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Claims-Made and Reported Claims-Made and Reported Policies and Insurer Profitability Policies and Insurer Profitability

in Medical Malpractice in Medical Malpractice

Patricia BornPatricia BornCalifornia State University at NorthridgeCalifornia State University at Northridge

M. Martin BoyerM. Martin BoyerHEC Montréal HEC Montréal

First-of-fiveFirst-of-five

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Claims-Made and Reported Policies and Claims-Made and Reported Policies and Insurer Profitability in Medical Insurer Profitability in Medical

Patricia Born, California State University at NorthridgePatricia Born, California State University at NorthridgeM. Martin Boyer, HEC MontréalM. Martin Boyer, HEC Montréal

AbstractAbstract. The liability crisis of the 1970s led to the introduction of a new . The liability crisis of the 1970s led to the introduction of a new type of insurance policy designed, according to Doherty (1991), to reduce type of insurance policy designed, according to Doherty (1991), to reduce the un-diversifiable uncertainty associated with writing long-tail liability the un-diversifiable uncertainty associated with writing long-tail liability lines. These new lines. These new claims-made and reported claims-made and reported policies gained favor in place policies gained favor in place of the traditional of the traditional occurrence coverage occurrence coverage in the early eighties not only in in the early eighties not only in medical malpractice, but also in the general liability arena. Under medical malpractice, but also in the general liability arena. Under occurrence coverage, a loss incurred in a given year is covered by the occurrence coverage, a loss incurred in a given year is covered by the contract for that year, regardless of when the claim is reported. In contrast, contract for that year, regardless of when the claim is reported. In contrast, a claims-made policy pays only the claims reported in the policy year. Our a claims-made policy pays only the claims reported in the policy year. Our paper presents a structure, conduct, and performance analysis à la Joskow paper presents a structure, conduct, and performance analysis à la Joskow (1973) of the medical malpractice insurance industry by focusing on the (1973) of the medical malpractice insurance industry by focusing on the differences between the two contracts. The main question we want to differences between the two contracts. The main question we want to address is why there are two types of contracts that cover the same risk address is why there are two types of contracts that cover the same risk exposure in the medical malpractice insurance industry whereas in other exposure in the medical malpractice insurance industry whereas in other lines of insurance, only one exists primarily.lines of insurance, only one exists primarily.

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Bone and flesh of paperBone and flesh of paper

Structure, conduct, and performance analysis Structure, conduct, and performance analysis paper à la paper à la Joskow.Joskow.

Originality lies in the comparison, withing the medical Originality lies in the comparison, withing the medical malpractice insurance market, of two contracts that co-exist: malpractice insurance market, of two contracts that co-exist: Claims-made and reported (CMR) versus Occurrence based Claims-made and reported (CMR) versus Occurrence based (OCC);(OCC);– Doherty (1991) says CMR contracts exist because insurers face an Doherty (1991) says CMR contracts exist because insurers face an

important undiversifiable risk, and CMR contracts allow to pass important undiversifiable risk, and CMR contracts allow to pass along to the policyholder this risk;along to the policyholder this risk;

– Boyer and Gobert (2006) say it depends on the policyholder’s Boyer and Gobert (2006) say it depends on the policyholder’s discount rate.discount rate.

Introduction of a new organisational structure, the risk Introduction of a new organisational structure, the risk retention group or RRG. retention group or RRG.

In the end, we want you to wonder what explains the In the end, we want you to wonder what explains the coexistance of the two contract forms in a given market.coexistance of the two contract forms in a given market.

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Contract penetrationContract penetration

Premium earned by type of contact for selected lines of business, 1995-1998. In millions of current dollars.

Line of business Contract 1995 1996 1997 1998

Medical malpractice OB $ 1,560 $ 1,501 $ 1,469 $ 1,532

  CMR $ 3,358 $ 3,455 $ 3,573 $ 3,686

  CMR/OB 2.15 2.3 2.43 2.4

Product liability OB $ 1,573 $ 1,553 $ 1,467 $ 1,467

  CMR $ 189 $ 243 $ 262 $ 165

  CMR/OB 0.12 0.16 0.18 0.11

Other liability OB $11,278 $11,012 $11,720 $11,183

  CMR $ 5,100 $ 5,833 $ 5,653 $ 5,985

  CMR/OB 0.45 0.53 0.48 0.54

Source. NAIC Research Quarterly, July 1999 page 20.

