A Risk Financing Focus: Physician Group Practices and Integrated Delivery Systems

by Rick Mortimer

HealthCare Professionals' Insurance Services, a division of
R.W. Mortimer & Associates Insurance Agents & Brokers, Inc. Brea, California


INDEX
Executive Summary
Preamble
The Changing Business of Health Care
The Malpractice Insurance Business
Financing Risk
Risk Management for Health Care Provider Organizations
The Role of Insurance Brokers
The Alternative


EXECUTIVE SUMMARY

RISK MANAGEMENT FOR THE HEALTH CARE INDUSTRY

For over 20 years, HealthCare Professionals' Insurance Services (HCP) has specialized in the development of insurance programs and alternative risk funding mechanisms for health care providers. HCP has earned recognition as a leader in the field by keeping pace with the evolutionary changes in the business of medicine, creating innovative solutions to the problems of managing the financial risk confronting a new generation of blended health care benefit plans and provider delivery systems.

HCP shares its perception of the challenges confronting the health care industry as it moves into a new millennium, by reciting history and focusing on the changes taking place in the business of medicine. It observes that each change in the health care delivery system has been accompanied by new theories of tort liability, which shift the financial burden from individual providers to large corporations with deeper pockets.

HCP focuses on the historical use of insurance and the traditional role of insurance brokers to emphasize its position that the new generation of health care plans and provider systems cannot afford to purchase their property, casualty, and professional liability insurance in a "business as usual" fashion. HCP encourages plan managers to add "fee-for-service" insurance brokers to their teams of outside legal and financial advisors.

By charging for its services on a fee basis, HCP has eliminated the conflict of interest inherent in commission-based, traditional brokerage houses. By not relying on insurance carriers' payment of commission as its sole compensation base, HCP has been able to foster the independence that has brought with it good working relationships and the respect of underwriters in every segment of the medical malpractice insurance marketplace, including direct writers and provider-owned carriers, as well as the traditional commercial markets.

By including HCP on their team of independent advisors, clients are not only able to take advantage of HCP's existing relationships, its expertise and broad base of knowledge gained through servicing of the needs of large health care provider networks and groups, but they also, with rare exceptions, save money in the process.

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PREAMBLE

Since 1959, R.W. Mortimer & Associates has been helping families and business owners meet their needs for financial security and peace of mind through the purchase of insurance. As the company grew, its founders recognized that one of the keys to its success was the ability to provide a level of professional expertise and personalized attention and service generally superior to that offered by its competitors. It also realized it could increase its competitive edge by catering to the specialized needs of selected industries.

The medical malpractice crisis of 1975-76 presented a unique opportunity to specialize in the health care industry. The company's principals played a key role in the formation of a doctor- owned, reciprocal insurance company to fill the void left when several commercial insurance underwriters ceased writing medical malpractice insurance policies in California. HealthCare Professionals' Insurance Services (HCP) was formed to cater to the insurance needs of physicians, surgeons, and other health care providers and organizations.

During the past 20 years, HCP has earned recognition in the health care industry as a leader in the creation and implementation of innovative solutions to the management of financial risk for large group practice health care providers and other similar organizations. This monologue shares HCP's insight into meeting the insurance and risk management needs of the changing health care industry, as it moves into the 21st century.


THE CHANGING BUSINESS OF HEALTH CARE

Prior the mid 1970's, it is estimated that over 90% of all physicians and surgeons were either in private practice or largely constituents of two- or three-member partnerships. Personalized care and attention to patients was emphasized, and house calls were not uncommon, until the malpractice crisis of 1975-76.
The crisis created a public awareness of the economics of the business of medicine when physicians went on strike to protest the rising cost of malpractice litigation and insurance. The cost of health care started escalating at rates which were multiples of the annual rate of inflation, as providers passed their increased costs of insurance on to their patients, and added charges for diagnostic tests and examinations many times performed principally to help avoid accusations of negligence.

Patients were pummeled from two sides by the rising cost of health care. They were not only forced to pay more for their health insurance, their family budgets were also effected by new policy exclusions and reduced benefits. Families that had never before failed to pay their medical bills began to find it difficult, if not impossible, to meet these obligations.

Doctors and other providers were also caught in a financial squeeze which threatened their economic positions. The pressure of coping with increased operating costs, and the expense of keeping pace with technological advances in their practices were compounded by their inability to collect 100% of their fees. Providers were faced with two choices: pursue their patients to collect, or write off their uncollectable receivables as bad debts. Either way, they recognized that the underlying problems would not be solved. They were forced to find ways to reduce the cost of their services without sacrificing quality.

