Medical Malpractice Insurance: Multiple Factors Have Contributed to Increased Premium Rates
Released: 2003-07-28T00:00:00

Letter

Background

Nearly all health care providers, such as physicians and hospitals, purchase insurance that covers expenses related to medical malpractice claims, including payments to claimants and legal expenses. The most common physician policies provide $1 million of coverage per incident and $3 million of coverage per year. Today the primary sellers of physician medical malpractice insurance are the physician-owned and/or operated insurance companies that, according to the Physician Insurers Association of America, insure approximately 60 percent of all physicians in private practice in the United States. Other health care providers may obtain coverage through commercial insurance companies, mutual coverage arrangements, or state-run insurance programs, or may self-insure (take responsibility for claims themselves). Most medical malpractice insurance policies offer claims-made coverage, which covers claims reported during the year in which the policy is in effect. A small and declining number of policies offer occurrence coverage, which covers all claims arising out of events that occurred during the year in which the policy was in effect.

Medical malpractice insurance operates much like other types of insurance, with insurers collecting premiums from policyholders in exchange for an agreement to defend and pay future claims within the limits set by the policy. Insurers invest the premiums they collect and use the income from those investments to reduce the amount of premium income that would have been required otherwise. Claims against a policyholder are recorded as expenses, or incurred losses, which are equal to the amount paid on those claims as well as the insurer’s estimate of future losses on those same claims. The liability associated with the portion of these incurred losses that have not yet been paid by the insurer is collectively known as the insurer’s loss reserve. In order to maintain financial soundness, insurers must maintain assets in excess of total liabilities—including loss reserves and reserves for premiums received but not yet earned—to make up what is known as the insurer’s surplus. State insurance departments monitor insurers’ solvency by tracking, among other measures, the ratio of total annual premiums to this surplus. Medical malpractice insurers generally attempt to keep their surplus approximately equal to their annual premium income.

Medical malpractice insurers establish premium base rates for particular medical specialties within a state and sometimes for particular geographic regions within a state. Insurers may also offer discounts or add surcharges for the particular characteristics of policyholders, such as claim histories or whether they participate in risk-management programs. The premium rates are based on anticipated losses on claims and related expenses, expected investment income, the need to build a surplus, and, for for-profit insurers, the desire to earn a reasonable profit for shareholders. In most states the insurance regulators have the authority to approve or deny proposed changes to premium rates.

For several reasons, accurately predicting losses on medical malpractice claims is difficult. First, according to a national insurer association we spoke with, most medical malpractice claims take an average of more than 5 years to resolve, including discovering the malpractice, filing a claim, determining (through settlement or trial) payment responsibilities, if any, and paying the claim. In addition, some claims may not be resolved for as long as 8 to 10 years. As a result, insurers often must estimate costs years in advance. Second, the range of potential losses is wide. Actuaries we spoke with told us that individual claims with similar characteristics can result in very different losses for the insurer, making it difficult to predict the ultimate cost of any single claim. Third, the predictive value of historical data is further limited by the often small pool of relevant policyholders. For example, a relevant pool of policyholders would be physicians practicing a particular specialty within a specific state and perhaps within a specific geographic area within that state. In smaller states, and for some of the less common but more risky specialties, this pool could be very small and provide only a limited amount of data that could be used to estimate future costs.

Medical malpractice insurance is regulated by state insurance departments and subject to state laws. That is, insurers selling medical malpractice insurance in a particular state are subject to that state’s regulations for their operations within that state, and all claims within that state are subject to that state’s tort laws. Insurance regulations can vary across states, creating differences in the way insurance rates are regulated. For example, one state insurance regulator we spoke with essentially let the insurance market determine appropriate rates, while another had an increased level of review, including approving specific company rates on a case-by-case basis. NAIC assists state insurance regulators in developing these regulations by providing guidance, model (or recommended) laws and guidelines, and information-sharing tools.

In response to concerns over rising premium rates, physicians, medical associations, and insurers have pushed for state and federal legislation that would, among other things, limit the amount of damages paid out on medical malpractice claims. A few states have passed legislation with such limitations over the past several years, and federal legislation is pending. On March 13, 2003, the House of Representatives passed the Help Efficient, Accessible Low-Cost, Timely Healthcare (HEALTH) Act of 2003, which includes, among other things, a limit on certain types of damages in medical malpractice claims. On March 12, 2003, a similar bill of the same name was introduced in the Senate, but as of June 2003, no additional action had been taken.

Both the Extent of Increases in Medical Malpractice Premium Rates and the Rates Themselves Varied across Specialties and States

Beginning in 1999 and 2000, medical malpractice insurers in our seven sample states increased their premium rates for the physician specialties of general surgery, internal medicine, and obstetrics/gynecology faster than they had since at least 1992. These specialties were the only ones for which data were available, and 1992 was the earliest year for which we could obtain comprehensive survey data. However, both the extent of these changes and the level of the premium rates insurers charged varied greatly across medical specialties, states, and even areas within states. From 1999 through 2002, one large insurer raised rates more for internal medicine than for general surgery, while another raised rates 12 times more for general surgery than for internal medicine. Changes in premium base rates among some of the largest insurers in each state ranged from a reduction of about 9 percent for obstetricians and gynecologists insured by one California company to an increase of almost 170 percent for doctors in the same specialty in one area of Pennsylvania. At the same time, premium rates for the same amount of coverage for the same medical specialty varied by a factor of as much as 17 among states—that is, the rate in one state was 17 times higher than the rate in a different state.

Premium Rates Have Grown Rapidly since 1998 for Certain Specialties in Some States

As figure 1 shows, premium base rates varied across our seven sample states from 1992 to 1998 but for most insurers remained relatively flat. Beginning in 1999 and 2000, however, most of these insurers began increasing their rates in larger increments. Many of the increases were dramatic, ranging as high as 165 percent, although some rates remained flat. Figure 2 shows the percentage increase in premium rates for the largest insurers in our seven sample states from 1999 through 2002. In the Harrisburg area of Pennsylvania, for example, the largest insurer increased premium base rates dramatically for three specialties: obstetrics/ gynecology (165 percent), general surgery (130 percent), and internal medicine (130 percent). At the same time, the consumer price index (CPI) increased by 10 percent. However, in California and Minnesota, premium base rates for the same specialties rose between 5 and 21 percent and in some cases fell slightly. The variations in the changes in premium base rates among our sample states appears to be consistent with the changes in states outside our sample, with insurers in some states raising premium rates rapidly after 1999 and insurers in other states raising them very little.

The Level of Premium Rates Also Varied across Specialties and States

We found that premium rates quoted by insurers in our seven sample states varied across medical specialties and states. According to some of the insurers and actuaries we spoke with, the differences in rates reflect the costs associated with medical malpractice claims against physicians in particular specialties. Specialties with a high risk of large or frequent losses on medical malpractice claims will have higher premium rates. For example, in 2002 the largest medical malpractice insurer in Texas quoted a base rate for the same level of coverage of $92,000 to obstetricians and gynecologists, $71,000 to general surgeons, and $26,000 to internists. Figure 3 shows the premium rates quoted by the largest medical malpractice insurers in our sample states for these three specialties.

Premium rates quoted by insurers in our seven sample states for the same medical specialty also varied across states and geographic areas within states (see fig. 3). Some of the insurers and actuaries we spoke with told us that these variations also reflect differences in insurers’ loss experiences in those venues. As figure 3 shows, the largest insurer in Florida quoted a premium base rate of $201,000 for obstetricians and gynecologists in Dade County, while the largest insurer in California quoted a premium based rate of $36,000 for similar physicians in northern California. Within Florida, the same large insurer quoted a premium base rate of $103,000 for obstetricians and gynecologists outside of Dade County—approximately 51 percent of the Dade County rate. Within Pennsylvania, the largest insurer quoted a premium base rate of $64,000 for doctors in Philadelphia— approximately 83 percent more than the rate it quoted outside the city.

Multiple Factors Have Contributed to the Increases in Medical Malpractice Premium Rates

Insurers’ losses, declines in investment income, a less competitive climate, and climbing reinsurance rates have all contributed to rising premium rates. First, among our seven sample states, insurers’ losses have increased rapidly in some states, increasing the amount that insurers expect to pay out on future claims. Second, on the national level insurers’ investment income has decreased, so that insurance companies must increasingly rely on premiums to cover costs. Third, some large medical malpractice insurers have left the market in some states because selling policies was no longer profitable, reducing the downward competitive pressure on premium rates that existed through most of the 1990s. Last, reinsurance rates for some medical malpractice insurers in our seven sample states have increased substantially, increasing insurers’ overall costs. In combination, all the factors affecting premium rates and the availability of medical malpractice insurance contribute to the medical malpractice insurance cycle of hard and soft markets. While predicting the length, size and turning points of a cycle may be impossible, it is clear that the relatively long period of time required to resolve medical malpractice claims makes the cycles more extreme in this market than in other insurance markets.

