Issue 8 December 2003 Underwriting Results Improved But... As we look back on the past year, we see some encouraging signs that the medical malpractice insurance crunch may be loosening up a bit. The void left by carriers that abandoned the market or retrenched is being, at least partially, filled by new entrants and players that have been waiting on the sidelines for the right time to get into the game. For the first time in several years, overall rate increases in 2002 outpaced losses. Take a look at the Top 25 Leading MedMal Underwriters table on page 4. During 2002, medmal premiums increased by 22.5% from $7,288,933,000 in 2001 to $8,928,252,000 while the underwriters' combined adjusted loss ratio dropped from 101.7% to 95.1%. Although the improvement doesn't put them in the black, it's encouraging. Of the Top 25 in 2002, only ten experienced Adjusted Loss Ratios that were higher than 2001. Among the worst hit were; Carrier Rank Points Deterioration Adjusted Loss Ratio MLMIC Group 1st 35 149.8% ISMIE Mutual 10th 36 109.2% Allianz of American 14th 62 112.2% Fairfax 18th 80 139.9% Although 3rd ranked GE Global's ratio increased by 24 points, it remained in the black at 76.8%. Sixth ranked Doctors Co.'s ratio climbed by 17 points while holding at a comfortably profitable 67.6%. American International Group, our country's largest, rose from 11th place to 2nd and reduced its adjusted loss ratio by 35.9 points from 136% to 100.1%. Although Zurich/Farmers reduced its ratio by 2.7 points, its 149.3% ranks it as having the 3rd worst Adjusted Loss Ratio. Surprisingly, St. Paul Companies runoff experience, although still unprofitable, improved by 39.7 points. The bad news is the cost of medmal insurance is continuing to rise as underwriters either struggle to get ahead of increasing claims severity and soaring numbers of large malpractice verdicts and settlements or posture themselves to take advantage of rising rate levels. Even though the appetite of many underwriters appears to be improving, healthcare providers will not see any rate relief until loss ratios are comfortably in the black. We don't see an end to the affordability crisis in the near future. The lack of affordability is having a direct effect on the availability of healthcare. In order to keep their practices financially afloat, many physicians are either limiting their practices, curtailing services, or relocating. As a consequence, many hospitals are faced with shortages of on-call physicians for certain "critical" specialties. Universally, healthcare providers agree that the best cure for the affordability crisis is a dose of major tort reform. Providers and their professional associations are collaborating as never before to lobby for malpractice reform legislation at the state and federal levels. They have achieved significant success in several states, particularly in Pennsylvania, Florida, and Texas where the malpractice crunch has been most acute. Although federal tort reform legislation has the strong backing of the Bush administration, it is not likely that any tort reform bill will see the President's desk in the near future. "A word to the wise, if you are considering an offer by a carrier that is not rated Excellent or Superior by AM Best or other accredited rating company, keep shopping." The affordability crisis has prompted healthcare providers to consider alternative risk transfer methods to control, if not reduce, their costs. Deductibles, self insurance trusts, captives, and risk retention groups, are the most common choices. But, as we warned in last fall's Frontline News, its caveat emptor - let the buyer beware. In the 1988-90 mini hard market we saw many RRG and RPG's jump into the market with prices undercutting long term players with AM Best A or higher ratings, only to fail a few years later. Rating companies offer crucial guidance on carriers' financial strength and claims paying ability. During the past two years, there have been numerous medmal carrier bankruptcies and withdrawals from the market. If carriers with scores of years of medmal underwriting experience, such as St. Paul and Farmers, could not find a way to earn a profit, the chances are grim for novice carriers, RRG's and RPG's that jump into the market with offers of discount prices backed by marginal financial statements. Be careful! A word to the wise, if you are considering an offer by a carrier that is not rated Excellent or Superior by AM Best or other accredited rating company, keep shopping. Another caveat; find out if the carrier is admitted or non-admitted in your state. If the carrier is non-admitted, it is not subject to your state's regulations and is not backed by its guarantee fund. Should the carrier fail, you will be responsible for the costs of settling claims asserted against you that would otherwise be paid by the carrier. And, it may be difficult, if not impossible, to find a carrier willing to provide you with prior acts coverage over a failed carrier. Some will not even provide prior acts coverage for retroactive dates previously covered by policies written by non-rated carriers. With the long tail exposure inherent in medical malpractice, long term security and peace of mind can only be obtained by purchasing insurance from quality insurers. The bottom line is, quality coverage from Excellent or Superior rated carriers will continue to be available from a significant number of carriers. It bears repeating; it's not an availability crisis, it's an affordability one. Our best advise after over 25 years of helping healthcare providers purchase all types of insurance, is to rely on good sound business