Two solutions emerged: First, solo practice physicians and surgeons began to cluster into groups organized to relieve them of distracting administrative chores and to spread the cost of doing business. The group practice concept was not only designed to reduce the cost of health care, but to offer patients greater access to a variety of specialists within one office who would tend to their needs more efficiently.

Secondly, in a parallel move, entrepreneurial physicians planted seeds which later flowered into health maintenance organizations (HMO), physician hospital organizations (PHO), and preferred provider organizations (PPO). Later on, independent practice organizations (IPA) and managed care organizations (MCO) emerged.

At the beginning of this decade, politicians moved health care reform to the top of their list of priorities. Threats of nationalized health care and a universal payment system have challenged the medical establishment and the health care industry to bring down the cost of health care or lose the delivery system we know today. As a result, health care organizations began to proliferate at an even faster rate.

Wall Street saw the opportunity to make money by supplying the capital to bring medical and health insurance providers together under one financial umbrella. In a move towards 24 hour health care, Workers Compensation insurance carriers began to be included under that umbrella. The public trading of stocks of Managed Care Organizations (MCO's) has served as a catalyst to move an increasing number of doctors out of private practice to become employees of wholly- owned subsidiaries or independent groups managed by physician practice management companies (PPM's) or MCO's.

A recent survey of 2,800 employers conducted by the employee benefit firm of Foster Higgins found that the number of employees enrolled in HMOs increased from 23% in 1994 to 27% in 1995. Significantly, the average cost to a company for HMO coverage fell from $3,556 to $3,255 per worker while the national health benefit costs for business, including all types of insurance, rose from $3,471 to $3,821. The reductions were achieved by challenging the traditional provider fee-for-service charges for office visits, tests, treatments or surgery, to a flat monthly payment based upon the number of individuals enrolled in the HMO, regardless of the services provided.

According to a Foster Higgins spokesman, employers believe that HMOs have squeezed everything they can out of doctors, hospitals and other providers and are concerned that further cost reductions will impact the quality of health care delivered. To find additional savings, business is now shifting its focus away from the providers and onto the HMO plans themselves.

The message is clear and presents a challenge to managers of HMOs and similar group practice models. Employers will not readily accept a compromise that reduces the quality of health care in return for dollar savings. They understand that the trade off can mean greater costs in terms of loss of productivity due to employee illness and disgruntlement. Nor can the health care provider organization afford the inevitable increase in medical malpractice complaints. HMO and "systems" managers must concentrate on finding other ways to reduce their administrative and operating costs if they want to be price competitive and not adversely effect quality.


THE MALPRACTICE INSURANCE BUSINESS

Prior to the 1975-76 crisis, commercial insurance companies collected an estimated 80% plus of the premium dollars paid by health care providers for malpractice insurance. In response to the commercial insurers' demands for overwhelming premium increases, doctors formed their own mutual and reciprocal insurance companies and cooperative underwriting facilities. Overnight, the "bed pan mutuals" (so-called by their commercial carrier competitors) captured the individual physician and small group market by convincing doctors to replace their expensive occurrence-type policies with the new claims-made coverage model, which offered the lure of lower operating overhead of their non-profit status, which would be passed on in the form of lower rates.

Other than changing to the claims-made policy form, by and large the new companies carried on the commercial underwriter's practice of catering to the needs of the individual physicians and surgeons who dominated the health care market place. When presented with requests for proposals from physician partnerships and other groupings, some struggled with the concept, and many continued to issue separate, stand-alone policies to each individual doctor, or refused the larger clinic opportunities. Carriers who specialized in covering hospitals and larger clinics avoided extending individual doctor coverage under their policies to independent physicians and surgeons who had been granted staff privileges by their hospital and/or clinic policyholders, as they did not view these physicians as a direct corporate risk.

The changes in the way health care protection is purchased, and the delivery of care by the accelerated growth of large group practices and managed care facilities has forced malpractice insurance underwriters to rethink the way they do business. Policies and services originally designed for individual practitioners and small groups do not fully meet the needs of providers that require protection for their corporate interests. Particularly the new demands for creative financing options for larger numbers of physicians under one buyer. Many underwriters are beginning to recognize that the malpractice exposure can be more accurately quantified when significant numbers of doctors are required to conform to defined treatment standards and are paid based upon patient volume rather than for services rendered. However, with this change has come a trend towards increasing numbers of medical malpractice cases of failure to diagnose which could be an out growth of managed care.

