|Title:||United States premiums earned in medical malpractice insurance by type of contact in dollars, ratios, and percent change for 1990 to 2006|
|Source:||Journal of Risk & Insurance|
Start of full article - but without data
Premium Earned (in Thousands of Current Dollars) in Medical
Malpractice Insurance by Type of Contact, 1990-2006
Total CMR Contract OCC Contract Ratio of CMR Premiums Premiums Premiums to OCC Contract Year Earned Earned Earned Earned Premiums
1990 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1991 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1992 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1993 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1994 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1995 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1996 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1997 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1998 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 1999 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2000 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2001 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2002 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2003 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2004 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2005 X,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX 2006 XX,XXX,XXX X,XXX,XXX X,XXX,XXX X.XX Annual increase 1990-2006 X.XX% X.XX% Annual increase 2001-2006 XX.XX% X.XX%
Note: Table includes all insurers reporting nonzero premiums in
the two types of medical malpractice policies.
Source: NAIC Annual Data Tapes-Property and Casualty Insurers,
Underwriting and Invest ment Exhibit.
The liability crisis of the 1970s led to the introduction of a new type of insurance policy designed to reduce the undiversifiable uncertainty associated with writing long-tail liability lines. These new claims-made and reported policies gained favor in place of the traditional occurrence coverage in the early 1980s not only in medical malpractice but also in the general liability arena. The main question we want to address in this article is why two types of contracts that cover the same risk exposure exist in the medical malpractice insurance industry whereas only one exists primarily in other insurance lines.
The medical malpractice insurance industry has been one of the most scrutinized industries in recent years. Periodic performance "crises"--evidenced by increasing premiums and reduced availability of liability coverage--have prompted a variety of legislative responses including, for example, legal reforms and the implementation of state victim compensation funds. Amid ongoing concerns for the rising cost of health care and an increase in the number of uninsured individuals for health-care services, it is not surprising that medical malpractice insurers' operations are called to question; to the extent that higher premiums or nonrenewal of coverage causes health-care providers to reduce or discontinue services, patients' access to care is disrupted. (X)
Attempts to explain problems in the medical malpractice insurance industry typically examine the influence of exogenous factors on the performance of the member insurers. These exogenous factors include increased litigation by patients, increased jury verdicts and out-of-court settlements, falling investment income, rising reinsurance rates, and changes in the legal environment. Interestingly, researchers have devoted little attention to developments within the industry and their potential influence on insurer performance. One such development was the introduction in the mid-1970s of claims-made and reported (CMR hereinafter) policies (X) in place of the traditional occurrence coverage (OCC hereinafter).
Touted as a way to reduce the uncertainty associated with writing long-tail liability lines (including the uncertain legal environment as in Doherty, 1991), claims-made policies gained favor not only in medical malpractice but also in the general liability arena (Sloan, Bovbjerg, and Githens, 1991). One major medical malpractice insurer, St. Paul Fire and Marine, switched its entire book of business to claims-made in the 1980s (and dropped completely the line XX years later). By 1984, claims-made policies accounted for XX percent of total premiums written in medical malpractice, leading Posner (1986) to predict that "further growth of up to seventy to eighty percent is extremely likely" (p. XX).
In our study, we examine firm-level variations in the use of CMR versus OCC policies in a national sample of insurers, for the period 1992-2006. We evaluate institutional and organizational factors that explain why CMR and OCC policies coexist. In our analysis, we focus on the differences between insurers using CMR policies only, OCC policies only, or a combination of the two types. In particular, we evaluate the respective roles of organizational form, scale and scope of operations, competition, and profitability, among other factors, in determining the types of policies offered.
The remainder of the article goes as follows. We next present the theoretical foundation for the emergence of CMR contracts alongside OCC contracts. In the third section, we present our analysis of the medical malpractice insurance market where the two contracts are sold competitively. We conclude in the fourth section and offer avenues of future research.
Several veins of insurance research have addressed questions pertaining to the unique structure of the U.S. insurance market. The variety of organizational forms, for example, has been linked to incentive conflicts and contracting costs (Mayers and Smith, 1988), capital requirements (Zanjani, 2007), and advantages in addressing problems in adverse selection (Ligon and Thistle, 2005), inter alia. The insurer's choice of distribution system has been related to contracting problems among policyholders, insurers, and agents (Kim, Mayers, and Smith, 1996); information asymmetry (Seog, 1999); and impediments to competition (Berger, Cummings, and Weiss, 1997).
