9 4.0% Source: December 1997 The Status of the Primary & Excess Medical Malpractice Market, by the New York Superintendent of Insurance

In the New Epoch: Profitability in Emerging Risks

As residual markets and financially distressed companies are dissolved or acquired, the remaining companies are still faced with difficult market conditions. Carriers in some regions are able to obtain renewal premiums at expiring rates and even slight rate increases are earned. On the other hand, when a new carrier enters a state/region, price wars immediately occur. Instead of companies fighting over traditional malpractice business, they should look at their insureds' emerging professional risks as opportunities for profitable growth.

Two examples of "emerging risks" are telemedicine and health care compliance. When tackling telemedicine, very few markets have been willing to specifically cover these activities. When examining health care compliance, facility underwriters have had a difficult time developing a product that their insureds are willing to purchase. The creative companies that spend the time to develop viable programs will find themselves in a position where they set the terms rather than having the competition dictate pricing.

Telemedicine can be defined as the use of telecommunications to provide medical services to patients who are distant from their physicians. The "tele" portion of telemedicine includes equipment such as telephones, the Internet, fax machines and video- conferencing equipment. The "medicine" application of telemedicine can be apply to several medical specialties including pathology, radiology, psychiatry, x-ray/imaging, cardiac monitoring and general surgery. Broader definitions of telemedicine can include the use of the Internet to deliver medical advice or transfer medical records. Examples of telemedicine providers include:

On-line pharmacies; Networks of providers that offer specialized medical services to patients in remote locations; and Physician websites that offer medical advice to individuals who may or may not be considered patients. While carriers are aware of their insureds' changing exposures, a willingness to cover them is being determined on a case-by-case basis. Chubb Executive Risk has a form specifically tailored to telemedicine risks. AIU (an AIG company) has a telemedicine form to cover suits outside of the U.S. As telemedicine becomes a more integral part of the healthcare industry, providers will move their coverage to markets that can address all of their exposures.

While the concept of healthcare compliance is not new, the exposure to loss arising from non-compliance has reached an all-time high. During the past few years the government's focus on healthcare fraud has impacted every component of the healthcare system. At first, only large teaching hospitals were targeted as being cheaters of the Medicare and Medicaid programs. Now everyone (durable medical equipment suppliers, laboratories, physicians, home healthcare agencies, etc.) have had to adjust their billing practices. The surge in lawsuits under the False Claims Act has resulted in new insurance products for billing errors. Individual practitioners and small groups have a laundry list of choices to protect themselves:

an endorsement from their med mal carrier that covers an investigation's legal expenses; an endorsement from their med mal carrier the covers legal expenses and ensuing fines; a stand-alone policy that covers expenses from an investigation; or a policy that covers expenses and fines. Sub-limits for compliance endorsements range from $25,000 to $100,000. In some cases there is no premium charge for the base limit ($25,000) and as little as $1,000 charged for a $100,000 limit. At these prices, every physician and physician group should carry the coverage.

Coverage for facilities, however, has not been as affordable or as readily available. Two criticisms have been made of the facility products: 1) too restrictive and 2) too expensive. High retentions, mandatory software products, audited compliance programs and/or six to seven-figure premiums are common features for the facility-based coverage.

Profitable growth among malpractice carriers will be found through niche underwriting and through new products. Since truly new and innovative products rarely have competition during their first few years, it is easier to obtain the rate for the targeted results. Carriers must begin to look at emerging risks as opportunities rather than ignoring them because they fall outside of the underwriting box.

In the New Epoch: Underwriting "Outside of the Box"

It has been a difficult period for the smaller mono-line malpractice carriers. Changes in provider purchasing (due to managed care), broker consolidation, overcapacity and new alternative risk vehicles have put considerable strain on these companies. In tough markets, risk assessment skills are critical in order to underwrite business that is both underpriced and profitable.