Progressive underwriters are willing to gamble their surplus to capture a share of the premium pool and related services paid by large managed care, group practice and integrated delivery facilities. Others are more cautious about taking on large groups of physicians at discounted rates, as losses are growing disproportionately to historical trends. Not only are commercial carriers reentering the market, but an increasing number of doctor-owned companies previously committed to underwriting primarily individual practitioners and small groups in single states are now willing to innovate and tailor their policies and services to the specific needs of large groups, hospitals, and integrated systems. If they do not, they face declining market share to the big commercial underwriter.


FINANCING RISK

During the past ten years, most group administrators have relied primarily on the purchase of insurance to finance the business risk associated with malpractice claims.

They have focused on reducing costs through mergers, acquisitions and internal growth, and by expecting their underwriter to discount the rates charged for individual medical specialties simply because of the large numbers of doctors available to insure.

At best, they have given only passing consideration to risk management methods, such as; loss prevention, mitigation, and risk retention, promoted by their physician owned and commercial insurers. Even so, this approach has worked well until most recently.

Between 1988 and 1993 group practices consistently negotiated rates which were up to 45% below the standard (solo practice) premiums charged by their carriers. These deep discounts turned the underwriter actuarial tables upside down as time passed. While the loss experience of solo practitioners and smaller groups (those paying under $250,000 annual medical malpractice premiums) remained largely within expected ranges, underwriters began to realize they had overestimated their ability to quantify and accurately price the exposures of larger groups. They suffered greater than anticipated losses on their discounted group accounts before beginning to tighten the underwriting tourniquet to stop the financial bleeding.

Note: In 1990, 29% of cases arose from failure or delay in diagnosis, and they represented just 19% of total indemnity. By 1995, these cases comprised 40% of the total and accounted for 32% of all 1995 indemnity. Average indemnity in failure to diagnose cases grew from $550,973 in 1990 to $775,123 in 1995. Of the indemnity awards of more than $1,000,000 only 2 involved diagnostic errors in 1995 compared to 13 in 1994, according to MIEC's 1995 California Large Loss Study.

During the past two years many carriers have been playing catch-up by increasing premiums for their larger group policyholders, in some cases by as much as 100%. Faced with intense price- driven competition from reemerging commercial underwriters, health care CFO's were pressured to find ways to mitigate the upward move in the cost of insurance. Those seeking to grow by acquisition and merger can no longer always count on increasing their profits by reducing their consolidated medical malpractice premiums through size discounts alone. Rather, they are faced with either: a) absorbing the premium increases, b) moving into the unfamiliar world of alternative risk financing, c) jumping at temporary price reductions offered by the vast array of new markets seeking large accounts (often attached to self-insured retention SIR) or, d) a combination of the various approaches.

Many CFO's are, for the first time, embracing the alternative funding mechanisms which have been used for decades by their counterparts in large industrial organizations. They are realizing that, in general, first dollar insurance is the most expensive way to finance risk. Rather than looking solely to insurance companies for protection, they are implementing loss prevention programs, exercising greater control over the management of claims, and reducing costs through a combination of risk retention and the purchase of excess insurance, among other loss sensitive plans.


RISK MANAGEMENT FOR HEALTH CARE PROVIDER ORGANIZATIONS

The significant changes in the way health care medical liability protection is purchased and the way health care services are delivered have generated a new variety of risks that must be addressed by health care providers.

By bringing the services of physicians, hospitals and other health care providers under the umbrella of one MCO, the separate images of each physician and entity is merged into one in the public's eye. Regardless of the nature of their relationship: whether the providers are employees, joint venturers, independent contractors, or subsidiaries, the whole becomes the sum of its parts. The creation of large organizations through mergers and acquisitions opens the vault to withdrawals for settlements of claims not typically experienced by smaller entities.

Claims of negligence are being asserted by patients who would not otherwise complain had they not been aggravated by the perception of a lack of continuity of care by attending physicians, prolonged delays in receiving treatment, or long waits to actually be seen by a physician. Claims triggered by patient hostility are becoming the norm and increasingly costly for MCO's, as their medical malpractice underwriter merely passes the costs back to them.