Increased Losses on Claims Are the Primary Contributor to Higher Medical Malpractice Premium Rates

Like premium increases, annual paid losses and incurred losses for the national medical malpractice insurance market began to rise more rapidly beginning in 1998. After adjusting for inflation, we found that the average annual increase in paid losses from 1988 to 1997 was approximately 3.0 percent but that this rate rose to 8.2 percent from 1998 through 2001. Inflation-adjusted incurred losses decreased by an average annual rate of 3.7 percent from 1988 to 1997 but increased by 18.7 percent from 1998 to 2001. Figure 4 shows paid and incurred losses for the national medical malpractice market from 1975 to 2001, adjusted for inflation.

Paid and incurred losses give different pictures of an insurer’s loss experience, and examining both can help provide a better understanding of an insurer’s losses. Paid losses are the cash payments an insurer makes in a given year, irrespective of the year in which the claim giving rise to the payment occurred or was reported. Most payments made in any given year are for claims that were reported in previous years. In contrast, incurred losses in any single year reflect an insurer’s expectations of the amounts that will be paid on claims reported in that year. Incurred losses for a given year will also reflect any adjustments an insurer makes to the expected amounts that must be paid out on claims reported during previous years. That is, as more information becomes available on a particular claim, the insurer may find that the original estimate was too high or too low and must make an adjustment. If the original estimate was too high, the adjustment will decrease incurred losses, but if the original estimate was too low, the adjustment will increase them.

Incurred losses are the largest component of medical malpractice insurers’ costs. For the 15 largest medical malpractice insurers in 2001—whose combined market share nationally was approximately 64.3 percent— incurred losses (including both payments to plaintiffs to resolve claims and the costs associated with defending claims) comprised, on average, around 78 percent of the insurers’ total expenses. Because insurers base their premium rates on their expected costs, their anticipated losses will therefore be the primary determinant of premium rates.

The recent increases in both paid and incurred losses among our seven sample states varied considerably, with some states experiencing significantly higher increases than others. From 1998 to 2001, for example, paid losses in Pennsylvania and Mississippi increased by approximately 70.9 and 142.1 percent, respectively, while paid losses in California and Minnesota increased by approximately 38.7 and 8.7 percent, respectively (see fig. 5). Because paid losses in any single year reflect primarily claims reported during previous years, these losses may not be representative of claims that were reported during the year the losses were paid.

From 1998 to 2001, aggregate incurred losses increased by large amounts in almost all of our seven sample states. As shown in figure 6, the highest rates of increase in incurred losses over that period were experienced by insurers in Mississippi (197.5 percent) and Pennsylvania (97.2 percent). Even in California and Minnesota, states with lower paid losses from 1998 through 2001, insurers experienced increases in incurred losses of approximately 40.5 and 73.2 percent, respectively, over the same period. As noted above, incurred losses in any single year reflect insurers’ expectations of future paid losses associated with claims reported in the current year—that is, claims that will be paid, on average, over the next 3 and one-half years (according to one industry association). And because insurers’ incurred losses have increased recently, insurers are expecting their paid losses to increase over the next several years.

According to actuaries and insurers we spoke with, increased paid losses raise premium rates in several ways. First, higher paid losses on claims reported in current or previous years can increase insurers’ estimates of what they expect to pay out on future claims. Insurers then raise premium rates to match their expectations. In addition, large losses (particularly paid losses) on even one or a few individual claims can make it harder for insurers to predict the amount they might have to pay on future claims. Some insurers and actuaries we spoke with told us that when losses on claims are hard to predict, insurers will generally adopt more conservative expectations regarding losses—that is, they will assume losses will be toward the higher end of a predicted range of losses. Further, large losses on individual claims can raise plaintiffs’ expectations for damages on similar claims, ultimately resulting in higher losses across both claims that are settled and those that go to trial. As described above, this tendency in turn can lead to higher expectations of future losses and thus to higher premium rates. Finally, an increase in the percentage of claims on which insurers must make payments can increase the amount that insurers expect to pay on each policy, resulting in higher premium rates. That is, insurers expecting to pay out money on a high percentage of claims may charge more for all policies in order to cover the expected increases.

Comprehensive Data on the Composition and Causes of Increased Losses Were Lacking

A lack of comprehensive data at the national and state levels on insurers’ medical malpractice claims and the associated losses prevented us from fully analyzing both the composition and causes of those losses at the insurer level. For example, comprehensive data that would have allowed us to fully analyze the severity of medical malpractice claims at the insurer level on a state-by-state basis did not exist. To begin with, data submitted by insurers to NAIC on the number of claims reported to insurers are not broken out by state. Rather, insurers that operate in a number of states report the number of claims for all their medical malpractice insurance policies nationwide. Also, while NAIC does collect data that can be used to measure the severity of claims paid in a single year (number of claims per state), NAIC began this effort only in 2000. As a result, we could not gather enough data to examine trends in the severity of paid claims from 1998 to 2002 at the insurer level. Similarly, comprehensive data did not exist that would have allowed us to analyze claim frequency on a state-by-state basis. As noted above, data that insurers submit to NAIC on the number of claims reported were not broken out by state prior to 2000. In addition, insurers do not submit information on the number of policies in effect or the number of health care providers insured. Finally, medical associations we spoke with in our sample states had not compiled accurate data on the number of physicians practicing within those states. As a result, we could not analyze changes in the frequency of medical malpractice claims in our sample states at the insurer level.

Data that would have allowed us to analyze how losses were divided between settlements and trial verdicts or between economic and noneconomic damages were also not available. First, insurers do not submit information to NAIC on the portion of losses paid as part of settlements and the portion paid as the result of a trial verdict, and no other comprehensive source of such information exists. However, all eight insurers and one of the trial lawyers’ associations we spoke with provided certain estimates about claims. The estimates of three insurers on the percentage of claims resulting in trial verdicts ranged from 5 to 7 percent. The estimates of four insurers and 1 state trial lawyers’ association of the percentage of trial verdicts being decided in favor of the insured defendant ranged from 70 to 86 percent. The estimates of four insurers and one state trial lawyers’ association of the portion of claims resulting in payment to the plaintiff ranged from 14 to 50 percent. Second, no comprehensive source of information exists on the breakdown of losses between economic damages, such as medical costs and lost wages, and noneconomic damages, such as compensation for pain and suffering. Several of the insurers and trial lawyers’ associations we spoke with noted that settlement amounts are not formally divided between these two types of damages and that consistent, comprehensive information on trial judgments is not collected. Furthermore, while judgment amounts obtained at trial may be large, several of the insurers we spoke with said that they most often do not pay amounts beyond a policyholder’s policy limits. Data on the final amounts insurers pay out on individual judgments are not collected, although they are reported in the aggregate as part of paid losses in insurers’ financial statements.

While losses on medical malpractice claims increase as the cost of medical care and the value of lost wages rise, losses in some states have far outpaced such inflation. Insurance, legal, and medical industry officials we spoke with suggested a number of potential causes for such increases. These potential causes included a greater societal propensity to sue; a “lottery mentality,” where a lawsuit is seen as an easy way to get a large sum of money; a sicker, older population; greater expectations for medical care because of improved technology; and a reduced quality of care and the breakdown of the doctor-patient relationship owing, for example, to factors such as the increasing prevalence of managed care organizations. While we could not analyze such potential causes for increased losses, understanding them would be useful in developing strategies to address increasing medical malpractice premium rates. That is, because losses on claims have such a profound effect on premium rates, understanding the reasons those losses have increased could make it easier to devise actions to control the rise in premium rates.

Medical Malpractice Insurers’ Investment Income Has Decreased

State laws restrict medical malpractice insurers to conservative investments, primarily bonds. In 2001, the 15 largest writers of medical malpractice insurance in the United States invested, on average, around 79 percent of their investment assets in bonds, usually some combination of U.S. Treasury, municipal, and corporate bonds. While the performance of some bonds has surpassed that of the stock market as a whole since 2000, annual yields on selected bonds since 2000 have decreased steadily since then (table 1).

