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Insurance Reform, Not Tort Reform Alone, Can Drop Premium Rates

Glauser, Jonathan MD, MBA

Legal Notes: Part 5 in a Series

Dr. Glauser is an assistant professor of medicine at Case Western Reserve University and attending staff faculty in emergency medicine at the Cleveland Clinic Foundation in Cleveland.

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The insurance industry has been quite vocal in support of reform and in criticizing excessive awards and frivolous lawsuits. To hear the rhetoric, these companies should be our strongest allies. It is worth investigating the forces driving malpractice premiums — they are more than greedy trial attorneys and sympathetic urban juries with no concept of the value of money and no stake in whether society functions.

Payments of claims are the most significant costs that malpractice carriers face. These constitute roughly two-thirds of their total costs: 74 percent of direct premiums written in 2001. (Americans for Insurance Reform, October 10, 2002.) The other roughly one-third of malpractice costs comprise legal costs for policyholders who are sued, as well as underwriting and administrative expenses. The increase in the average payment for a malpractice claim has risen fairly steadily since 1986, at an annual growth rate of approximately eight percent. (Congressional Budget Office, www.cbo.gov/showdoc.cfm.)

Insurers paid only 31 cents for every premium dollar to injured victims' claims for the 13 years after MICRA was passed

Each year, approximately 15 malpractice claims are filed for every 100 physicians, with around 30 percent resulting in an insurance payment. (The Medical Malpractice Crisis: Recent Trends and the Impact of State Tort Reforms. Presented at the Council on Health Care Economics and Policy Conference, Washington, D.C., March 3, 2003.)

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Insurance Reform vs. Tort Reform

Medical malpractice is not a new problem. The first liability case in this country was heard in Connecticut in 1798, involving the setting of a fractured leg. (AAFP Direct May 17, 2002; www.aafp.org/ad/afp1266.htm.) Neither is tort reform a new concept. As noted last month, the commonly cited model for tort reform is California's Medical Injury Compensation Reform Act (MICRA), enacted in 1975.

Recall the essentials of MICRA: A cap of $250,000 on compensation for “noneconomic” injuries, allowing payments on an installment plan, a three-year statute of limitations, enactment of a sliding scale for attorneys' fees, and eliminating the “collateral source rule.” It has been claimed, however, that it was insurance reform passed in 1988 under Proposition 103 that caused rates to drop and stabilize from 1989 to 2003. (The Foundation for Taxpayer and Consumer Rights. How Insurance Reform Lowered Doctors' Medical Malpractice Rates in California, and How Malpractice Caps Failed. March 7, 2003; www.consumerwatchdog.org.)

The figures cited to back up these claims are notable. Insurers paid only 31 cents for every premium dollar to injured victims' claims for the 13 years (1975–1988) after MICRA was passed. The loss ratio of 31 percent was considered pretty low, meaning that the other 69 cents of the premium dollar was going to insurance company overhead and lawyers — and profit. Malpractice insurance premiums soared 47 percent from 1985 to 1988, and premiums earned during the mid-1980s in that state increased by more than 20 percent annually. Doctors' premiums increased 450 percent in the 13 years following MICRA and preceding Proposition 103, prompting consideration of insurance reform.

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Proposition 103

Proposition 103 rolled back all property and casualty insurance rates by 20 percent and statutorily froze them for one year. It created “prior approval” regulation of insurers, allowing the insurance commissioner to reject or alter insurance increase requests. It incidentally made the insurance commissioner an elected position, and ended the insurance industry's exemption from state and federal anti-trust laws. It also allowed consumers to challenge insurers' rate increase proposals. Major medical malpractice insurers paid more than $135 million in rebates to physicians as a result of Proposition 103. It has been claimed that insurance reform, not tort reform, reined in malpractice premiums in California. (The Foundation for Taxpayer and Consumer Rights. How Insurance Reform Lowered Doctors' Medical Malpractice Rates in California, and How Malpractice Caps Failed. March 7, 2003; www.consumerwatchdog.org.)

It is worth noting that since 1988, California's malpractice premiums have lagged behind those of the rest of the United States, and that the insurance industry's loss ratio in that state since Proposition 103 now oscillates around 50 percent. From a physician's perspective, most would agree that it is a positive development that California medical malpractice insurers spend an average of 35 percent of premiums on defense costs, compared with the national average of 21 percent. That is, California insurance companies in the 1990s started spending more than the national average fighting claims, as opposed to paying claims. Therefore, it would appear that insurance reform, much more than tort reform, provided relief to doctors in that state.

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Why Are Rates Rising?