Plaintiff lawyers are cashing in on new theories of tort liability which may hold MCO's vicariously accountable for the overt acts, or the negligence of their providers. Failure to properly select or deselect panel providers or monitor their performance is becoming more common as causes of action. Allegations of failure or refusal to provide, or pay for, experimental or otherwise controversial treatment for life-threatening maladies are resulting in million dollar settlements. Few are covered for claims arising out of physicians' medical liability by conventional medical malpractice insurance policies. New insurance products are developing and are becoming more readily available for handling the growing exposures of this burgeoning industry.

While claims of malpractice are generally understood, large MCO's are confronted by an array of other kinds of risk. Examples of these include: Workers Compensation claims, claims against directors and officers for malfeasance and antitrust violations, claims alleging discrimination in the credentialing of providers, violations of various state and federal statutes and regulations governing employment practices (including ERISA), and assumption of claims-made prior-acts a.k.a. tail exposure of acquired providers.

The realization that some losses can be predicted with reasonable accuracy and budgeted for as a routine cost of doing business enables management to rethink how it uses insurance to control the cost of risk.

An analogy helps to illustrate the point of buying first dollar insurance coverage. Every retail shop owner knows that the loss of merchandise to shoplifters is part of the regular cost of doing business. Some ask their insurance broker if they can purchase a shoplifting policy. Although the answer is no, the creative broker will ask how much the owner expects to lose, mark up the result by 25%, and quote a premium. Rather than pay 25% more than their expected losses, merchants add projected shoplifting losses to their inventory costs, and mark up their prices accordingly.

Unlike the shoplifting losses in the foregoing analogy, the reasonably predictable cost of malpractice, miscellaneous liability, workers compensation, and health care benefit plans are already included in the premiums paid by MCO's to the insurers. Rather than pay the "mark- up", it is possible for MCO's to obtain premium reductions larger than the cost of their expected losses by agreeing to retain large portions of their predictable losses. But a word of caution is required:

Insurance; an ingenious modern game of chance in which the player is permitted to enjoy the comfortable conviction that he is beating the man who keeps the table.
-Ambrose Bierce

CFO's must not be lulled into a false sense of security by thinking they can always beat the cost game through the use of deductibles and risk retention. The decision-making process is complex, and it goes beyond the simple calculation of premium credits based upon deductible amounts retained.

The decision process starts with charting the organizational structure and its obligations to providers, and the development of a risk profile. The decision to use deductibles and risk retention to reduce costs should not be made until the CFO understands the MCO's obligations, has become comfortable with the accuracy of the loss predictions, is clear on who is going to administer the routine claims, has quantified the variable costs of claims administration, and has determined the maximum amount of accumulated claims payments the MCO can absorb in any given year. Because more than one type of insurance may be involved, extreme care must be taken to integrate the deductible and retention limits of separate coverages and treat them as though they were one. In addition, the client should, with the assistance of its Broker/Consultant, pick the retention amounts itself, rather than rely solely on the reinsurer to select the attachment points. These should be set with an eye to the client's profitability and comfort zone, not those of the reinsurer.

Deductibles and retentions are typically "self-funded". Claims that fall under the assumed amounts are generally paid out of cash flow. Larger organizations may find it advantageous to consider alternative ways to fund their risks. The formation of a captive insurance company, participation in a captive pool, the use of a rent-a-captive, reinsurance, and other methods must be considered, as well as the business and tax advantages or disadvantages of each.

Three Risk Management Terms to be Familiar With:

RISK CONTROL:
encompasses the avoidance or elimination of risk and risk reduction through loss control. Loss control reduces the probability that loss will occur and also reduces the magnitude of losses that do occur. Risk control, however, only addresses a portion of the risk management process and is not a complete solution in itself.

RISK FINANCING:
involves various techniques to pay for losses that occur in spite of risk control tech- niques that are utilized. It involves assumption of risk and risk transfer. Assumption or retention of risk, either wholly or partially means that the risk is borne or financed internally.

RISK TRANSFER:

can mean either a contractual transfer of risk or transfer through the purchase of insurance


THE ROLE OF INSURANCE BROKERS

Despite what most insurance agents would have you believe, the purchase of insurance is relatively uncomplicated. Most individuals and business managers know it is prudent to buy insurance to protect their assets. Because many buyers look upon insurance as a necessary evil and a mere commodity, they generally look upon agents and brokers as little more than shopping services to find the best price for the type of policy wanted. They place little value on the agent's or broker's services because insurance companies pay them commissions for bringing the buyer to them and servicing the business once placed.