We analyzed the average investment returns of the 15 largest medical malpractice insurers of 2001 and found that the average return fell from about 5.6 percent in 2000 to an estimated 4.0 percent in 2002. However, none of the companies experienced a net loss on investments at least through 2001, the most recent year for which such data were available. Additionally, almost no medical malpractice insurers overall experienced net investment losses from 1997 to 2001.

Medical malpractice insurers are required by state insurance regulations to reflect expected investment income in their premium rates. That is, insurers are required to reduce their premium rates to consider the income they expect to earn on their investments. As a result, when insurers expect their returns on investments will be high, as returns were during most of the 1990s, premium rates can remain relatively low because investment income covers a larger share of losses on claims. Conversely, when insurers expect their returns on investments will be lower—as returns have been since around 2000—premium rates rise in order to cover a larger share of losses. During periods of relatively high investment income, insurers can lose money on the underwriting portion of their business yet still make a profit. That is, losses from medical malpractice claims and the associated expenses may exceed premium income, but income from investments can still allow the insurer to operate profitably. Insurers are not allowed to increase premium rates to compensate for lower-than- expected returns on past investments but must consider only prospective income from investments.

None of the insurers that we consulted regarding this issue told us definitively how much the decreases in investment income had increased premium rates. But we can make a rough estimate of the relationship between return on investment and premium rates. When investment income decreases, holding all else constant, income from premium rates must increase by an equal amount in order for the insurer to maintain the same overall level of income. Thus the total amount of investment assets relative to premium income determines how much rates need to rise to compensate for lost investment income. Table 2 presents a hypothetical example. An insurer has $100,000 in investment assets and in the previous year received $25,000 in premium income, for a ratio of investment assets to premium income of 4 to 1. If the return on investments drops 1 percentage point and all else remains constant, the insurer must raise premium rates by 4 percent in order to compensate for the reduced investment income. If the return on investments drops by 2 percentage points, premium rates must rise by 8 percent to compensate.

This relationship can be applied to the 15 largest medical malpractice insurers—countrywide—from 2001. Data show that in 2001 the insurers’ total investment assets were, on average, around 4.5 times as large as the amount of premium income they earned for that year. Applying the relationship established above and holding other factors constant, a drop of 1 percentage point in return on investments would translate into roughly a 4.5 percent increase in premium rates. As a result, if nothing else changed, the approximately 1.6 percentage point drop in the return on investments these insurers experienced from 2000 through 2002 would have resulted in an increase in premium rates of around 7.2 percent over the same 2-year period.

Downward Pressure on Premium Rates Has Decreased as Profitability Has Declined

Since 1999, the profitability of the medical malpractice insurance market as a whole has declined—even with increasing premium rates—causing some large insurers to pull out of this market, either in certain states or nationwide. Because fewer insurers are offering this insurance, there is less price competition and thus less downward pressure on premium rates. According to some industry and regulatory officials in our seven sample states, price competition during most of the 1990s kept premium rates from rising between 1992 and 1998, even though losses generally did rise. In some cases, rates actually fell. For example, during this period premium rates for obstetricians and gynecologists covered by the largest insurer in Florida—a state where these physicians are currently seeing rapid premium rate increases—actually decreased by approximately 3.1 percent. Some industry participants we spoke with told us that, in hindsight, premium rates charged by some insurers during this period may have been lower than they should have been and, after 1998, began rising to a level more in line with insurers’ losses on claims. Some industry participants also pointed out that this pricing inadequacy was masked to some extent by insurers’ adjustments to expected losses on claims reported during the late 1980s as well as their high investment income. For many insurers the incurred losses associated with the policies sold during the late 1980s turned out to be higher than the actual losses for the same policies, resulting in high levels of reserves. During the 1990s, as insurers eliminated these redundant reserves by adjusting their current loss reserves for these previous overestimates, current calendar year incurred losses fell and reported income increased. These adjustments, together with relatively high levels of investment income, allowed insurers to keep premium rates flat and still remain profitable.

Selling Medical Malpractice Insurance Has Become Less Profitable

Beginning in the late 1990s, medical malpractice insurers as a whole began to see their profits fall. Figure 7 shows the return on surplus—also called return on equity—for the medical malpractice insurance industry as a whole. Profitability began declining faster in 1998 and in 2001 dropped considerably even as premium rates were increasing in many states, resulting in a negative rate of return, or loss. Some of the factors pushing premium rates upward were also factors in insurers’ declining profitability: higher losses on medical malpractice claims, higher reinsurance costs, and falling investment income.

Medical malpractice insurers in some of our sample states have experienced particularly low levels of profitability since around 1998 (see fig. 8). The loss ratio reported here is the ratio of incurred losses, not including other expenses (often referred to as loss adjustment expenses) related to resolving those claims, to the amount of premiums earned in a given year. Loss ratios above 100 percent indicate that an insurer has incurred more losses than premium payments, a sign of declining profitability. Loss ratios in all seven sample states have increased since 1998, and except for California, all had loss ratios of more than 100 percent for 2001.

This declining profitability has caused some large insurers either to stop selling medical malpractice policies altogether or to reduce the number they sell. For example, beginning in 2002 the St. Paul Companies— previously the second-largest medical malpractice insurer in the United States—stopped writing all medical malpractice insurance because of declining profitability. In 2001, St. Paul had sold medical malpractice insurance in every state and was the largest or second-largest seller in 24 states. St. Paul was not alone. Other large insurers have also stopped selling medical malpractice insurance in since 1999: PHICO Insurance Company, which sold insurance primarily in six states, including Florida, Pennsylvania, and Texas; MIIX Insurance Company, which sold insurance primarily in five states, including New Jersey and Pennsylvania; and Reciprocal of America, which sold insurance primarily in six states, including Alabama, Mississippi, and Virginia. Other insurers reduced the number of states in which they sold medical malpractice insurance: SCPIE Indemnity Company, which in March 2003 essentially stopped selling insurance outside of California, and First Professionals Insurance Company, which has said that beginning in 2003 it will essentially stop selling insurance outside of Florida.

When a large insurer leaves a state insurance market, the supply of medical malpractice insurance decreases, and the remaining insurers may not need to compete as much on the basis of price. In addition, the remaining insurers are limited in the amount of insurance they can supply to fill the gap, because state insurance regulations limit the amount of insurance they can write relative to their surplus (the amount by which insurers’ assets exceed their liabilities). For mutual, nonprofit insurers, increasing the surplus can be a slow process, because surplus must generally be built through profits or by obtaining additional funds from policyholders. Commercial insurers can obtain funds through capital markets, but even then, convincing investors to invest funds in medical malpractice insurance when profits are falling can be difficult.

Remaining Insurers Have Increased Prices to Reflect Expected Losses

According to industry participants and observers, as the competitive pressures on premium rates decreased, it appears that insurers were able to more easily and more quickly raise premium rates to a level more in line with their expected losses. That is, absent competitive pressure that may have caused insurers to keep premium rates at lower levels, which in hindsight were perhaps too low for the ultimate losses the insurers would have to pay, it appears that insurers were able to raise premium rates to match their loss expectations. As noted earlier, losses increased to a great extent in some states, and thus some insurers may have increased premium rates dramatically.

While it appears clear that a reduction in price competition has allowed insurers to more easily and more quickly increase premium rates to a level more in line with insurers’ expected losses, we identified at least three factors that seem to suggest that these premium rates are not inconsistent with expected losses. First, if the higher premium rates were above what was justified by insurers’ expected losses, profitability would be increasing. But profits are not increasing, indicating that insurers are not charging and profiting from excessively high premium rates. Second, according to some industry participants we spoke with, physician-owned insurers have little incentive to overcharge their policyholders because those insurers generally return excess earnings to their policyholders in the form of dividends. Third, in most states the insurance regulators have the authority to deny premium rate increases they deem excessive. While the information that state regulators require insurers to submit as justification for premium rate increases varies across states, in general it includes data on expected losses.

Reinsurance Premium Rates Have Increased

A further reason for recent increases in medical malpractice premium rates in our seven sample states was that the cost of reinsurance for these insurers has also increased, increasing the total expenses that premium and other income must cover. Insurers in general purchase reinsurance, or excess loss coverage, to protect themselves against large unpredictable losses. Medical malpractice insurers, particularly smaller insurers, depend heavily on reinsurance because of the potential high payouts on medical malpractice claims.

