Winds of change

What does US healthcare reform mean for the medical professional liability market? HRMR gets an expert view from rating agency AM Best.

The US medical professional liability market is in a unique period of transition, with US health reform creating new opportunities and pressures for insurers of medical risk.

In this interview with Henry Witmer, assistant vice president, AM Best Company and Thomas Redman, manager, industry research, AM Best Company, we examine financial results, loss trends and industry developments. We also explore the issue of growing competition from new organizations, including many hospitals that have begun to cover the medical risks of their physician employees.

 
Why is the US professional liability market in a period of transition?
Henry Witmer: There are several things, especially changes occurring in the delivery of healthcare. It’s not just the Affordable Care Act that President Obama has asked Congress to put through into law—even before that there have been new procedures, greater depth of effort in applying patient safety initiatives, the implementation of electronic medical records and certainly a crying need for providing coverage for uninsured people so that they can get medical care.

There has been increased use of ancillary providers (nurse practitioners and other intermediate qualified providers who are not fully licensed physicians, but can perform some of the same functions as physicians). Specific to the insurance companies there are ongoing soft market conditions, but despite this they are still able to generate profits.

What is the outlook for the market?
HW: There are continuing soft market conditions—we don’t see that turning around any time soon but on the other hand we see consolidation going on in two areas: among the medical care providers, the physicians and related disciplines, plus consolidation among insurance companies that provide medical professional liability coverage for those medical care providers.

What can you tell from the financial results?
Thomas Redman: Medical professional liability insurance has a very long, exaggerated market cycle and what we have seen for the past several years has been the upside of the market with strong earnings and surplus growth. That was true in 2012 when earnings were about $2 billion pre-tax and with about $1.5 billion of surplus growth, and it’s been strong for several years.

However, there is, as part of that, a reliance on prior year loss reserve redundancy recognition—that is, the companies set up liabilities associated with future claims and as time has gone on they have released those reserves. These releases of loss reserves have been significant in support of earnings.

 
In 2012, $1.7 billion of the $2 billion pre-tax earnings related to those prior year reserve releases. If we want to take the pulse in a more precise way we can look at operating cash flows—and when we do, we see
that from 2010 to 2012 they were basically cut in half. The industry went from about $1.7 billion of positive net operating cash flow
down to about $870 million this past year. Premium rates have been declining, and $650 million of the $830 million difference is premiums, but there is also a smaller uptick in loss payments, so there’s pressure on the loss side.

When we look at it from the standpoint of premium funding per reported claim (in other words, how much money does a company have in terms of earned premium related to every claim that gets reported) we see that in 2003 after 12 months of development there was
about $80,000 of premium per reported claim. It went up in 2006 which was pretty much the high point of the market to about $130,000 and in 2012 it was back down to $100,000. So we’re still above a low point in the cycle in 2003, though we are more than halfway down.

Lastly, on the claims side, we’re seeing indications of movement upwards. That’s been true in terms of the paid claim severities. And, when we look at incurred loss development we see that the development factors (comparing accident year incurred development between calendar years) have increased in the first three years of development associated with claims made policies such that it indicates something like $300 million of additional losses would be suggested by the actuarial data for accident year 2011. What you get from reviewing the financial results is the sense of many years of strong earnings and surplus growth, and now the industry is bolstered for the downside that appears to have arrived.

What’s driving the loss trends?
HW: Since the last difficult market period or hard market period in the early 2000s there’s been a long-term and steady decline in frequency and severity until the last year or two. More recently, the frequency has started to flatten out and severity is rising, somewhat slowly, not aggressively but slowly and it’s certainly starting to show up in the numbers. The severity is not rising much more than the general rate of inflation overall but there are pockets where it’s rising a little faster, and other pockets where it’s not. Rates are still coming down and eating into the redundancies that were built up over the last number of years.

What industry developments are currently affecting the market?
HW: The Affordable Care Act is certainly going to accelerate changes that are occurring in the delivery of medical care but it’s hard to tell what all of that will be. The other main area is that there’s a continuing emphasis on patient safety and risk management at least on the part of medical professional liability insurance companies. There are greater computer capabilities to analyze big data as they call it, or metadata. The companies—especially the ones that are larger and have better access to greater volumes of data—will analyze loss data and claims data so they can tailor their risk management and patient safety programs to be much more effective than they might have been in the past.

Is there new competition in the market and where is it coming from?
HW: Two types of competition are going on in the market simultaneously: one is hospitals acquiring physician practices—the theory behind it is that some of these, especially the higher specialties in the surgery areas, tend to bring patients into the hospital so they want to have better control over the physicians and incorporate them into overall hospital programs and acquire those practices so that they are within the hospital’s sphere. This kind of thing has occurred in the past but it unwound itself over a number of years because the physicians weren’t truly happy as they thought they might have been as employees of the hospital.
However, there are other reasons why some physicians are happy with the arrangement—it gives them a steadier base of income, and no need to worry about finding patients and all of the red tape that’s involved with operating a practice these days. They want to just hand off the administrative burden of operating a practice to somebody else who can operate it more efficiently on a larger scale.

There’s also competition in the sense not necessarily of hospitals acquiring physician practices but what are called aggregators, where a large group would acquire a number of different practices and even practices of different types, creating a very large group which would give them pricing control and access to equipment on a bulk buying basis. It’s less expensive to operate some of these practices than it would be if they were on their own.

Competition is also occurring among the professional liability insurance companies because whereas in the past many of them were single state, single line types of insurers they really are seeing the benefits in many cases of diversification across geographic boundaries within the US, so they are expanding their efforts to attain scale. That links back to the prior point about analyzing data: when you have a larger volume of data you can be more effective—you’re going to analyze it more effectively so there are some scale benefits by diversifying and expanding. Then, however, you’re going to be bumping into some of your competitors in their respective markets, so there is some competition in that respect.

Why are some hospitals covering the risks of their physician
employees by using captives?
HW: A number of the larger hospital systems with hospitals in a number of locations would have a captive insurance company that would handle most of the day-to-day claims that occur with the hospital. If they have acquired physician practices, many would then roll those physician risks into that captive as well. That would help them to handle a claim because then one claim, which might involve both the hospital and a physician or several physicians, could be handled by one attorney as one large claim rather than trying to coordinate between the physician’s insurer, who might be different from the hospital’s insurer or the hospital’s captive. It just makes it easier for them to be able to do that.

What opportunities and pressures does US health reform impose on insurers?
HW: The risk profile is changing because of changes in the delivery of medical care. The Affordable Care Act is coming into place and doctors are looking either to retire or sell their practice or become part of a larger organization to make it much more efficient for them to run a practice rather than trying to do everything themselves. There’s also anticipated to be a rise in coverage being provided to the previously uninsured. With that you have a large increase in the number of patients and the number of doctors coming out of medical school that is not able—at least not initially—to keep up with the sudden influx of new patients, so they are becoming more reliant on the ancillary providers.

It puts the doctors into more of a managerial role as opposed to being more closely involved with the patient care itself. There’s the larger multidisciplinary ground I mentioned earlier, but I think the medical care environment is quite resourceful and they’ll see themselves through some of these changes. What exactly that is going to be—it’s hard to tell at this point but I’m sure they’ll be able to do well in the long term. There may be some upheavals and some challenges but I think they’ll be able to determine and handle the requirements that are needed for the delivery of healthcare. 