Causes of the Medical Malpractice Crisis?
A Working Paper styled as a weblog entry to Unintended Consequences
©2005 Douglas Simpson, J.D., Wethersfield, CT, DougSimpson.com 
“Behind Those Medical Malpractice Rates” (New York Times, 2/22/05) included a statement that “legal costs do not seem to be at the root of the recent increase in malpractice insurance premiums.”  Testing this assertion requires examination of the complex dynamics of the insurance network and is complicated by a lack of appropriately segmented data and contradictory assertions.  Alternative views can be found in a review of selected literature that is attached as a Word file.  KeyPad-verified comments are welcome.
Abstract:  A review of selected studies of the causes of insurance cost crises in medical malpractice liability.  
•	A 2003 GAO study examines the effects of incurred and paid losses, the insurance cycle and the withdrawal of insurers voluntarily or due to insolvency. 
•	In 2003-2004, Pennsylvania studies funded by the Pew Charitable Trusts examined the role of waxing and waning competitive initiatives, periods of “disequilibrium,” and the role of insurers of last resort including Joint Underwriting Associations (JUAs) and Patient Compensation Funds (PCFs).  
•	The 2003 Senate testimony of the Physician Insurers Association of America (PIAA) points to operating ratios and premium/surplus ratios as constraining capacity of physician-owned insurers.  
•	A 2004 national quantitative study at Dartmouth College found a “fairly weak” relationship between medical malpractice payments and premiums. 
•	A 2004 report from the National Association of Insurance Commissioners (NAIC) reported correlations between number of insurers writing and premium levels and concluded that insurer losses have driven premium increases in recent years.  
•	A 2005 study of the Texas Closed Claim Database (TCCD) using data for the period 1998-2002 found no significant relation between premium levels and changes in claim outcomes and expenses after controlling for population growth and per capita usage of medical services.  
•	The literature agreed on the need for improved data with segmentation appropriate for research in this field.
The author adds a perspective on the insurance cycle, comparing the participants’ situation to an iterated prisoner’s dilemma complicated by non-commercial risk bearers that provide explicit or implicit subsidies. The author suggests study of insurance market crises using tools of network theory including “phase transitions” and “cascade effects.”  He also suggests consideration of an “imputed premium cost,” being the differential between real aggregate premiums and the aggregate premium that would apply in the absence of subsidized market makers offering insurance below actuarial cost.
GAO 2003 Reports on Medical Malpractice Rates 
In 2003 testimony, GAO officials reported on studies of factors contributing to rising medical malpractice (med mal) insurance premium rates and the implications for the health care system.  The GAO noted four influences on rising premium rates:  increased losses (the "greatest contributor"), decreases in investment income, vigorous competition leading to insolvencies and market withdrawals and rises in reinsurance rates beginning in September 2001.
These factors combined to move the med mal market through hard and soft phases that were more volatile than for “short tail” lines.
The study distinguished between paid losses and incurred losses.  Paid losses are actual cash payments for claims and adjustment expenses; incurred losses are an insurer’s estimates of payments expected in future years.  The GAO found that "incurred losses are the largest component of medical malpractice insurer's costs."  Id. p. 6. Looking at A.M. Best data from 1975 through 2001, it concluded that insurers' experience of paid losses influences premium rates by affecting their estimation of incurred losses.  Graphing the two sets of data indicated that the incurred losses are more volatile on both the upside and downside than are paid losses.
The GAO described the med mal market cycle using the nomenclature of the insurance business, in which the mid-70's and mid-80's were described as "hard" markets, "generally characterized by rapidly rising premium rates, tightened underwriting standards, narrowed coverage, and often by the departure of some insurers from the market."  Id. p. 10.  From 1990 to 1998, the market was “hard,” "characterized by slowly premium rates, less stringent underwriting standards, expanded coverage, and strong competition among insurers."  Id.