Reinsurance industry officials and medical malpractice insurers we spoke with told us that reinsurance premium rates have increased for two reasons. First, reinsurance rates overall have increased as a result of reinsurers’ losses related to the terrorist attacks of September 11, 2001. Second, reinsurers have seen higher losses from medical malpractice insurers and have raised rates to compensate for the increased risk associated with providing reinsurance to the medical malpractice market. Some insurers and industry participants told us that reinsurance premium rates had risen substantially since 1998, with the increases ranging from 50 to 100 percent. Other insurers told us that in order to keep their reinsurance premium rates down, they increased the dollar amount on any loss at which reinsurance would begin, essentially increasing the deductible. Thus, while reinsurance rates may not have increased, the amount of risk the medical malpractice insurers carry did. One insurer estimated that while its reinsurance rates had increased approximately 50 percent from 2000 to 2002, this increase had resulted in only a 2 to 3 percent increase in medical malpractice premium rates.

The Medical Malpractice Insurance Market Moves through Hard and Soft Insurance Markets

All of the factors affecting premium rates and availability contribute to the length and amplitude of the medical malpractice insurance cycle. Like other property-casualty insurance markets, the medical malpractice market moves through cycles of “hard” and “soft” markets. Hard markets are generally characterized by rapidly rising premium rates, tightened underwriting standards, narrowed coverage, and often by the departure of some insurers from the market. In the medical malpractice market, some market observers have characterized the period from approximately 1998 to the present as a hard market. (Previous hard markets occurred during the mid-1970s and mid-1980s.) Soft markets are characterized by slowly rising premium rates, less stringent underwriting standards, expanded coverage, and strong competition among insurers. The medical malpractice market from 1990 to 1998 has been characterized as a soft market. According to a series of studies sponsored and published by NAIC in 1991, such cycles have been present in the property-casualty insurance market since at least 1926, and until the mid-1970s lasted for an average of approximately 6 years from the peak of one hard market to the next. However, the cycle that began at the peak of the hard market in 1975 lasted for around 10 years. The current cycle has lasted for around 17 years— since 1985—and it is not yet clear that the current hard market has peaked.

Cycles in the Medical Malpractice Market Tend to Be Volatile

The medical malpractice insurance market appears to roughly follow the same cycles as the overall property-casualty insurance market, but the cycles tend to be more volatile—that is, the swings are more extreme. We analyzed the swings in insurance cycles for the medical malpractice market and for the entire property-casualty insurance markets using annual loss ratios based on incurred losses (see fig. 9). Our analysis showed that annual loss ratios for medical malpractice insurers tended to swing higher or lower than those for property-casualty insurers as a whole, reflecting more extreme changes in insurers’ expectations. Because premium rates are based largely on insurers’ expectations of losses, premium rates will fluctuate as well.

The medical malpractice insurance market is more volatile than the property-casualty insurance market as a whole because of the length of time involved in resolving medical malpractice claims and the volatility of the claims themselves. Several years may pass before insurers know and understand the profits and losses associated with policies sold in a single year. As a result, insurers may not know the full effects of a change in an underlying factor, such as losses or return on investments, for several years. So while insurers in other markets that do not have protracted claims resolutions can adjust loss estimates and premium rates more quickly to account for a change in an underlying factor, medical malpractice insurers may not be able to make adjustments for several years. In the interim, medical malpractice insurers may unknowingly be under- or over-pricing their policies.

When insurers do fully understand the effects of a change in an underlying factor, they may need to make large adjustments in loss estimates and premium rates. As a result, premium rates in the medical malpractice insurance market may move more sharply than premium rates in other lines of property-casualty insurance. For example, if insurers have been unknowingly overestimating their losses and overpricing their policies, as some insurers told us happened during the late 1980s, large liabilities build up to cover the losses. When the insurers realize their estimates have been too high, they must reduce those liabilities to reflect their losses accurately. Reducing liabilities also reduces incurred losses and therefore increases insurers’ income, allowing insurers to charge lower premium rates even in the face of increased losses and still maintain profitable operations—a point some insurers made about the 1990s. But when the liability account has been reduced sufficiently and income is no longer increasing as a result of this adjustment, insurers may need to raise premium rates to stay profitable.

The competition that can exist during soft markets and periods of high investment income can further exacerbate swings in premium rates. As noted earlier, competition among insurers can put downward pressure on premium rates, even to the point at which the rates may, in hindsight, become inadequate to keep an insurer solvent. When the insurance market hardens, some insurers may leave the market, removing the downward pressure on premium rates and allowing insurers to raise premium rates to the level that would have existed without such competition. Because competition may have kept rates low, the resulting increase in premium rates that accompanies a transition to a hard market may be greater than it would have been otherwise.

According to some industry experts, periods of high investment income can bolster the downward pressure that exists during soft markets. That is, high investment income can contribute to the increased profitability of an insurance market. This profitability can, in turn, cause insurers to compete for market share in order to take advantage of that profitability, thereby forcing premium rates even lower. In addition, according to these industry experts, high investment income allows insurers to keep premium rates low for long periods of time, even in the face of increasing losses, because investment income can be used to replace premium income, allowing insurers to meet expenses. But if interest rates drop at the same time the market hardens (and reduced interest rates can be a contributor to the movement to hard market), insurers may have to increase premium rates much more in a shorter period of time than they would have if investment income had not allowed premium rates to remain lower to begin with.

Predicting and Moderating the Cycle is Difficult

While the medical malpractice insurance market will likely move through more soft and hard markets in the future, predicting when such moves might occur or the extent of premium rate changes is virtually impossible. For example, the timing and extent of the unexpected changes in the losses that some researchers believe are responsible for hard markets are virtually impossible to predict. In addition, as we have seen, many factors affect premium rates, and it is just as difficult to predict the extent of any future changes these factors might undergo. While interest rates may be high during soft markets, it is not possible to predict how much higher they might be in the future and thus what effect they might have on premium rates. Predicting changes in losses on medical malpractice claims would be even harder, given the volatility of such losses. Further, some of the factors affecting premium rates, such as losses and competition, vary across states, and the effect of soft or hard markets on premium rates in one state could not be generalized to others. Finally, other conditions affecting premium rates have changed since earlier hard and soft markets, limiting our ability to make accurate comparisons between past and future market cycles.

Similarly, agreement does not exist on whether or how insurance cycles could be moderated. The NAIC studies mentioned above noted that the most likely primary causes of insurance cycles—changes in interest rates and losses—were not subject to direct insurer or regulatory control. In addition, the studies also observed that underpricing by insurers during soft markets likely increases the severity of premium rate increases during the next hard market. But they did not agree on the question of using regulation to prevent such swings in premium rates. Such regulation could be difficult, for two reasons. First, because losses on medical malpractice claims are volatile and difficult to predict, regulators could have difficulty determining the appropriate level of premium rates to cover those losses. In addition, restricting premium rate increases during hardening markets could hurt insurer solvency and cause some insurers to withdraw from a market with an already declining supply of insurance.

The Medical Malpractice Insurance Market Has Changed since Previous Hard Markets

The medical malpractice insurance market as a whole has changed considerably since the hard markets of the mid-1970s and mid-1980s. These changes have taken place over time and have been the result primarily of actions insurers, health care providers, and state regulators have taken to address rising premium rates. For example, insurers have moved from occurrence-based to claims-made policies, physicians have formed mutual nonprofit insurance companies that have come to dominate the market, hospitals and groups of hospitals or physicians have increasingly chosen to self-insure, and states have passed laws designed to slow the increase in medical malpractice premium rates.

Beginning in the 1970s, Insurers Began Selling Claims-Made Rather Than Occurrence-Based Policies

In order to more accurately predict losses and set premium rates, in the mid-1970s most medical malpractice insurers began to change the type of insurance policy they offered to physicians from occurrence based to claims made. As we have noted, claims-made policies cover claims reported during the year the policy is in effect, while occurrence-based policies cover claims arising out of events that occurred during the year in which the policy was in effect. Because claims-made policies cover only reported claims, insurers can better estimate the payouts they will have to make in the future. Occurrence-based policies do not provide such certainty, because they leave insurers liable for claims related to the incidents that occurred during a given year, including those not yet reported to the insurer.

Claims-made policies can create difficulties for physicians needing or wanting to change insurers, however, because the physician rather than the insurer retains the risk of claims that have not yet been reported to the insurer. However, most companies today offer separate policies providing coverage for claims resulting from incidents that may have occurred but were not reported before the physician switched companies. The vast majority of policies in existence today are claims-made policies. In each of the seven states we studied, for example, the leading insurer’s policies were predominantly (if not exclusively) claims-made. This change in the type of policy sold means that any changes to premium rates during future hard or soft markets may differ from such changes in previous such markets.