If they have not done so, each medical malpractice carrier should add a section to their underwriting manual titled "Outside of the Box". Underneath this section there should be a supply of blank pages, one No.2 pencil, a hand-held calculator, a coin (to toss) and a rabbit's foot. This may sound a little extreme but not far from the truth. The rapid changes that affect future profit or loss are not included in a three-ring underwriting manual. Underwriters cannot afford to give away coverage nor can they ignore opportunities because a risk falls outside of the underwriting box. An underwriter's response to a changing market defines him or her. An innovative underwriter is one who identifies shifts in healthcare dynamics and makes assumptions regarding the effect those shifts will have on future losses. A static underwriter is one who acknowledges there are differences in the industry but he or she refuses to change their underwriting process until losses have resulted from the changes.

Simply put, healthcare risks are forever evolving. The changes and their effect on losses can be a result of payer-provider dynamics (i.e. managed care), improvements in technology (e.g. anesthesiology) or new legislation like the Patients' Bill of Rights Act. Combinations of changes (a growing aged population and patient rights legislation) have had a negative impact on every major writer of nursing home liability. Recognizing these changes on a macro level as well as on an account-specific basis allows underwriters to price a risk properly.

Underwriting outside of the box will mean being more than a mono-line malpractice carrier. Companies will need to address providers' ancillary coverage needs and their desire to assume more risk. Property, providers excess and workers' compensation can easily be introduced to a carrier's arsenal of products. Just as easy are the introductions to vendors, who can offer rent-a-captive services, managed care consulting and compliance audits.

There are several methods for expanding into new lines of insurance. The first step is to examine whether the existing staff has the skills necessary to underwrite the new line. If the answer is yes, then a laundry list of issues need to be explored: underwriting guidelines, policy forms, distribution systems and of course, the use of reinsurance. The amount of time for researching all of the items may go beyond a company's window of opportunity. The quick remedy may be a turnkey product or use of an MGA.

Working outside of the box must include delivering alternative risk transfer solutions to clients. Alternative risk transfer is not limited to the Fortune 500„• accounts, nor is it limited to the top 20 commercial carriers. Mutual Insurance Corporation of America's subsidiary, MICOA Consulting, LLC, offers alternative risk transfer services such as rent-a-captive services and other non-traditional insurance solutions. PHICO Re Ltd., formed in 1998 as a Bermuda-based reinsurer, specializes in captive excess insurance and loss portfolio transfers. PHICO also offers rent-a-captive services. For those companies that do not have the money to develop these products, partnering with a reinsurance intermediary is a quick remedy to offer clients self-insurance options.

In the New Epoch: Using the Internet

The insurance industry has been accused of being one of the last industries to utilize the Internet effectively. As a banking client, many of us can use the Internet to review our checking account balance, have bills paid and purchase various products/services offered through our bank. As a malpractice insured, company websites do very little in terms of simplifying transactions or automating services.

If the Internet is going to be an effective tool for medical malpractice carriers, their websites will have to do more than provide general company information. Sites will have to offer financial transactions and services: premium payment, transfer data for coverage changes, online physician credentialing, incident reporting and more. If sites are going to be used to provide information, it must be useful information: current loss summaries, continuing medical education courses and risk management tips.

While providing all of the above mentioned services will take some time (and money), it is nowhere near state-of-the art. Thousands of credit card transactions are performed on the Internet on a daily basis; however, none of the carrier sites we examined provide online premium payment. We could not find a web site that offers the ability to notify the company of changes in medical specialty or the ability to perform incident notification. Most carriers have compromised by providing phone and address information to notify the company.

For those companies who are looking for solutions to reduce expenses, the Internet is the answer. Underwriting staff can be reduced if you have a sophisticated rating engine linked to a company's website. Risk management seminars can be moved from expensive hotel conference rooms to a web page accessed by password. If the state mutuals and RRGs are going to compete with the commercial markets, they will need tools like the Internet to move as fast (and cheaply) as their competition.