Since 1999, profitability in the sector declined, several insurers became insolvent and others (notably St. Paul/Travelers) left the market, contributing to its hardening.  GAO reported data that until 1998, aggregate med mal insurer profits remained above 12% of net worth, but fell in during the 1999 - 2001, the last year on which the study had data.  Id., p. 29, Figure 7.  The GAO noted that the absence of segmented data on losses, verdicts and medical industry conditions “complicates the ability of insurers, regulators, and the Congress to understand current market conditions and to formulate effective, sustainable solutions."  Id. p. 16.  United States, General Accounting Office, "Medical Malpractice Insurance: Multiple Factors Have Contributed to Premium Rate Increases" GAO-04-128T  (Testimony by Richard J. Hillman and Kathryn G. Allen, October 1, 2003). Available at: http://www.gao.gov/new.items/d04128t.pdf (viewed March 5, 2005). United States, General Accounting Office, "Medical Malpractice Insurance: Multiple Factors Have Contributed to Premium Rate Increases," GAO-03-702 (June, 2003) Available at: http://www.gao.gov/new.items/d03702.pdf (viewed March 5, 2005)
Pew Project on Medical Liability in Pennsylvania
The Project on Medical Liability in Pennsylvania reports is funded by the Pew Charitable Trusts and commissioned a study by William M. Sage of prior crises of availability and affordability in med mal insurance.  In a 2004 report, Sage reported that the 1960’s were a period of “disequilibrium,” in which med mal coverage became more risky for commercial insurers.  A crisis of availability in the 1970s was followed by a crisis of affordability in the 1980s that triggered the shift to “claims made” policy formats.   “The financial boom of the 1990s encouraged many carriers to compete for new geographic markets by relaxing underwriting criteria and lowering premiums.”  Sage, “The Forgotten Third:  Liability Insurance and the Medical Malpractice Crisis,” Health Affairs, Vol 23, Issue 4, 10-21 (July 2004).
As the 90’s ended, Sage found that incurred loss frequency and severity trended up, and insurers’ profits fell below acceptable returns on equity. Commercial insurers such as St. Paul withdrew from the med mal market.  The 9/11 disaster consumed a large portion of the capital that commercial insurers need to make coverage available for unprofitable lines like med mal.  Several insurers were forced to liquidate due to insolvency, including several owned and managed by health care providers. The survivors became more selective and raised rates. Id.
In another Pew-funded study, Professor Frank A. Sloan examined the role of government participation in the med mal insurance sector.  In the 1980s, Pennsylvania organized a Joint Underwriting Association (JUA) and the Patient Compensation Fund (PCF).  
	A JUA typically operates as an insurer of last resort, to which physicians and hospitals could turn if they could not obtain insurance from the “standard” marketplace.  Its operating losses are eventually passed back as assessments upon the private insurers in the state, adding to their costs of providing commercial insurance.  A PCF takes on liability above certain thresholds, acting in the capacity of excess insurer.  A PCF was introduced in Pennsylvania during the 1975-76 crisis to absorb the “shock” losses of the more serious cases.  Its operating losses are also passed back into the private marketplace as assessments, much like those of the JUA.   Sloan, “Public Medical Malpractice Insurance,” Project on Medical Liability in Pennsylvania, March 2004, available at: http://medliabilitypa.org/research/files/sloan0304.pdf
	Sloan relied in part on a study by Randall R. Bovbjerg and Anna Bartow (Bovbjerg and Bartow) that focused on the PCF in Pennsylvania, which was set up and run on a “pay as you go” basis in which initial assessments covered only immediate cash needs and the “long tail” was an unfunded liability.  The Pennsylvania PCF was known as the CAT Fund (now the Medical Liability Catastrophic Loss or MCARE Fund) and followed the classic pattern of such funds. Low initial assessments in the 70s and 80s rose in the 90s as unfunded obligations accumulated to exceed $200 million annually, about equal to the total premium paid to private insurers.  A large emergency surcharge in 1995, necessary to catch up on deferred cash needs, created what has been called a “mini-crisis” specific to Pennsylvania.  Bovbjerg and Bartow, “Understanding Pennsylvania’s Medical Malpractice Crisis,” Project on Medical Liability in Pennsylvania, June 2003, available at: http://www.medliabilitypa.org/research/report0603
Testimony of PIAA
	The Physician Insurers Association of America (PIAA) is a trade association of physician-owned insurers.  It reported insuring over 60% of the doctors in the U.S. in 2003 when its president, Lawrence E. Smarr, testified before the United States Senate.  Smarr pointed to systemic deterioration of the combined ratio, a common measure of operating performance for insurers that compares losses and expenses to earned premiums.  