Beginning in the Mid-1970s, Groups of Physicians Joined Together to Form Mutual Insurance Companies

Faced with a surge in the frequency and severity of claims, many of the for- profit insurers left the medical malpractice insurance market in the mid- 1970s. At the time, medical malpractice insurance was only a small portion of most of the insurers’ overall business, so many companies chose simply to discontinue their medical malpractice lines. However, this market exodus led to a crisis of availability for physicians who wanted or needed professional liability insurance. In response to this unmet demand, physicians, often in connection with their state medical societies, joined together to form physician-owned insurance companies. Initially, physicians often needed to contribute capital in addition to their premiums so that the companies would meet state capitalization requirements.

These new physician-owned insurance companies differed from existing commercial carriers in several ways. First, the physician-owned companies wrote predominantly claims-made policies, which, as previously discussed, allowed the insurers to more accurately predict losses and set premium rates. Second, in their initial years the new companies themselves enjoyed significant short-term cost savings over commercial companies. Most medical malpractice claims take several years to be resolved, and the policies offered by the physician-owned companies covered only future incidents of malpractice, so the companies had no existing claims that needed to be paid immediately. The commercial companies’ occurrence- based policies continued to provide coverage for malpractice that had occurred before the new physician-owned companies began offering policies. Thus the physician-owned companies would not incur the same level of obligations as the existing carriers for several years, allowing the physicians to pay an amount similar to the commercial premium and use much of that money as capital contributions to surplus. Physician-owned companies have several other advantages. To begin with, physician-owned companies have a cost advantage because they do not need to provide shareholders with profits. In addition, the physician-owned companies may have some underwriting advantages over the for-profit entities, such as an intimate knowledge of local doctors and hospitals and the legal customs and climate. Finally, several insurers told us that these physician-owned companies may have a different management philosophy than for-profit companies, one that places greater emphasis on risk management and thus lowers the incidence of claims. This philosophy may also extend to defending claims more aggressively than traditional insurers.

Physician-owned and/or operated insurance companies have grown to dominate the medical malpractice insurance market, despite the fact that most of them have not had the same access to the traditional capital markets as for-profit insurers and therefore have had to build up their surplus through premiums and capital contributions. Although several physician-owned and/or operated insurance companies have expanded their geographic presence and lines of insurance in the last decade, most of these companies write insurance primarily in one state or a few states and usually sell only medical malpractice liability insurance. Further, many of the companies that had previously expanded have now retreated to their original area and insurance line. As a result of this continuing change in the composition of the medical malpractice insurance market, changes in premium rates in the next soft market may be different from previous markets, when commercial carriers dominated the market.

A Growing Number of Individual Hospitals and Hospital and Physician Groups Have Begun Self- Insuring

Over the past several years, an increasing number of individual hospitals and consortia of hospitals and physicians have begun to self-insure in a variety of ways. Officials from the American Hospital Association estimated that 40 percent of its member hospitals are now self-insured. In states such as Florida that allow individual physicians to self-insure, individual health care providers are also insuring themselves. Other hospitals and groups of physicians are joining alternative risk-sharing mechanisms, such as risk retention groups or trusts. Although some hospitals and physicians have used these alternatives in the past, some industry experts we spoke to said that the increasing movement to such arrangements under the current market conditions indicates that some health care providers are having difficulty obtaining insurance in the traditional market.

While these arrangements could save money on the administrative costs of insurance, they do not change the underlying costs of claims. Hospitals and physicians insured through these arrangements often assume greater financial responsibility for malpractice than they would under traditional insurance arrangements and thus face a potentially greater risk of insolvency. Although self-insured hospitals generally use excess loss insurance for claims that exceed a certain amount, the hospitals must pay the entire amount up to that threshold. Rather than a known number of smaller payments on an insurance policy, the hospitals risk an unknown number of potentially larger payments. And the threshold for excess loss insurance is rising in a number of states. In Nevada, for example, some hospitals’ excess loss insurance used to cover claim amounts in excess of $1 million but now covers amounts above $2 million, leaving self-insured hospitals with $1 million more exposure per claim. Self-insured physicians, who have no other coverage for large losses, risk their personal assets with every claim.

Hospitals and physicians are not the only ones more at risk under these alternative arrangements. Claimants seeking compensation for their injuries may have more difficulty obtaining payments from some of these alternative entities and self-insured hospitals and physicians, for several reasons. First, these entities and the self-insured are subject only to limited public oversight, as state insurance departments do not regulate them. Further, these entities do not participate in the state-run safety nets that pay claims for insolvent insurance companies (state guaranty funds). Once such a risk-sharing consortium fails, claimants may have no other recourse but to try to enforce judgments against physicians personally. But enforcing a judgment against a physician personally is generally more difficult than obtaining payment under an insurance policy from a solvent insurance company.

Data on these forms of insurance are sparse, so the extent to which physicians and hospitals are using such arrangements is difficult to measure. For example, NAIC and state insurance department data do not include information on self-insurance or on most alternative risk-sharing vehicles. In addition, one industry group has estimated that the information available from A.M. Best, a recognized industry data source, accounts for less than half the costs resulting from medical malpractice claims. Like the growth of physician-owned insurance companies, however, the growth of such forms of insurance since the previous soft market may affect the extent to which premium rates change in the next soft market.

All States Have Passed Laws Designed to Reduce the Growth of Medical Malpractice Premium Rates

Since the medical malpractice crisis of the mid-1970s, all states have enacted some change in their laws in order to reduce upward pressure on medical malpractice premiums. Most of these changes are designed to reduce insurers’ losses by limiting the number of claims filed, the size of awards and settlements, and the time and costs associated with resolving claims. Other changes are designed to help health care providers by more directly controlling premium rates. Appendix II contains a more detailed explanation of some of the types of legal changes that some states have made, and appendix III contains more detail on the relevant laws in our seven sample states.

Most of the state laws aimed at controlling premium rates attempt to reduce insurer losses related to medical malpractice claims. Many of these laws have similar provisions, the most controversial being the limitation, or cap, on subjective, nonmonetary losses such as pain and suffering (noneconomic damages). Several insurers and medical associations argue that such a cap will help control losses on medical malpractice claims and therefore moderate premium rate increases. But several trial lawyer and consumer rights associations argue that such caps will limit consumers’ ability to collect appropriate compensation for their injuries and may not reduce medical malpractice premium rates.

A cap on noneconomic damages may decrease insurers’ losses on claims by limiting the overall amount paid out by insurance companies, especially since noneconomic damages can be a substantial portion of losses on some claims. Further, such a limit may also decrease the number of claims brought against health care providers. Plaintiffs’ attorneys are usually paid based on a percentage of what the claimant recovers, and according to some trial attorneys we spoke with, attorneys may be less likely to represent injured parties with minor economic damages if noneconomic damages are limited.

Caps on noneconomic losses may have effects beyond reducing insurers’ costs. In theory, for example, after the frequency and severity of losses have been reduced, insurers will decrease premium rates as well. Insurers may also be better able to predict what they will have to pay out in noneconomic damages because they can more easily estimate potential losses, reducing the uncertainty that can give rise to premium rate increases. Insurers reported that economic damages (generally medical costs and lost wages), are more predictable than noneconomic damages, which are generally meant to compensate for pain and suffering and thus are very difficult to quantify.

In addition to attempting to decrease losses on medical malpractice claims, two of our sample states have passed laws directly affecting premium rates and insurance regulations. In a 1988 referendum, California passed Proposition 103, which includes, among other things, a 20 percent rollback of prices for all property-casualty insurers (including medical malpractice insurers), a 1-year moratorium on premium rate increases, and a provision granting consumers the right to challenge any commercial insurance rate increases greater than 15 percent. In 1995, Texas passed legislation that required many insurance carriers, including medical malpractice insurers, to reduce rates to a level deemed by the Texas Department of Insurance to be acceptable, allowing for a reasonable profit. Texas passed the legislation in conjunction with changes to Texas’ tort system. The legislators wanted to avoid creating a windfall for insurers and believed that the companies would not lower premium rates on their own until the impact of the changes to the tort system could be actuarially determined.