In sharp contrast to the organizational form and the distribution systems literature in insurance economics, not much economic theory has been developed to explain the rationale of having different types of insurance contracts designed to cover the same risk as in the case of claims-made versus occurrence contracts. One paper that addresses directly the theoretical underpinning of claims-made contracts is Doherty's (1991). He contends that CMR contracts were designed as an answer to market-wide uncertainty that the insurance industry could not diversify. (X) His theoretical analysis shows that the main difference between the contracts is in the way that premiums are determined. When insurance is purchased for multiple periods, premiums for OCC are based on information available at that time. In CMR contracts, insurers can defer the premiums' estimate for events giving rise to claims until after the event year. This feature adds flexibility when exogenous factors, such as changes in liability rules, add uncertainty in the underwriting environment. Boyer and Gobert (2007) contend, on the other hand, that the only reason why CMR policies exist is that policyholders are more myopic than insurers.
Given these reasons for the emergence of CMR contracts, it is interesting to observe that OCC contracts are still offered to cover the same risk exposure in the medical malpractice insurance industry. As Doherty (1991) reports, this phenomenon is likely driven by insurers' specific needs for diversifying the risk and exercising control over premiums. It is thus likely caused by a combination of firm-specific characteristics and exogenous factors; our study's purpose is to examine these characteristics and factors.
Our analysis of the medical malpractice insurance industry by contract type first establishes the importance of each type of contract in the U.S. economy as a whole and explores the association between the contract type and organizational form. We then examine several features of market conduct to see if insurers' choice of contract type is correlated with the array of other insurance products that are offered by insurers, the number of states they operate in, and the sheer size of their operations. Finally, we assess the financial performance of the two lines of medical malpractice coverage by looking at the loss ratios, expense ratios, and combined ratios for each year in the period under study. Our analysis also focuses on how losses develop under each contract type to compare the difficulty of predicting accurately future losses.
The Political Economy of Medical Malpractice Insurance In our assessment of the medical malpractice contract types, we acknowledge that a variety of other factors have influenced the landscape on which the industry operates. For instance, the medical malpractice market experiences more volatile cycles of hard and soft markets than other property and casualty markets. These tough cycles have induced a variety of changes in the medical malpractice regulatory and legal environments over the past few decades. Most recognized and the most studied have been a variety of reforms to the tort environments. (X) Uncertainty in the legal environment and state-level reform efforts are likely contributors to the popularity of CMR contracts.
Aside form tort reform, the availability crisis of the 1970s has generated enough turmoil to induce the creation of state "residual" markets to provide malpractice insurance to high-risk providers through joint underwriting associations (JUA). (X) Another impact of liability crises was the enactment of the federal Liability Risk Retention Act of 1986 that encouraged the formation of risk retention groups (RRG), which are important providers of CMR contracts.
Market Structure and Contract Penetration
Contract Penetration and Market Growth. A primary component of industrial organization studies of the insurance industry is their focus on its industrial structure. While the number and type of institutions in the market are necessary components, we begin our assessment of the industry structure with an emphasis on the prevalence of the two different types of contracts in the industry. Table X presents the premiums earned in the medical malpractice insurance industry from 1990 through 2006, and as a function of the type of contract that was in force.
As we can see, total premiums earned by medical malpractice insurers more than doubled from 1990 through 2006. The annual rate of increase in premiums earned was X.XX percent for OCC policies and X.XX percent for CMR policies, with most of the differential increase occurring in the last X years. From 2001 until 2006, however, the annual increase in premiums earned was XX.XX percent for CMR policies and only X.XX percent for OCC policies. We see two possible explanations for having a higher growth rate of CMR premiums than OCC premiums: more policyholders are choosing CMR policies over time, and CMR policies are becoming more expensive.
Ownership Structure and Contract Type. The ownership structure of insurers that distribute each type of contract is another important component of the organization of the market. Table X presents the market share of insurers as a function of their ownership structure (stock company, mutual, reciprocal, RRG, or other types of ownership) as well as a function of the type of contract they sell (OCC only, CMR only, or both) for three specific years: 1992, the first year of our data set; 1998; and 2006, the last year of our data set. Panel A of Table X presents the market share (measured by earned premiums) by ownership structure for the entire medical malpractice insurance industry. We see that although stock insurers still provide insurance to the majority of medical malpractice policyholders, their market share in 2006 (XX.XX percent) is markedly smaller than that in 1992 (XX.XX percent). Mutual insurers as well as RRGs filled the gap left by the departure of stock insurers as both increased significantly their presence in the market between 1992 and 2006. This is particularly true for RRGs, whose market share tripled. The rapid reduction in the stock insurers' market share between 1998 and 2006 occurred in both types of contracts as we can see in Panels B and C of Table X, but not at the same time. (X) We see in these two panels that the market share of stock insurers' varied differently depending on the type of contract that was sold. Indeed, whereas the CMR insurance market share of stock companies did not vary much between 1992 and 1998, the market share of stock companies increased by almost XX percentage points in the case of OCC contracts.
From 1998 until 2006, the market share of stock insurance companies dropped by approximately XX percentage points in the two contract markets. We also see, over these X years, the rapid emergence of RRGs, especially when the insurance contract is claims-made. Whereas RRGs only occupied X.XX percent of the CMR market in 1992, in 2006 they catered to X.XX percent of the market. The story is similar in Table X, where we examine the number of medical malpractice insurers.