judgment, work closely with a professional broker and do your due diligence. For those who choose to go it alone and forego quality, we leave you with but one word; BEWARE! QUOTABLES Many are destined to reason wrongly; others, not to reason at all, and others to persecute those who reason. ~ Voltaire Downgrades Keep Mkt. Hard "Despite soaring premium income and a rebounding stock market, insurers are still in a recovery mode. For the third straight year, property-casualty insurer downgrades by A.M. Best's topped the number of upgrades - and by a large margin (188 downgrades versus only 57 upgrades in the 12-month period ending in July). The picture this year is even more grim than a similar trend in the same period in 2002, when there was a narrower gap between 151 downgrades versus a healthier 76 upgrades. The cause is no secret - Best cited the lingering effects of soft market underpricing, resulting in adverse loss-reserve developments, and eroded capital base and weakened balance sheets. Also, while the stock market is up, low, stagnant interest rates have limited investment income. The conclusion: the hard market is not over yet. Carriers will have to keep premium income rising to replenish their capital and bolster their bottom lines to maintain and improve their ratings." "Downgrades Keep Mkt. Hard." National Underwriter. November 17, 2003. 107-46-32. Medical Crises Across the US "The AMA has declared a medical liability crisis exists in 18 U.S. states, containing roughly half the nation's population, where doctors face escalating malpractice insurance premiums or risk losing their insurance altogether for many practices such as obstetrics." "U.S. Doctors Leader: Medical Liability Reform a Must." Reuters Limited. June 19, 2003. AIG Reports Loss on Reserve Additions - AIG Recorded a Net Loss of $103.8 Million. Associated Press 2/13/03 Virginia regulators placed Reciprocal of America, the largest medical-liability writer in the state, into receivership Jan. 29 after a review by the state's Bureau of Insurance found the company "to be in hazardous financial condition". BestWire 2/3/03 Norcal Compromises on Planned 2004 Rate Increase. Norcal Press Release 10/7/03 Farmers Exits the Medmal Line After 50+ Years. USA Today 9/24/03 A.M. Best Downgrades Ratings of MLMIC Group, Princeton Ins Company and OHIC Ins Co AM BEST 6/12/03 Medmal Rate Hikes Blamed on Big Losses - GAO Report Hailed. Business Ins 8/4/03 Malpractice Crisis Threatens Health Market Independent Agent 04/03 Conning Research: Medical Malpractice Insurance Crisis Worsens Kitchen Public Relations 6/18/03 Investors Demand AP Capital CEO's Resignation After $77 million 3Q Loss. National Underwriter 11/21/03 Physicians Insurance declined capital call on its policyholders by WA - DOI. Looks to raise rates again in 2004. PI Newsletter News Flash "In 1990, more than 1,270 property/casualty insurers served the U.S. market. Today, fewer than 940 remain. Insurers have paid dearly not adhering to disciplined underwriting and cost-based pricing. The average number of insolvencies rose from 12 a year in the 1970's to 27 a year in both the 1980's and 1990s. For the first three years of this decade, there has been an average of 33 insolvencies a year." Excerpt from Best's Review Article - by Frank J. Coyne - December 2003 Tillinghast Study; Costs Were 13.3% Higher Than 2001: Second Year of Double-Digit Growth Rates. Medical malpractice costs totaled nearly $25 billion in 2002, or $85 per person, compared with $5 per person in 1975. The increase in medical malpractice costs continues to outpace increases in overall U.S. tort costs, rising an average of 11.9% per year versus an increase of 9.3% per year in all other tort costs NEW YORK (BUSINESS WIRE) 12/10/2003 The Story Behind the Affordability Crisis Physicians across the country are asking the question; "What difference does it make if there are lots of companies offering me medical malpractice insurance yet I can't afford to pay their price?" To answer their question, we need to go back a bit in history to explain why prices have risen so high. Until the mid 90s, intense competition kept premiums below the amount underwriters needed to pay claims. Because of the time it takes to settle claims, the prevailing logic was that the income earned on invested loss reserves would make up the shortfall. This all changed when they found themselves caught between the rock of rising frequency and severity of claims and the hard place of rapidly declining interest rates and an insurgence of bears into the stock market. The insurance companies had only one way to break free; raise their rates. St. Paul set the stage in 1999 when Georgia's insurance commissioner denied its request for a significant rate increase. Georgia's, as well as other states' regulators were under intense pressure from consumer advocates and physicians' lobbyists to keep rates low. No one realized that, after being ranked as a leading medmal underwriter for over 65 years, St. Paul was about to entirely withdraw from the medmal market. St. Paul's logic was simple; if they couldn't get the premium they needed to correct the red ink, why should they continue to lose money. However, rather than abandon Georgia's physicians entirely, St. Paul non-renewed their policies and offered to replace them with policies underwritten by its "non-admitted" surplus lines affiliate at much higher prices. As a non-admitted carrier, St. Paul's affiliate was able to charge what the market would bear. St. Paul ultimately gave up its fight with regulators and left the entire market late in 2001. When underwriters are unable to