RELEASED: JUNE 2003
Report to Congressional Requesters US Senate
US General Accounting Office (GAO) Washington DC
WHY GAO DID THIS STUDY
Over the past several years, large increases in medical malpractice insurance premium rates have raised concerns that physicians will no longer be able to afford malpractice insurance and will be forced to curtail or discontinue providing certain services.
Additionally, a lack of profitability has led some large insurers to stop selling medical malpractice insurance, furthering concerns that physicians will not be able to obtain coverage.
To help Congress better understand the reasons behind the rate increases, GAO undertook a study to (1) describe the extent of the increases in medical malpractice insurance rates, (2) analyze the factors that contributed to those increases, and (3) identify changes in the medical malpractice insurance market that might make this period of rising premium rates different from previous such periods.
WHAT GAO RECOMMENDS
GAO is not recommending executive action. However, to further the understanding of conditions in current and future medical malpractice markets, Congress may wish to consider encouraging the National Association of Insurance Commissioners and state insurance regulators to identify and collect additional, mutually beneficial data necessary for evaluating the medical malpractice insurance market.
WHAT GAO FOUND
Since 1999, medical malpractice premium rates have increased dramatically for physicians in some specialties in a number of states. However, among larger insurers in the seven states GAO analyzed, both the premium rates and the extent to which these rates have increased varied greatly (see figure).
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Multiple factors, including falling investment income and rising reinsurance costs, have contributed to recent increases in premium rates in our sample states. However, GAO found that losses on medical malpractice claims--which make up the largest part of insurers' costs--appear to be the primary driver of rate increases in the long run. And while losses for the entire industry have shown a persistent upward trend, insurers' loss experiences have varied dramatically across our sample states, resulting in wide variations in premium rates. In addition, factors other than losses can affect premium rates in the short run, exacerbating cycles within the medical malpractice market.
For example, high investment income or adjustments to account for lower than expected losses may legitimately permit insurers to price insurance below the expected cost of paying claims.
However, because of the long lag between collecting premiums and paying claims, underlying losses may be increasing while insurers are holding premium rates down, requiring large premium rate hikes when the increasing trend in losses is recognized.
While these factors may explain some events in the medical malpractice market, GAO could not fully analyze the composition and causes of losses at the insurer level owing to a lack of comprehensive data.
GAO's analysis also showed that the medical malpractice market has changed considerably since previous hard markets. Physician-owned and/or operated insurers now cover around 60% of the market, self-insurance has become more widespread, and states have passed laws designed to reduce premium rates. As a result, it is not clear how premium rates might behave during future soft or hard markets.
June 27, 2003 Letter
Congressional Requesters
Since the late 1990s, premium rates for medical malpractice insurance have increased dramatically for physicians in certain specialties and states. (1) These increases have raised concerns that many physicians will no longer be able to afford malpractice insurance and may be forced to curtail or discontinue providing services. These concerns have been heightened as some large insurers, faced with declining profits, have either stopped selling medical malpractice insurance or reduced their operations in a number of states.
But disagreement exists over the causes of increased premium rates and what, if anything, should be done in response to the current situation. For example, some have argued for tort reform as a means of lowering certain awards in medical malpractice lawsuits and advocate legislative changes at the state level designed to place a cap on such awards.
Others have argued for medical reforms as a means of reducing the incidence of medical malpractice or for insurance reforms as a way to moderate premium rate increases. In response to these concerns, you asked us to determine the reasons behind the recent increases in some medical malpractice insurance rates. (2)
Our specific objectives were to (1) describe the extent of the increases in medical malpractice insurance rates, (2) analyze the factors that have contributed to the increases, and (3) identify changes in the medical malpractice insurance market that may make the current period of rising premium rates different from earlier periods of rate hikes. We will also issue a related report that describes the effect of rising malpractice premiums on access to health care and related issues. (3)
Recognizing that the medical malpractice market can vary considerably across states, as part of our review we judgmentally selected a sample of seven states--California, Florida, Minnesota, Mississippi, Nevada, Pennsylvania, and Texas--in order to conduct a more in depth review in each of those states. Our sample contains a mix of states based on the following characteristics: extent of any recent increases in premium rates, status as a "crisis state" according to the American Medical Association, presence of caps on noneconomic damages, state population, and aggregate loss ratios for medical malpractice insurers within the state.
Except where noted otherwise, our analyses were limited to these states. Within each state, we spoke to one or both of the two largest and currently active medical malpractice insurers, (4) 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.
To examine the extent of increases in medical malpractice insurance rates in our sample states, we reviewed annual survey data collected by a private company. (5) To analyze the factors contributing to the premium rate increases in our sample states as well as nationally, we reviewed data provided by medical malpractice insurers to state insurance regulators, the National Association of Insurance Commissioners (NAIC), (6) and A.M. Best (7) on insurers within our sample states as well as the 15 largest writers of medical malpractice insurance nationally in 2001 (whose combined market share nationally was approximately 64.3%).
We also spoke with officials from professional actuarial and insurance organizations and national trial attorney and medical associations and reviewed their testimonies before Congress.