Interested parties debate the impact these various measures may have had on premium rates. However, a lack of comprehensive data on losses at the insurance company level makes measuring the precise impact of the measures impossible. As noted earlier, in the vast majority of cases, existing data do not categorize losses on claims as economic or noneconomic, so it is not possible to quantify the impact of a cap on noneconomic damages on insurers’ losses. Similarly, it is not possible to show exactly how much a cap would affect claim frequency or claims- handling costs. In addition, while most claims are settled and caps apply only to trial verdicts, some insurers and actuaries told us that limits on damages would still have an indirect impact on settlements by limiting potential damages should the claims go to trial. But given the limitations on measuring the impact of caps on trial verdicts, an indirect impact would be even more difficult to measure. Further, state laws differ dramatically, so comparing their impact is difficult. For example, limitations on damages can vary drastically in amount, type of damages covered, and how the limitations apply. Some states have caps of $250,000 on noneconomic damages, while other states have caps up to several times that amount. Moreover, some dollar limits change over time—for instance, because they are indexed to inflation—while others do not. Some states apply the cap to all damages, including economic damages, and some apply the cap “per occurrence” of malpractice. That is, the total amount collected by all parties injured by an act of medical malpractice cannot exceed the cap, regardless of how many physicians, hospitals, or other health care providers may be partially liable for the injuries. In contrast, for example, Nevada’s recently passed limitations on damages allow multiple plaintiffs to collect the full limit from any number of responsible defendants.

The filing and resolution of medical malpractice claims is regulated, to a great extent, by states’ tort and insurance laws. Changes to such laws can thus have a great effect on both the frequency and severity of those claims, which in turn can affect premium rates. Because many states have made changes to these laws, it is difficult to predict the extent to which premium rates might change in future markets.

Conclusions

Multiple factors have combined to increase medical malpractice premium rates over the past several years, but losses on medical malpractice claims appear to be the primary driver of increased premium rates in the long term. Such losses are by far the largest component of insurer costs, and in the long run, premium rates are set at a level designed to cover anticipated costs. However, the year-to-year increase in premium rates can vary substantially because of perceived future losses and a variety of other factors, including investment returns and reinsurance rates. Moreover, the market for medical malpractice insurance is not national, but depends on the varying framework of insurance, legal, and health care structures within each of the states. As a result, both the extent and the effects of changes in losses and other insurance-related factors on premium rates also vary by state.

While losses aggregated for the industry as a whole have shown a relatively consistent upward trend over time, the loss experience of any single company is likely to vary from year to year and to increase more rapidly in some years than in others. At the same time, because of the long lag between collecting premium income and paying on claims, premium rates for the next year must be high enough to cover claims that will be reported that year, the majority of which will be paid over the next 3 to 5 years. And due to the volatility of the ultimate payouts on medical malpractice claims, it is difficult for insurers to predict the amount of those payouts with great certainty. As a result, changes in current losses can have large effects on perceived or estimated future losses and consequently on premium rates, because if insurers underestimate what will be needed to pay claims, they risk not only future profits but potentially their solvency.

However, factors other than losses--such as changes in investment income or the competitive environment--can also affect premium rate decisions in the short run. These factors can either amplify or reduce the effect of losses on premium rates. For example, high expected returns on investment may legitimately permit insurers to price insurance below the expected cost of paying claims. But incorrect projections of continuing high returns could cause insurers to continue to hold prices down for too long, even though underlying losses may be rising. When such factors affect most or all medical malpractice insurers, the result appears as a period of stable or falling premium rates or a period of sharply rising rates. When they alternate, these periods may describe the soft and hard phases of the medical malpractice insurance cycle.

Based on available data, as well as our discussions with insurance industry participants, a variety of factors combined to explain the malpractice insurance cycle that produced several years of relatively stable premium rates in the 1990s followed by the severe premium rate increases of the past few years. To begin with, insurer losses anticipated in the late 1980s did not materialize as projected, so insurers went into the 1990s with reserves and premium rates that proved to be higher than the actual losses they would experience. At the same time, insurers began a decade of high investment returns. This emerging profitability encouraged insurers to expand their market share, as both the downward adjustment of loss reserves and high investment returns increased insurers’ income. As a result, insurers were generally able to keep premium rates flat or even reduce them, although the medical malpractice market as a whole continued to experience modestly increasing underlying losses throughout the decade. Finally, by the mid- to late 1990s, as excess reserves were exhausted and investment income fell below expectations, insurers’ profitability declined. Regulators found that some insurers were insolvent, with insufficient reserves and capital to pay future claims. In 2001, one of the two largest medical malpractice insurers, which sold insurance in almost every state, determined that medical malpractice was a line of insurance that was too unpredictable to be profitable over the long term. Alternatively, some companies decided that, at a minimum, they needed to reduce their size and consolidate their markets. These actions, taken together, reduced the availability of medical malpractice insurance, at least in some states, further exacerbating the insurance crisis. As a result of all of these factors, insurers continuing to sell medical malpractice insurance requested and received large rate increases in many states. It remains to be seen whether these increases will, as occurred in the 1980s, be found to have exceeded those necessary to pay for future claims losses, thus contributing to the beginning of the next insurance cycle.

While this explanation accounts for observed events in the market for medical malpractice insurance, it does not provide answers to other important questions about the market for medical malpractice insurance, including an explanation of the causes of rising losses over time. The data currently collected do not permit many of the analyses that would provide answers to these questions. This lack of data is due, in part, to the nature of NAIC’s and states’ regulatory reporting requirements for all lines of insurance, which focus primarily on the information needed to evaluate a company’s solvency. Most insurance regulators do not collect the data that would allow analyses of the severity and frequency of medical malpractice claims for individual insurer operations within specific states. Moreover, insurers are generally not required to submit to NAIC or state regulators data that would show how insurers losses are divided between settlements and trial verdicts or between economic and noneconomic damages. Finally, the increasing use of insurance or self-insurance mechanisms that are not subject to state or NAIC reporting requirements further complicates a complete analysis. While more complete insurance data would help provide better answers to questions about how the medical malpractice insurance market is working, other data would be equally important for analyzing the underlying causes of rising malpractice losses and associated costs. These data relate to factors outside the insurance industry, such as policies, practices, and outcomes in both the medical and legal arenas.

However, collecting and analyzing such data were beyond the scope of this report.

Matter for Congressional Consideration

Health care providers have suffered through three medical malpractice insurance “crises” in the past 30 years. Each instance has generated competing claims about the extent of the problem, the causes, and the possible solutions. In each instance, a lack of necessary data has hindered and continues to hinder the efforts of Congress, state regulators, and others to carefully analyze the problem and the effectiveness of the solutions that have been tried. Because of the potential for future crises, and in order to facilitate the evaluation of legislative remedies put in place by various levels of government, Congress may want to consider taking steps to ensure that additional and better data are collected. Specifically, Congress may want to consider encouraging NAIC and state insurance regulators to identify the types of data that are necessary to properly evaluate the medical malpractice insurance market—specifically, the frequency, severity, and causes of losses—and begin collecting these data in a form that would allow appropriate analysis. Included in this process would be an analysis of the costs and benefits of collecting such data, as well as the extent to which some segments of this market are not captured by current data-gathering efforts. Such data could serve the interests of state and federal governments and allow both to better understand the causes of recurring crises in the medical malpractice insurance market and formulate the most appropriate and effective solutions.

NAIC Comments and Our Evaluation

NAIC’s Director of Research provided us with oral comments on a draft of this report. The Director generally agreed with the report’s findings, conclusions, and matter for congressional consideration. Specifically, the Director agreed that the medical malpractice markets are not national in nature and vary widely with regard to their insurance markets, regulatory framework, legal environment, and health care structures. Furthermore, the Director stated that the medical malpractice insurance industry has shown an upward trend in losses over time and that this rise can be attributed to a variety of causes that are difficult to measure or quantify. The Director also said that he does not believe that excess profits by insurers are in evidence.

The Director told us that NAIC is working on a study of the medical malpractice marketplace that he hopes will be ready for distribution in the summer of 2003. The Director stated that NAIC, like GAO, had identified many data limitations that make the study of this line of insurance difficult. As a result, the Director generally agreed with our matter for congressional consideration that Congress consider encouraging NAIC and state regulators to identify and collect additional information that could be used to properly evaluate the medical malpractice insurance market. The Director stated that while such efforts would require some additional resources, the costs would not be prohibitive and the efforts would provide needed information. The Director also provided technical comments, which we have incorporated into the report as appropriate.

As agreed with your offices, unless you publicly announce the contents of this report earlier, we plan no further distribution until 30 days from the report date. At that time, we will send copies of this report to the Chairmen of the Senate Committee on Governmental Affairs and its Subcommittee on Oversight of Government Management, the Federal Workforce, and the District of Columbia; the Chairman of the House Committee on the Judiciary; and the Chairman of the House Committee on Energy and Commerce. We will also send copies of this report to other interested congressional committees and members, and we will make copies available to others on request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staffs have any questions regarding this report, please contact me or Lawrence Cluff at (202) 512-8678. Additional contributors are acknowledged in appendix IV.