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Contract penetrationContract penetrationTable 1. Premium earned (in millions of current dollars) in medical malpractice insurance by type of contact, 1990-

2005.

year CMR OCCRatio of CMR to

OCC

1990 2,915,177 1,235,550 2.36

1991 2,863,482 1,178,349 2.43

1992 2,943,184 1,173,719 2.51

1993 3,116,520 1,181,586 2.64

… … … …

2000 3,490,482 1,861,044 1.88

2001 4,061,636 1,718,908 2.36

2002 6,726,972 2,430,379 2.77

2003 5,806,058 2,496,678 2.33

2004 6,639,518 2,145,038 3.10

2005 6,563,621 2,065,908 3.18

1990-2005 5.56% 3.49%

2001-2005 12.75% 4.70%

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Contract type and ownership formContract type and ownership form

200519981992

Panel A: All Medical Malpractice business

Panel C: Occurrence policies

Panel B: Claims Made policies

Source: NAIC Annual Data Tapes – Property and Casualty Insurers, Underwriting and Investment Exhibit.

0.03%0.69%0.04%Others

1.60%0.27%0.27%RRG

8.50%4.00%7.89%Reciprocal

33.68%26.59%31.81%Mutual

56.19%68.45%59.98%Stock

0.45%1.10%0.08%Others

8.23%2.16%2.26%RRG

15.17%17.38%19.06%Reciprocal

27.74%21.71%20.37%Mutual

48.41%57.65%58.23%Stock

0.35%0.99%0.07%Others

6.64%1.62%1.69%RRG

13.57%13.56%15.87%Reciprocal

29.16%23.10%23.63%Mutual

50.27%60.74%58.73%Stock

Table 2. Market Shares by Ownership Structure, Contract Type for Selected years (1992, 1998 and 2005)

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Contract type and ownership formContract type and ownership formTable 3. Number of Firms by Ownership Structure, Contract Type for

Selected years (1992, 1998 and 2005)

Stock Mutual Reciprocal RRG Other Total

1992

Any MM Policies 284 33 21 10 7 355

OCC Policies 239 28 16 5 6 294

CMR Policies 183 20 19 9 4 235

1998

Any MM Policies 306 35 19 16 8 384

OCC Policies 232 28 16 8 4 288

CMR Policies 231 25 16 15 6 293

2005

Any MM Policies 245 29 29 90 3 396

OCC Policies 151 23 20 21 3 218

CMR Policies 217 27 29 86 2 361

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ConcentrationConcentrationTable 4. Industry Concentration (Premiums Earned Market Share) by Table 4. Industry Concentration (Premiums Earned Market Share) by

Contract Type, Selected years: 1992, 1998 and 2005Contract Type, Selected years: 1992, 1998 and 2005

Top insurerTop-4 insurers

Top-8 insurers

Top-20 insurers

1992

CMR contracts 0.16 0.29 0.43 0.64

OCC contracts 0.14 0.43 0.61 0.82

Overall 0.12 0.28 0.39 0.61

1998

CMR contracts 0.10 0.25 0.38 0.62

OCC contracts 0.18 0.45 0.59 0.80

Overall 0.08 0.24 0.38 0.62

2005

CMR contracts 0.08 0.22 0.35 0.58

OCC contracts 0.18 0.56 0.68 0.86

Overall 0.07 0.24 0.38 0.60

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EntryEntryTable 5. Entry of firms into medical malpractice lines of business

by type of contract, 1992-2005

Has not sold medical malpractice insurance in any form in the past two years

Existing medical malpractice insurer

Year new CMR new OCC new either new CMR new OCC

1992 5 21 23 8 21

1993 4 8 12 7 12

1994 21 13 33 29 18

1995 15 14 25 27 26

1996 10 22 27 14 24

1997 14 12 19 22 15

1998 19 18 33 24 20

1999 26 25 31 30 27

2000 18 24 32 20 30

2001 8 16 24 26 39

2002 48 28 61 68 34

2003 42 23 61 49 31

2004 58 13 61 60 19

2005 19 5 21 19 15

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ExitExitTable 6. Number of firms exiting the medical malpractice insurance line

of businessby type of contract, 1990-2004

Writing both types of contracts Writing only one type

yearStopped

allStopped CMR

onlyStopped OCC

onlyStopped

CMRStopped OCC

1992 13 9 5 3 9

1993 16 3 0 3 13

1994 16 1 1 4 13

1995 24 1 7 13 11

1996 25 1 17 2 23

1997 21 8 8 5 8

1998 44 10 13 9 25

1999 69 32 33 32 9

2000 18 0 2 11 7

2001 41 23 27 12 8

2002 20 5 6 9 6

2003 62 21 30 8 35

2004 26 17 17 5 4

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Economies of scopeEconomies of scope