Conclusion

Medical malpractice crises in the 1970s and 1980s resulted in the formation of provider-owned carriers as well as JUAs and other state managed facilities. As new markets entered this line during the 1990s, the provider markets saw their market share slow to single-digit growth. Since we are not in a malpractice crisis, it is fair to say that JUAs and compensation funds are no longer necessary. The JUA/PCF business is one source of potential new business for the provider mutuals.

Even if you exclude the JUA/PCF business, there are sufficient resources and new business opportunities for specialty malpractice carriers to succeed well beyond the year 2000. If the provider owned companies continue sound underwriting practices, explore emerging risks and are willing to deliver new products and services to their clients, they will be on equal footing with their commercial counterparts. Many of the specialty companies are adequately capitalized to offer new lines of coverage and alternative risk services. For those who do not have the financial wherewithal, relationships can be developed with reinsurers and/or MGAs to supply the necessary coverage or service.

Ding! Ding! Round one has begun. If you are a mono-line writer, are you working with a carrier to deliver P&C products to your insureds? Is your intermediary providing you with rating-agency consultation? Has someone in your organization been assigned to develop new products? If the answer to these questions is no, you may have already lost the fight.

SURVEY OF PATIENT COMPENSATION FUNDS

State Surcharge Applies to: Surcharge Amount Collector Limit Requirements Other Indiana Applies to all healthcare providers. "Healthcare provider" is defined as all individuals, partnerships, limit liability corporations and institutions licensed by state to provide healthcare or professional services. It also includes all universities, employers and governing bodies that provides healthcare to its students, faculties or employees. It also includes HMOs. Annual surcharge will not exceed 200% of healthcare providers malpractice insurance. The Insurer - Surcharge shall be collected on same basis as premiums by insurer, risk manager or surplus lines agent. As of 1990, the maximum payout shall be $750,000. Healthcare provider must carry medical malpractice insurance. Kansas Applies to all defined healthcare providers. Definition of provider is similar to that of Indiana, but it does not include optometrists, pharmacists, physical therapists or health maintenance organizations. Annual surcharge is a percentage of underlying premium. There are options available for the amount of coverage purchased in excess of the statutory primary limits. The Insurer Provider must buy primary limits of $200K/$600K Insurer must notify the state that base coverage is in place. A Coverage Statement is utilized by all authorized insurers. Louisiana Applies to all healthcare providers Surcharge determined by the LA Insurance Rating Commission. Insurer, risk manager or surplus lines agent. Board of Fund will collect from self-insured healthcare providers. Healthcare providers shall not be liable for claims in excess of liability amounts of $100K. Maximum assumed by provider is $500K. Nebraska Defined as most individuals and entities authorized by law to provide professional medical services. Approximate 5% of annual premium. Either insurer or insured can submit the surcharge. $200K/$600K for individuals, $200K/$1 mil for hospitals. Fund coverage is capped at $1.25 mil Does not apply to non-admitted coverage New Mexico Doctors, corporations and various physician assistants Surcharge is based on class of the professional Insurer $200K/$600K individual Company must be licensed to write medical malpractice Pennsylvania All providers licensed and approved by the Commonwealth to deliver medical services. Close to 70% of the prevailing primary premium rates Insurer $4OOK/$1.2M non-hospitals, $400K/$2M hospitals Applies to admitted and non-admitted business South Carolina Applies to all licensed healthcare providers - individuals and facilities. Yr. 1 - 100% of JUA premium; Yr.2 75/% of JUA prem.; Yr.3 + 50% of JUA premium The Fund $100k/$300K Voluntary Wisconsin Residency requirements trigger participation in the fund. Applies to all licensed healthcare providers - individuals and facilities. Surcharge is based on a fee schedule. $1m/$3m Mandatory and applies to admitted and non-admitted business.

No Patients Compensation Funds exist in the remaining states. Other states have had legislation for Funds, however they are either insolvent or were deemed unconstitutional.