However, those few MCO's that have risk management professionals on staff regularly rely on the advice and services of a knowledgeable independent broker. The challenge is to find a Broker with a working knowledge of the health care industry, with hands-on experience in dealing with the risks faced by health care providers, and who is schooled in the art of risk financing- not merely with the purchase of insurance. Only a handful of Brokers in the United States are able to meet these criteria with any consistency.

Alternative Markets Cannot be Ignored

Before the 1975-76 crisis, most doctors, hospitals, and other health care providers relied upon the leadership of their medical societies and associations to select the carrier and designated sales agent. As a result, their "sponsored" programs effectively stifled competition for their business, and created quasi-monopolies for the bidders (carriers and agent) who won their endorsement.

Although the formation of doctor-owned companies appeared initially to increase competition, most were founded around the nucleus of the members of local medical societies and, therefore, catered specifically to the needs of the individual practitioners. Few would allow agents or brokers to sell their policies. Only recently have some of these companies revamped their operating premise. They have entered the group practice arena and have been forced to play catch-up with their commercial competitors who lost the physician market 20 years ago while maintaining control of the larger risk market. They are under pressure to acquire the knowledge of risk management techniques and alternative funding mechanisms necessary if they are to capture a representative share of the large health care provider market. Many are relying on qualified brokers for help.

The typical insurance agent is not equipped to deal with the complexities of the business risks confronting large health care providers. Even many who have the requisite skills cannot be relied upon to place their client' needs above their own interests. Why? Because there is an inherent conflict of interest in the way most brokers do business: on a strict commission basis.

Most brokers break their client's premiums into two parts: part one is paid to the carrier, part two is kept by the broker as a commission for services rendered. The buyer seldom knows the breakdown of these two parts.

The dilemma facing the commission-oriented broker is that they must cater to the carrier's needs while trying to serve the client at the same time. Because the carrier dictates the underwriting conditions and sets the rates for the broker's commissions, it is unusual for these brokers to approach any direct writing carrier, including the bed pan mutuals, because as a rule direct writers price their policies net of commissions.

Traditional brokers are caught between the proverbial rock and a hard place: the better job they do for their client in reducing costs, the less they get paid.

Therefore, like Diogenes searching for an honest man, CFO's should take the advice of a commission-only broker with caution. The physicians' medical malpractice insurance marketplace is much larger than traditional-large commercial commission paying markets.


THE ALTERNATIVE: HEALTHCARE PROFESSIONALS' INSURANCE SERVICES (HCP)

R.W. Mortimer has taken a leadership role in changing the way insurance agents and brokers do business by establishing a specialized health care division. HCP's principals made a commitment to professionalism by structuring this division's compensation on the basis of value of the advice given and the services rendered.

Rather than provide the "shopping service" typically offered by brokers who utilize only commission-based markets, and by adopting a fee-for-service strategy, HCP positioned itself to become a vital member of its client's team of independent management advisors. HCP expects to make a significant contribution to its client's financial success by serving shoulder-to-shoulder with their attorneys, accountants, actuaries, and risk management team to employ the latest risk financing techniques and seek out cost reduction opportunities wherever available for its client.

HCP's function is to help its client evaluate their exposures to loss and to structure financing plans designed to fit their specific needs. Even those clients with risk management departments already in place can benefit from the services provided by HCP. Importantly, HCP never has to factor its own financial needs into any proposal it presents to its client.

Because HCP presents itself as a member of its client's team of independent management advisors, it is able to open doors to insurance carriers overlooked by, or not otherwise available to, commission brokers. Due to its ongoing dealings in the underwriting marketplace, it has developed a working relationship with virtually all of the leading medical malpractice underwriters. HCP has earned an impeccable reputation for integrity and technical competence that risk managers can use to their advantage.

HCP's principals and staff of qualified service representatives recognizes it cannot be all things to all people. That is why HCP does not hesitate to consult with other experts in their respective fields. HCP assumes the role of coordinator and assembles and monitors the team of actuaries, claims investigators, loss and quality control technicians, captive managers, (if necessary) and other experts to complement the services it provides. The same concept applies to the selection of an insurance carrier and the placement and service of the insurance piece. HCP's broad and unbiased knowledge of the many insurance carriers and products results in a wider variety of options from which HCP's clients are able to chose and is unique to professional medical malpractice insurance.