Considering investment income, 1.15 is about a “break-even” combined ratio, according to Smarr.  Higher combined ratios indicate unprofitable operations.  Tillinghast data showed PIAA members reaching unprofitable combined ratios in 2000, with worse ratios in 2001.  He pointed to deterioration in his members’ premium to surplus ratio that diminished capacity to prudently write new business.  Smarr, L.E. “Statement of the Physician Insurers Association of America,” Before a joint hearing of the U.S. Senate Judiciary Commiteee. and the Health, Education, Labor and Pensions Committee, Feb.11, 2003. Available at: http://www.thepiaa.org/pdf_files/February_11_Testimony.pdf
The Study at Dartmouth
In August 2004, Professors Baicker and Chandra of Dartmouth College reported on their quantitative study of the relationship between medical malpractice losses and premium levels.  Using state-level data from the Medical Liability Monitor (MLM) and the National Practitioner Data Bank (NPDB), they reported a “fairly weak” relationship between med mal payments and premiums.  Katherine Baicker and Amitabh Chandra, “The Effect of Malpractice Liability on the Delivery of Health Care” (National Bureau of Economic Research, Working Paper 10709, August 2004).  Available at: http://www.nber.org/papers/w10709
	Baicker and Chandra computed population-weighted average state premium, acknowledging criticism of the quality of NPDB data and defending it as the best available. They segmented and analyzed data on over 250 thousand payments and compared averages of data from 1991-1993 to those from 2000-2003.  They concluded that payments are only marginally correlated with premiums, and are not the driver of premium increases, while acknowledging the possibility that insurers may instead use payment information not based on historical or realized payments. 

2004 NAIC Report 
	In 2004, the National Association of Insurance Commissioners (NAIC) reported a study of market conditions in the med mal insurance system between 1992 and 2002.  It agreed with the GAO that “there is insufficient available data to study every aspect of medical malpractice insurance market problems.” Eric Nordman, Davin Cermak and Kenneth McDaniel, “Medical Malpractice Insurance Report:  A Study of Market Conditions and Potential Solutions to the Recent Crisis,” (NAIC 2004), p. 16.  Available from http://www.naic.org. 
“Long-run profitability,” according to the NAIC report, “is one of the most important indicators of market problems in an insurance market.”  Id. P. 17.  Persistently high profits suggest insufficient competition and artificially high prices.  Persistently low profits indicate competitors charging inadequate rates to gain or keep market share, or an inability to raise premium for other reasons.  NAIC also reported a “moderate negative correlation (-0.5369) between the median insurer direct premium written and the number of insurers writing premium in the United States.”  Id. p. 18, Figure 1.  In other words, as insurers enter a market, prices tend to fall, and as they leave, prices tend to rise.  The NAIC also reported a “moderately strong” negative correlation between the number of insurers writing, the median incurred loss (-0.5876) and the median paid losses (-0.5812).  In other words, as losses increase, insurers exit the market and return as losses decrease.
 	The NAIC concluded: “Insurer losses have been the driving force of medical liability rate increases over the past several years.” Id. p. 21.  Access to the raw data used by the NAIC would be valuable, but other researchers have reported that NAIC declines requests for outside researchers access to its data.
 2005 Study of the Texas Closed Claim Database (TCCD)
After the 70s crisis, the Texas Department of Insurance (TDI) collected data on over 150,000 closed claims, including 16,000 med mal claims.  The resulting database, covering the period 1988 – 2002 and was used in a quantitative study to test relationships between med mal claims costs and insurance premiums in Texas.  The first reported academic study of that database was released in March 2005 from the University of Texas Center on Lawyers, Civil Justice and the Media.  Bernard Black, Charles Silver, David A. Hyman and William M. Sage, Stability, Not Crisis: Medical Malpractice Claim Outcomes in Texas, 1988-2002, (2005) at: http://papers.ssrn.com/abstract=678601. 
The Texas researchers controlled for population growth and per capita usage of health care in Texas.  They found stable med mal claim counts and costs over the period, with some growth in defense expenses.  They suggested that contrary statistics cited by others might be explained by a failure to adjust for the decline in the number of small claims paid (which increases the average claim payment) and a failure to adjust for inflation.  