Scope and Methodology

Recognizing that the medical malpractice market can vary considerably across states, we judgmentally selected a sample of seven states in order to conduct a more in-depth review in each of those states. Except where otherwise noted, our analyses were limited to these states. We selected our sample so that we would have a mix of states based on the following characteristics: extent of recent increases in premium rates, status as an American Medical Association crisis state, presence of caps on noneconomic damages, state population, and aggregate loss ratio for medical malpractice insurers within the state. The states we selected were California, Florida, Minnesota, Mississippi, Nevada, Pennsylvania, and Texas. Within each state we spoke to one or both of the two largest and currently active sellers of medical malpractice insurance, the state insurance regulator, and the state association of trial attorneys. In six states, we spoke to the state medical association, and in five states, we spoke to the state hospital association. Due to time constraints, we did not speak to the medical or hospital associations in Texas or the hospital association in Florida. We used information obtained from these organizations to help answer each of our objectives and, as outlined below, also performed additional work for each objective.

To examine the extent of increases in medical malpractice insurance rates for the largest insurers in our sample states, we reviewed annual survey data on medical malpractice premium rates collected by a private data collection company. While individual insurers determine whether to respond to the survey, we believe the data to be representative for the three medical specialties for which the company collects data—internal medicine, general surgery, and obstetrics/gynecology—because of both the number of insurers responding to the survey and the states represented by them. The premium rates collected in the survey are base rates, which do not reflect discounts or additional charges by insurers, so the actual premium rates charged by insurers can vary from the premium rates collected in the survey. We could not determine the extent to which the actual premium rates charged varied from the base rates, but among the insurers we spoke with, the actual premium rates charged in 2001 and 2002 ranged from about 50 to 100 percent of the base rates. We did not test the reliability of the survey data.

To analyze the factors contributing to the premium rate increases in our sample states and other states, we examined data from state insurance regulators, the National Association of Insurance Commissioners (NAIC), A.M. Best, the Securities and Exchange Commission, and the Physician Insurers Association of America on insurers in our sample states as well as the medical malpractice insurance market as a whole. We did not verify the reliability of these data. Where possible, we obtained data from 1975 to the present. As noted earlier in this report, comprehensive, reliable data that would have allowed us to quantify the effect of individual factors on medical malpractice premium rates did not exist. We also reviewed relevant academic studies and industry guidance. In addition, we spoke with officials from the insurers and state insurance departments in our sample states, as well as professional actuarial and insurance organizations. To analyze factors that were likely to vary among states— losses on medical malpractice claims, reinsurance rates, and competition among insurers—we reviewed data for one or both of the two largest and active medical malpractice insurers in our samples states. We also reviewed aggregate data on losses for all insurers in each state as well as the U.S. medical malpractice insurance market as a whole. To analyze factors that were likely to be common among medical malpractice insurers in all states—investment income and the presence of an insurance cycle— we reviewed either A.M Best data for the 15 largest medical malpractice insurers as of 2001 (whose combined market share nationally was approximately 64.3 percent), or NAIC data for all medical malpractice insurers reporting data to NAIC. Also as noted earlier in this report, data and scope limitations prevented us from fully analyzing the factors behind increased losses from medical malpractice claims.

To analyze how the national medical malpractice insurance market has changed since previous periods of rising premium rates, we reviewed studies published by NAIC; analyzed insurance industry data compiled by NAIC and A.M. Best; reviewed tort laws across all states and state insurance regulations; spoke with insurers and state insurance regulators in our sample states; and spoke with officials from national professional actuarial, insurance, legal, consumer rights, medical, and hospital organizations.

We conducted our work from July 2002 through June 2003 in accordance with generally accepted government auditing standards.

Legal Summary

Each state’s tort laws generally govern the way in which medical malpractice claims or lawsuits are resolved. As discussed in this report, most state laws aimed at controlling premium rates attempt to reduce insurer losses related to medical malpractice claims. Although these laws take many different forms, they usually have at least some of the provisions summarized in this appendix. State courts have dealt differently with these kinds of provisions, and some states have found that some of these kinds of provisions are unconstitutional. The provisions summarized in this appendix are not the only ones that might impact the treatment of medical malpractice claims in states’ tort systems.

Limits on Damages. Damages in medical malpractice cases usually consist of two categories, economic damages and noneconomic damages. (Although punitive damages can be available in cases of gross negligence and outrageous conduct of the health care provider, juries rarely award punitive damages in medical malpractice cases.) Economic damages generally consist of past and future monetary damages, such as lost wages or medical expenses. Noneconomic damages generally consist of past and future subjective, non-monetary loss, including pain, suffering, marital losses, and anguish. Although some states have limits on the total amount of damages recoverable in a medical malpractice suit, most states with limits, as well as pending federal legislation, have emphasized a limit only on noneconomic damages. As discussed in this report, limitations on damages can vary drastically in amount, type of damages covered, and application.

As mentioned in this report, limitations on damages can impact frequency of lawsuits as well. Plaintiffs’ attorneys are usually paid based on a percentage of what the claimant recovers, and according to some trial attorneys we spoke to, attorneys may be less likely to represent an injured party with minor economic damages if noneconomic damages are limited. One consumer rights group told us that suits with limited economic damages are typical in cases where the plaintiff is not working and does not have substantial costs of future medical care.

Evidence of Collateral Source Payments. At common law, or without any legislative intervention, a plaintiff would be able to recover all damages sustained from a liable defendant, even if the plaintiff were going to receive money from other sources, called “collateral sources,” like health insurance policies or Social Security. Some states have modified this common law rule with statutes that allow defendants to show that the claimant is going to receive funds from collateral sources that will compensate the claimant for damages he or she is attempting to collect from the defendant. These statutes authorize, to various extents, decreasing the defendant’s liability by the amount the claimant will receive from other sources. In the state summaries in appendix III, if a state has not modified the common law rule regarding collateral sources, the chart will say “no modification.”

Joint and Several Liability. Joint and several liability is the common law rule that a plaintiff can collect the entire judgment from any liable defendant, regardless of how much of the harm that defendant’s actions caused. Some states have eliminated joint and several liability, making each defendant responsible for only the amount or share of damage he or she caused the plaintiff. Other states have eliminated joint and several liability only for noneconomic damages. Some states have eliminated joint and several liability for defendants responsible for less than a specified percentage of the plaintiff’s harm; for example, if a defendant is less than 50 percent responsible, that defendant might need to pay only for that percentage of the plaintiff’s damages.

Attorney Contingency Fees. Most plaintiff attorneys are paid on a contingency fee basis. A contingency fee is one in which the lawyer, instead of charging an hourly fee for services, agrees to accept a percentage of the recovery if the plaintiff wins or settles. Some states have laws that limit attorney contingency fees. For example, in California a plaintiff’s attorney can collect up to 40 percent of the first $50,000 recovered, 33 percent of the next $50,000 recovered, 25 percent of the next $500,000 recovered, and 15 percent of any amount exceeding $600,000. Provisions that decrease attorneys’ financial incentives to accept cases could decrease the number of attorneys willing to take the cases. These limits were based on the belief that they would lead to more selective screening by plaintiffs’ attorneys to ensure that the claims filed had merit. In the state summaries in appendix III, if a state does not have limits in place specifically for attorneys in medical malpractice cases, the chart will say “no modification.”

Statute of Limitations. The amount of time a plaintiff has to file a claim is known as the “statute of limitations.” Some states have reduced their statutes of limitations on medical malpractice claims. This decrease could limit the number of cases filed by claimants. Special time requirements for minors are not noted on the summaries in appendix III.

Periodic Payment of Damages. Defendants traditionally pay damages in a lump sum, even if they are being collected for future time periods, such as future medical care or future lost wages. However, some states allow or require certain damages to be paid over time, such as over the life of the injured party or period of disability, either through the purchase of an annuity or through self-funding by institutional defendants. Some insurers we spoke with said that purchasing annuities can reduce insurers’ costs, and that periodic payments better match damage payments to future medical costs and lost earnings incurred by injured parties, assuring that money will be available to the injured party in the future. A consumer rights group we spoke with told us that, because periodic payments stop at the death of an injured party, there may be unsatisfied medical bills at the time of the injured party’s death.

Expert Certification. Many states require that medical experts certify in one way or another the validity of the claimant’s case. These statutes are designed in part to keep cases without merit, also known as frivolous cases, out of court. Expert certification requirements also have the potential to get as many relevant facts out in the open as early as possible, so that settlement discussions are fruitful and it becomes unnecessary to take as many cases to trial, thus decreasing the claims-handling costs of the case.