To figure out what rates are rising, consider what drives the costs of insurance companies in the first place. As mentioned last month, when companies in any industry leave the market (in this case, Phico, St. Paul, Frontier, Reciprocal of America, and MIIX), prices go up. For example, in West Virginia and Nevada, St. Paul had 43 percent and 36 percent of the market, respectively. This doesn't fully explain why premiums rise, however, because presumably as other malpractice insurers enter the market, future increases should be moderated. So, let's get back to basics.

The cost of actually defending a case has grown by about eight percent annually. In fact, the amount of medical malpractice insurers have paid out directly tracks the rates of medical inflation. That is, paid claims per doctor have risen at approximately the rate of medical inflation as a whole. (Americans for Insurance Reform, October 10, 2002.)

For example, the cost of legal defense grew from around $8000 per claim in 1986 to approximately $27,000 per claim in 2002. This belies the claim that there has been an explosion in medical malpractice payouts at any given time during the past 30 years. As an aside, it is worth noting that medical malpractice rates are related to reinsurance markets, so that catastrophic events such as Hurricane Andrew or the terrorist attacks of Sept. 11 raise our professional liability insurance rates. (Congressional Budget Office, www.cbo.gov/showdoc.cfm.)

Probably more significant is the behavior of the stock markets. Premiums rise and fall with the state of the economy. Insurance companies expect to settle claims five years after premiums are collected. This period reflecting the gains or losses experienced by the insurance industry's market investments until it pays out losses is called the “float.” The float in medical malpractice is longer than that, say, of auto insurance, reflecting a lag of five to 10 years between premiums and payouts. The insurance carriers invest the funds, and these investments become an important source of income. When the market tanks, premiums go up. Annual investment returns from 2000–2002 dropped by an average of 1.6 percent, enough to account for a 7.2 percent increase in premiums, or about half of the 15 percent increase in rates estimated by the Centers for Medicare and Medicaid Services. (Congressional Budget Office, Jan. 8, 2004:1; www.cbo.gov/showdoc.cfm?index=4968; General Accounting Office GAO-03-702, June 2003:27.)

Insurance rates for doctors skyrocketed twice in my career: in the mid-1970s and the mid-1980s. In each case, the crisis occurred during a time of weakened economy and dropping interest rates. When insurance companies' investments are doubly hit, they compensate for loss of investment income by raising premiums sharply. The claim has been made that jury verdicts are largely irrelevant to the problem. (Americans for Insurance Reform, October 10, 2002.)

As one might expect, premium rates go in cycles. If expectations of future claims prove to be too high, companies accumulate reserves, which may subsequently become drawn down. Likewise, during years of high interest rates or high insurer profits, insurers compete fiercely for premium dollars to maximize return. They price competitively, and insure poor risks just to get dollars to invest, a “soft” market.

The “crises” in the 1970s and 1980s, on the other hand, were “hard markets.” When interest rates dropped, the stock market plummeted, and the industry responded by raising rates. The claim was made in the Wall Street Journal that St. Paul had too much money in reserve during the 1980s, compensated by “releasing” its reserves in the 1990s, a time when smaller companies were coming into the market, and slashing prices to generate new customers. Rates fell so low that prices became inadequate to cover claims for the smaller companies, and St. Paul pulled out of the medical malpractice market. (Wall Street Journal June 24, 2002.)

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The Bottom Lines

Our insurance rates have been and will continue to be tied to the overall economy and to catastrophic events in the world that have little to do with the practice of medicine. Capping or otherwise restricting awards, offsetting awards by the value of collateral-source benefits, and reducing statute of limitations for filing claims all slow the growth of premiums. To say that tort reform is not at least part of the solution is completely false.

Ups and downs in insurance rates do parallel the state of the economy. Unfortunately for physicians, premiums for doctors tend to go up most sharply during bad economic times when people can least afford sharply increased costs of doing business.

All of this notwithstanding, it seems logical that outrageous and unpredictable verdicts drive up costs of insurance. To say that payouts from medical malpractice “only” parallel the rate of health care inflation is hardly reassuring, considering the unconscionable rate of health care inflation in the U.S.

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Insurance Reform: The Bottom Lines

  • ▪ Insurance rates are tied to the economy.
  • ▪ Because insurance rates parallel the economy, premiums rise most during bad times when people can least afford increased costs.
  • ▪ Capping awards, offsetting awards by collateral-source benefits, and reducing statute of limitations for filing claims all slow the growth of premiums.

Source: Jonathan Glauser, MD, MBA.

© 2004 Lippincott Williams & Wilkins, Inc.