In addition, we analyzed data on medical malpractice claims collected by insurers, state regulators, and others in our sample states as well as nationally.
To analyze how the national medical malpractice insurance market has changed since previous periods of rising premium rates, we reviewed studies published by NAIC, reviewed state insurance regulations and tort laws, and spoke to the insurers and state insurance departments in our sample states. We also spoke to officials from national professional actuarial, legal, and insurance organizations. Appendix I contains a more detailed description of our methodology.
RESULTS IN BRIEF
Since 1999, medical malpractice premium rates for physicians in some states have increased dramatically. Among the seven states that we analyzed, we found that both the extent of the increases and the premium levels varied greatly not only from state to state but across medical specialties and even among areas within states.
For example, the largest writer of medical malpractice insurance in Florida increased premium rates for general surgeons in Dade County by approximately 75% from 1999 to 2002, while the largest insurer in Minnesota increased premium rates for the same specialty by about 2% over the same period.
The resulting 2002 premium rate quoted by the insurer in Florida was $174,300 a year, more than 17 times the $10,140 premium rate quoted by the insurer in Minnesota. In addition, the Florida insurer quoted a rate for general surgeons outside Dade County of $89,000 a year for the same coverage, approximately 51% of the rate it quoted inside Dade County.
Multiple factors have contributed to the recent increases in medical malpractice premium rates in the seven states we analyzed. First, since 1998 insurers' losses on medical malpractice claims have increased rapidly in some states.
For example, in Mississippi the amount insurers paid annually on medical malpractice claims, or paid losses, (8) increased by approximately 142% from 1998 to 2001 after adjusting for inflation. (9) We found that the increased losses appeared to be the greatest contributor to increased premium rates, but 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 the composition and causes of those losses.
For example, data that would have allowed us to analyze claim severity at the insurer level on a state-by-state basis or determine how losses were broken down between economic and noneconomic damages were unavailable. Second, from 1998 through 2001 medical malpractice insurers experienced decreases in their investment income (10) as interest rates fell on the bonds that generally make up around 80% of these insurers' investment portfolios.
While almost no medical malpractice insurers experienced net losses on their investment portfolios over this period, a decrease in investment income meant that income from insurance premiums had to cover a larger share of insurers' costs. Third, during the 1990s insurers competed vigorously for medical malpractice business, and several factors, including high investment returns, permitted them to offer prices that in hindsight, for some insurers, did not completely cover their ultimate losses on that business.
As a result of this, some companies became insolvent or voluntarily left the market, reducing the downward competitive pressure on premium rates that had existed through the 1990s. Fourth, beginning in 2001 reinsurance rates for medical malpractice insurers also increased more rapidly than they had in the past, raising insurers' overall costs. (11)
In combination, all of these factors contribute to the movement of the medical malpractice insurance market through cycles of hard and soft markets--similar to those experienced by the property-casualty insurance market as a whole--during which premium rates fluctuate. (12)
Cycles in the medical malpractice market tend to be more extreme than in other insurance markets because of the longer period of time required to resolve medical malpractice claims, and factors such as changes in investment income and reduced competition can exacerbate the fluctuations.
While the medical malpractice insurance market as a whole had experienced periods of rapidly increasing premium rates during previous hard markets in the mid-1970s and mid-1980s, the market has changed considerably since then. These changes are largely the result of actions insurers, health care providers, and states have taken to address increasing premium rates. Beginning in the 1970s and 1980s, insurers began selling "claims-made" rather than "occurrence-based" policies, (13) enabling insurers to better predict losses for a particular year.
Also in the 1970s, physicians, facing increasing premium rates and the departure of some insurers, began to form mutual nonprofit insurance companies. Such companies, which may have some cost and other advantages over commercial insurers, now comprise a significant portion of the medical malpractice insurance market.
More recently, an increasing number of large hospitals and groups of hospitals or physicians have left the traditional commercial insurance market and begun to insure themselves in a variety of ways--for example, by self-insuring.
While such arrangements can save money on administrative costs, hospitals and physicians insured through these arrangements assume greater financial responsibility for malpractice claims than they would under traditional insurance arrangements and thus may face a greater risk of insolvency. Finally, since periods of increasing premium rates during the mid-1970s and mid-1980s, all states passed at least some laws designed to reduce medical malpractice premium rates.
Some of these laws are designed to decrease insurers' losses on medical malpractice claims, while others are designed to more tightly control the premium rates insurers can charge. These changes make it difficult to predict how medical malpractice premiums might behave during future hard and soft markets.
This report includes a matter that Congress may want to consider as it looks for ways to improve the ability of Congress, state insurance regulators, and others to analyze the current and future medical malpractice insurance markets. Specifically, Congress may want to consider encouraging NAIC and state insurance regulators to identify and collect additional data necessary to evaluate the frequency, (14) severity, (15) and causes of losses on medical malpractice claims.
We received comments on a draft of this report from NAIC's Director of Research. The Director generally agreed with the report's findings and matters for congressional consideration, and provided technical comments that we have incorporated as appropriate. The Director's comments are discussed in greater detail at the end of this 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 mln of coverage per incident and $3 mln 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% 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 (16)--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. (17) 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 …
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