Arbitration. Some states have enacted arbitration statutes that address medical malpractice claims specifically. Some of these statutes require that the arbitration agreement meets standards that are designed to alert the patient to the fact that he is waiving a jury trial through the use of a specific size of font, or by specifying the precise wording that must be contained in the agreement. Although most courts have held that medical malpractice claims can properly be submitted to arbitration, litigation involving the arbitration statutes has involved issues such as whether the patient knew he was waiving the right to a jury trial, whether the patient who agrees to arbitration had appropriate bargaining strength, and whether third parties have authority to bind others to arbitration.

By providing an option for arbitration, parties can avoid the larger expense of taking claims to court. However, some industry experts said that these arbitration provisions may not be binding and may result in the losing party deciding to take the case to court in any event, so arbitration can simply increase expenses without affecting the ultimate resolution of the dispute.

Advanced Notice of Claim. Advanced-notice-of-claim provisions require claimants to give defendants some period of time, 90 days for example, prior to filing suit in court. Some insurers and plaintiffs’ attorneys we spoke with said that this requirement aids plaintiffs and defendants in resolving meritorious claims outside of the court system and allows plaintiffs’ attorneys to obtain relevant records to determine whether a case has merit. However, another group we spoke to said that the advanced notice of claim provision in that group’s state was ineffective.

Bad Faith Claims. As mentioned in this report, some insurers we spoke with told us that they can be liable for amounts beyond an insurance policy’s limits, if the policyholder requests the insurer to settle with the plaintiff for an amount equal to or less than the policy limit, and the insurer takes the case to trial, loses, and a judgment is entered in an amount greater than the policy limits. Industry experts we spoke to said that, under those circumstances, the insurer could be liable for acting in “bad faith.” In some states, like Nevada, this bad faith claim can be brought only by the insured physician; that is, the physician can seek payment from the insurance company if the physician has paid a plaintiff beyond a policy’s limits. In contrast, in Florida, the plaintiff can sue a physician’s insurer directly for the insurer’s alleged improper conduct in medical malpractice cases. The difficulty of establishing that an insurer acted in bad faith varies according to state law. Insurers in three of our study states—Texas, California, and Florida—said that bad faith litigation was a substantial issue in their states.

State Summaries

This appendix describes the specific medical malpractice insurance environment in each the seven sample states we evaluated for this report. (See figs.10-16.)

Market Description

Typical Coverage Type and Limit. This section summarizes the type of medical malpractice insurance coverage typically issued in the state, as well as the standard coverage limits of these policies. Coverage limits can range from $100,000/$300,000 to up to $2 million /$6 million. The lower number is the amount the insurer will pay per claim and the higher number is the total the insurer will pay in aggregate for all claims during a policy period. There are several types of insurance coverage available.

Occurrence-based insurance provides coverage for claims that arise from incidents that occur during the time the insurance policy is in force, even if the policy is not continued. Claims that arise from incidents occurring during the policy period that are reported after the policy’s cancellation date are still covered in the future.

Claims-made insurance provides coverage for claims that arise from incidents that occur and are reported during the time the insurance policy is in force.

Prior acts coverage is a supplement to a claims-made policy that can be purchased from a new carrier when changing carriers. Prior acts coverage covers incidents that occurred prior to the switch to a new carrier but had not been previously reported.

Tail coverage is an option available from a former carrier to continue coverage for those dates that the claims-made coverage was in effect.

Regional Differences. This section notes any major regional differences in premium rates quoted by insurers within the state using the base rate for general surgery as a comparison. The Medical Liability Monitor annually surveys providers of medical malpractice insurance to obtain their premium base rates for three specialties: internal medicine, obstetrics/gynecology, and general surgery. In the state summaries, descriptions of regional differences in premium rates are based on Medical Liability Monitor information.

Frequency and Severity. This section describes the extent to which insurers and state regulators we spoke with believe frequency and severity are changing in each state. Frequency is usually defined as the number of claims per number of doctors, counting doctors in different specialties as more or fewer doctors depending on the risk associated with the specialty. Severity is the average loss to the insurer per claim.

Insurer Characteristics and Market Share

Insurer Characteristics. This section describes the various types of insurers present in each of the states. In addition to traditional commercial insurance companies, the following entities or arrangements can provide liability protection: Physician insurer associations or physician mutuals are physician owned and operated insurance companies that provide medical liability insurance.

Reciprocals are similar to mutuals, except that an attorney-in-fact often manages the reciprocal.

Risk retention groups are insurance companies owned by policyholders. Risk retention groups are organized under federal law—the Liability Risk Retention Act of 1986.

Trusts are a form of self-insurance and consist of segregated accounts of health care entities that estimate liabilities and set aside funds to cover them.

Market Share. This section describes the medical malpractice market in each of the states. Recent changes in the market are also noted in this section.

Joint Underwriting Association (JUA). This section details whether a state has created a JUA and the extent of its use. A JUA is a state- sponsored association of insurance companies formed with statutory approval from the state for the express purpose of providing certain insurance to the public.

Rate Regulation

This section describes the regulatory scheme employed by each state. Statutory requirements generally provide that insurance rates be adequate, not excessive, and not unfairly discriminatory. The degree of regulation of medical malpractice insurance rates varies from state to state. States may have “prior approval” requirements in which all rates must be filed with the insurance department before use and must be either approved or disapproved by the department of insurance. Other states have “file and use” provisions in which the insurers must file their rates with the state’s insurance department; however, the rates may be used without the department’s prior approval.

State Tort Laws

This section identifies key components of each state’s efforts to address the medical malpractice insurance situation by targeting ways in which medical malpractice claims are processed through the court system. The following legal provisions are summarized for each state: Appendix II has a description of each of these provisions, in addition to other provisions that are not summarized herein, but that might impact medical malpractice claims. For the information on state provisions in appendix III, we relied upon a summary of state tort laws compiled by the National Conference of State Legislatures (NCSL) in October of 2002. We independently reviewed selected sections of the NCSL summary for accuracy, and supplemented the NCSL information with information from interviews with industry officials. The state laws summarized herein might have changed since the date of the NCSL publication. Additionally, as noted in appendix II, the state tort laws summarized in this appendix are not the only ones that might impact the treatment of medical malpractice claims in states’ tort systems.

GAO Contacts and Staff Acknowledgments

GAO Contacts

Acknowledgments

In addition to those individuals named above, Patrick Ward, Melvin Thomas, Andrew Nelson, Heather Holsinger, Rudy Chatlos, Raymond Wessmiller, Rachel DeMarcus, and Emily Chalmers made key contributions to this report.

Related GAO Products

Medical Malpractice: Effects of Varying Laws in the District of Columbia, Maryland, and Virginia. GAO/HEHS-00-5. Washington, D.C.: October 15, 1999.

Medical Malpractice: Federal Tort Claims Act Coverage Could Reduce Health Centers' Costs. GAO/HEHS-97-57. Washington, D.C.: April 14, 1997.

Medical Liability: Impact on Hospital and Physician Costs Extends Beyond Insurance. GAO/AIMD-95-169. Washington, D.C.: September 29, 1995.

Medical Malpractice Insurance Options. GAO/HEHS-94-105R. Washington, D.C.: February 28, 1994.

Medical Malpractice: Maine's Use of Practice Guidelines to Reduce Costs. GAO/HRD-94-8. Washington, D.C.: October 25, 1993.

Medical Malpractice: Estimated Savings and Costs of Federal Insurance at Health Centers. GAO/HRD-93-130. Washington, D.C.: September 24, 1993.

Medical Malpractice: Medicare/Medicaid Beneficiaries Account for a Relatively Small Percentage of Malpractice Losses. GAO/HRD-93-126. Washington, D.C.: August 11, 1993.

Medical Malpractice: Experience with Efforts to Address Problems. GAO/T-HRD-93-24. Washington, D.C.: May 20, 1993.

Practitioner Data Bank: Information on Small Medical Malpractice Payments. GAO/IMTEC-92-56. Washington, D.C.: July 7, 1992.

Medical Malpractice: Alternatives to Litigation. GAO/HRD-92-28. Washington, D.C.: January 10, 1992.

Medical Malpractice: Data on Claims Needed to Evaluate Health Centers' Insurance Alternatives. GAO/HRD-91-98. Washington, D.C.: May 2, 1991.

Medical Malpractice: A Continuing Problem With Far-Reaching Implications. GAO/T-HRD-90-24. Washington, D.C.: April 26, 1990.

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