charge enough to keep pace with their policyholders' claims, their first line of defense is to tighten their underwriting standards. Between 1999 and 2003, notable carriers such as CNA, AIG, Zurich, Interstate, Chicago and SCPIE retrenched and declared moratoriums on new business while they weeded the highest risk from their lists of policyholders. Others, including PHICO, Frontier and Reliance were involuntarily forced out of the market when state regulators declared them to be insolvent. Availability joined affordability as a cause for concern. Nearly $1.2 billion in written premiums had to be absorbed by those who stayed in the market. Because the majority of physicians that had been displaced had purchased their insurance from commercial for profit insurers, a significant number of them looked to the non-profit physician owned carriers to rescue them. Many were disappointed when the carriers either told them they were not accepting new applications or they didn't meet the carriers' underwriting standards. As discussed in our lead article on page one, the medmal market saw some improvement in its 2002 underwriting results and the availability crunch began to loosen as 2003 matured and new players entered the market. Many of the new entrants have avoided the rate regulations of the various states by electing to do business on a non-admitted basis. Since virtually all of the physician owned companies do business on an admitted basis, they are still struggling to obtain approval of "adequate" rates. Consider the experiences of SCPIE, a physician owned company converted to a publicly traded company and NORCAL, a physician owned mutual insurance company. This year, SCPIE asked the California Insurance Commissioner to approve a 15.6% overall rate increase. At the result of a hearing before an Administrative Law Judge, SCPIE was only granted a 9.9% increase. Following the SCPIE ruling, NORCAL followed the protocol prescribed by the Judge and asked for a 9.9% increase. The Commissioner strongly urged NORCAL to adopt a radically reduced rate increase that was inconsistent with NORCAL's actuarial analysis. Rather than face a delay in the rate filing process and incur a potentially costly hearing, NORCAL reluctantly agreed to accept a 2.91% overall rate increase for 2004. The plight of Seattle based Physicians Insurance A Mutual Company, serves as an example of what happens when claims significantly exceed premiums and rates are increased. After consistently operating profitably for over 20 years, the company's surplus dropped by $21.5 million in 2002. To compensate for the loss, it increased its 2003 rates by 17.4% which compounded the company's problems. Historically it had maintained a net premium to surplus ratio of approximately .85 to 1. With its rates significantly increased and over 30% of its capital base wiped out, its ratio ballooned to a marginal 1.81 to 1. A.M. Best then down graded its financial rating from an A- to a B++. As a result, the company tightened its underwriting standards, has filed for additional rate increases to be implemented in 2004, and is looking to its policyholders to contribute $30 million in additional capital over the next three years. As a mutual insurance company, it cannot sell stock to raise the much needed additional capital. So why are these examples so important? They serve as a classic example of supply and demand economics. If commercial multiple peril carriers can't get approval for the rate increases they need, they exit the line altogether and use their capacity to write profitable types of insurance. But physician owned carriers can't leave the market for two reasons. First, they are obligated to their policyholder owners. Second, they generally only underwrite mono-line medmal coverage and do not earn income from other lines they can use to help offset their medmal losses. Their most viable alternatives are to tighten their underwriting standards, induce their policyholders to implement loss control measures, put up a vigorous defense against claims, and accept the highest rate increases regulators will allow. The end result is that many doctors who are rejected by the physician owned companies will be forced to look to non-admitted excess and surplus lines companies for coverage. They will have to pay the highest prices and face the greatest affordability issue. Those accepted by admitted commercial carriers and fortunate enough to meet the tightened underwriting standards of physician owned carriers will pay more for their policies but significantly less than demanded by non-admitted carriers. Bottom line, there is no one answer to the opening question. The cost of medmal insurance will continue to rise as long as the dollars paid out in claims and operating expenses exceeds income. Those physicians with good records should be able to absorb their increased cost. Those with marginal records or in high risk specialties will most likely be unable to pass on their costs and may be forced to either practice without insurance or retire. All should raise their voices in collective support of national tort reform and work diligently to weed the malfeasant practitioners from their prestigious ranks. Rick Mortimer This newsletter is for general informational purposes only. It is intended to provide a limited overview of the market and to provide thought provoking ideas for our readership to consider when arranging for risk transferal programs and insurance. Publisher: HealthCare Professionals' Insurance Services. d.b.a. R.W. Mortimer & Associates Insurance Agents & Brokers, Inc., A Brown & Brown, Inc. Company Editor Rick Mortimer