	They concluded that the significant spike in med mal insurance premiums after 1999 did not result from changes in claims outcomes or expenses.  Instead, the most likely cause was the dynamics of the insurance market and a failure to forecast claims using the approach of a “rational Bayesian analyst.”  Id. p. 35.  Their alternative causes echoed those cited by the GAO: significant under pricing during the 1990s; overestimates of losses during the closing years of the 20th century; and external market stresses due to the disasters and economic swings of 2001.  They concluded that attempts to avoid crises in medical malpractice insurance prices should focus on the insurance markets rather than on the tort system.  Id.
Need for Meaningful Statistical Base
	The lack of appropriate data is a consistently reported challenge to scientific analysis of the relationship between med mal liability loss costs and insurance prices.  The GAO recognized this in their 2003 report, saying “Overall, adequate data do not exist that would allow us and others to provide definitive answers to important questions about the market for medical malpractice insurance, including an explanation of the causes of rising losses over time and the precise effect of tort reforms on premium rates.”  GAO-04-128T (2003) at p.3.   The National Association of Insurance Commissioners agreed in its 2004 report, saying that an underlying theme in the literature reviewed “was the fact that medical malpractice data was inconsistent, incomplete, difficult to obtain and even more difficult to interpret.” NAIC, op cit., p. 4. 
Some thoughts:
Commercial risk bearers, such as insurance companies, have multiple options when acceptable profitability thresholds are passed, as they were in the late 1990s.  They may choose to not play, and to withdraw from the most unprofitable jurisdiction or from the market entirely.  St. Paul (now Travelers/St.Paul) took that route in 2001.   They may respond incrementally, out of a desire to “stay in” and continue to make a market, by attempting to increase rates, tightening underwriting standards or narrowing coverage. 
The risk bearer finds itself caught in a variation on an iterated Prisoner’s Dilemma. If it “holds ranks” with the market, it may maintain its market share and current cash flow, but become unprofitable and watch its surplus be consumed by operating losses.   If it “breaks ranks” with the market, raising prices or tightening underwriting in anticipation of a possible market turn, it risks losing its best policyholders to more competitive risk bearers, retaining its worst policyholders and watching its cash flow shrink, making a bad situation worse. 
The better capitalized risk bearers may be able to hold out longer, but may have more choices as to where to expose their limited capacity, and may be able to better see “the shadow of the future.”  Marginally capitalized risk bearers unable to raise new capital may have to choose between withdrawal and insolvency.  During the strains following 9/11, some chose unwisely.  See, e.g., Douglas Simpson, “Search for Deep Pockets Widens in Reciprocal of America Case,” Unintended Consequences, Mar. 3, 2005 at http://www.dougsimpson.com/blog/archives/000380.html.
With each “hard” market, non-commercial risk bearers, such as risk retention groups, providers’ mutuals, and reciprocals, have gained market share, sharing a purpose to “provide access to insurance and stability to the market.”  Smarr, p. 4.  Some may lack the experience to effectively respond to under pricing and unprofitability. They may also find that their options are especially limited both by market factors and by the political problem of gaining member approval for price increases.  They may also lack the capacity to take up the slack when commercial insurers withdraw, may be unable to raise new capital and find themselves dependent on reinsurers when reinsurers increase prices dramatically.  Id.
Quasi-public risk bearers, such as Joint Underwriting Associations (JUA) and Patient Compensation Funds (PCFs), with their explicit and implicit market subsidies, may be even less responsive to market forces.  In “hard” markets, such facilities often grow to a large share of a market, providing capacity at below-market prices.  Their activities may mask relationships between losses, profitability and insurance prices.
 	In a system as complex as the insurance network, increasing costs can be and are expressed in many ways other than prices.  With better data and new conceptual approaches, new insights may be gained.
Questions for further research:
•	Can network theory provide some insight into the dynamics of the upward “breakouts” of insurance market prices following extended periods of unprofitability?  For example, are dramatic turns in the insurance cycle examples of “phase transitions” in which a network dynamically shifts from an ordered to a disordered state?  Could that explain a “cascade” of price increases, market withdrawals and political reactions? 
•	Would it help to introduce an “imputed premium cost,” being the differential between realized aggregate premium cost and the aggregate premium cost that would apply if there were no subsidized risk bearers and others providing coverage below ultimate cost?

© 2005 Douglas Simpson, J.D., Wethersfield, CT 06109
Adjunct Professor, University of Hartford
Lecturer, University of Connecticut School of Law
http://DougSimpson.com