We see an important consolidation of stock insurance companies that were selling occurrence policies as their number plunged from XXX in 1992 to only XXX in 2006. The most impressive growth in the number of medical malpractice insurers comes in the form of RRGs. Whereas there were only XX RRGs in 1992, there were XXX in 2006, XX of which wrote CMR contracts, and XX of which wrote OCC contracts. At the same time, the number of stock insurers writing only OCC contracts declined substantially, going from XXX in 1992 (XXX minus XXX) to XX (XXX minus XXX) in 2006.
Suppose one were to rank the ownership structure from the form that has the most risk-bearing ability to the ownership structure that has the least risk-bearing ability, stock companies would clearly have the highest. Because stock insurers can raise extra capital on the market, they are better positioned than any other organizational form to compensate for an unexpected catastrophic loss. What ownership structure would rank the lowest in terms of risk-bearing capacity? We argue that, ceteris paribus, RRGs have the lowest ability to absorb a catastrophic loss for two reasons: the absence of an internal capital market and the low diversification of their risk portfolio.
RRGs have less ability to assume a catastrophic loss because a federal statute (X) prohibits them from insuring personal lines of insurance, thus reducing an RRG's ability to benefit from much economies of scope. Although they can purchase reinsurance as can other insurers, RRGs are typically monoline insurers and therefore cannot access surplus from other lines (see Phillips, Cummins, and Allen, 1998). Finally, RRG policyholders cannot gain access to state guaranty funds in case of insolvency. Consequently, RRG managers should have the hardest time raising capital following a catastrophic loss.
In terms of capital market access, mutual insurance companies and reciprocals lie between stock companies and RRGs, but with mutual insurers being slightly more able to access the capital market than reciprocal insurers. We see in Table X that, similar to RRGs, reciprocals are more likely than mutual insurers to sell CMR than OCC contracts.
The results displayed in the previous two tables support Doherty's (1991) view (among others) that occurrence contracts are inherently riskier for an insurer because exposures are more difficult to diversify. It is therefore understandable to see stock companies, which can more easily access capital markets, be more present in OCC lines than in CMR lines. At the other extreme, RRGs have the hardest time gaining access to the capital market. There is thus no surprise to find RRGs mainly selling medical malpractice insurance through CMR contracts since it is the type of contract for which the access to the capital market is less important.
Concentration Ratios. A third aspect of the market structure of medical malpractice insurance between claims-made and occurrence lines of business is market concentration. It is well established from microeconomic theory that a more concentrated market should provide larger producer surplus. The insurance market is no different, so that we should expect more concentrated lines of insurance business associated with greater insurer profitability. (X) Table X presents the top firm market share, the top X firm market share, the top X firm market share, and the top XX firm market share by contract type for 1992 and 2006.
For all four measures, concentration decreased from 1992 to 2006 for CMR contracts, but it increased for OCC contracts. Overall, combining the two contract types, the top firm and the top X firm market share decreased between 1992 and 2006, but the top X and top XX concentration did not move significantly. Looking in particular at the 2006 market shares, we see that the market for CMR policies is a lot less concentrated than the market for occurrence policies. Indeed, for the OCC market, the top firm, top X firm, and top X firm market shares is roughly twice as large as in the CMR market.
A possible interpretation of why the occurrence market is more concentrated is that insurers that were selling only OCC policies started selling CMR policies, thus eating away at the market shares of established insurers in the CMR market. Another interpretation is that insurers entering the market were more likely to provide CMR than OCC contracts. We examine this interpretation further in Tables X (entries) and X (exits).
As we see in Table X, many more companies are entering the medical malpractice insurance market with CMR contracts than with OCC contracts in the last X years of our data set (XXX completely new CMR insurers since 2002 compared to XX new OCC insurers). Among existing medical malpractice insurers, we see the same phenomenon (XXX OCC insurers started writing CMR contracts since 2002 compared to XXX CMR insurers that started writing OCC contracts during the same period). This difference is not compensated by a similar difference in the number of firms exiting each type of medical malpractice insurance market as we see in Table X.
We see in the table that XX insurers decided to stop writing occurrence policies from 2001 to 2004 while maintaining their CMR line of business open, and only XX insurers did the opposite. From 1992 through 2004, the number of insurers in the CMR line increased by XX companies, whereas the number of insurers in the occurrence line decreased by XXX companies. Whether it is the concentration ratio or the number of entries net of the number of exits, the implication is similar: we should expect to observe a decrease in the profitability of the CMR contract whereas the profitability of the occurrence contracts should have gone up with time.
We now turn our focus to the firms' behavior. Entry and exit choices, described above in our assessment of the structure of the industry, are just two of many decisions the insurer faces in providing malpractice insurance coverage. Another decision is related to the scale and scope of operations, and the choice of contract types offered.