Table 8. Average share of total P/L business in Medical Malpractice(selected years)

1992 1998 2001 2002 2005

Writes OCC only 0.091 0.090 0.077 0.151 0.173

Writes CMR only 0.503 0.310 0.330 0.439 0.568

Writes both 0.347 0.383 0.328 0.355 0.542

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Performance: Loss ratioPerformance: Loss ratioTable 12. Median loss ratio (losses incurred divided by premiums

earned) in medical malpractice insurance by type of contact, 1990-2005

yearCMR loss

ratioOCC loss

ratioMM loss ratio CMR versus OCC

1990 0.718 0.828 0.719 Yes

1991 0.914 0.768 0.778 Yes

1992 0.877 1.000 0.880 Yes

1993 0.795 0.880 0.840 No

1994 0.708 0.749 0.666 No

1995 0.778 0.706 0.717 No

1996 0.873 0.707 0.798 Yes

1997 0.770 0.732 0.731 No

1998 0.775 0.700 0.737 Yes

1999 0.890 0.795 0.857 Yes

2000 0.882 0.804 0.848 Yes

2001 0.874 0.808 0.854 Yes

2002 0.723 0.678 0.682 Yes

2003 0.754 0.632 0.725 Yes

2004 0.695 0.671 0.684 Yes

2005 0.692 0.553 0.684 Yes

1995-2005 0.791 0.708 0.756 Yes

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Performance: Combined ratioPerformance: Combined ratio

Figure 1: Combined Ratios, 1992-2005

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Year

Co

mb

ined

Rat

io

Firms writing only CMR Firms writing only OCC

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New entrant loss ratio?New entrant loss ratio?

Table 14. Median reported loss ratios for new entrants from entrance through eight years in the market, by contract type

Years writing contract type:

CMR only OCC onlyWriting

bothCMR versus OCC

1 (initial year) 0.566 0.710 0.660 No

2 0.681 0.690 0.684 No

3 0.727 0.750 0.726 No

4 0.752 0.760 0.783 No

5 0.730 0.703 0.750 Yes

6 0.815 0.695 0.763 Yes

7 0.817 0.681 0.774 Yes

8 (fully developed)

0.815 0.730 0.768 No

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Loss developmentLoss development

Figure 2: Loss Development

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year

Med

ian

Lo

ss R

atio

OCC 1990 CMR 1990 OCC 1994 CMR 1994 OCC 1998 CMR 1998

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ConclusionConclusion

1.1. There is little evidence of the extent to which claims-made There is little evidence of the extent to which claims-made and occurrence policies are distributed over time, across and occurrence policies are distributed over time, across states, or across firms. One benefit of our analysis is to states, or across firms. One benefit of our analysis is to provide an up-to-date assessment of the use of these provide an up-to-date assessment of the use of these policies. policies.

2.2. Although claims-made policies may be less risky than Although claims-made policies may be less risky than occurrence coverage for insurers, it is not clear that this occurrence coverage for insurers, it is not clear that this translates into a higher risk-adjusted profitability. translates into a higher risk-adjusted profitability.

3.3. We hypothesize that firm and market characteristics jointly We hypothesize that firm and market characteristics jointly explain the use of claims-made versus occurrence policies. explain the use of claims-made versus occurrence policies. While claims-made policies provide an opportunity for While claims-made policies provide an opportunity for insurers to control long term exposures, we suspect that insurers to control long term exposures, we suspect that certain types of medical providers demand occurrence certain types of medical providers demand occurrence coverage due to the nature of the risks they face. coverage due to the nature of the risks they face.

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ConclusionConclusion

4.4. We note a significant movement toward the claims-made We note a significant movement toward the claims-made and reported insurance contracts as well as an increase in and reported insurance contracts as well as an increase in the participation of risk retention groups, a new the participation of risk retention groups, a new organizational form of insurance regulated under a federal organizational form of insurance regulated under a federal charter. charter.

5.5. Finally, our results highlight differences in the loss Finally, our results highlight differences in the loss development, but no robust differences in overall financial development, but no robust differences in overall financial performance of insurers who resort to a particular strategy performance of insurers who resort to a particular strategy for providing medical malpractice coverage. for providing medical malpractice coverage.

Our research establishes the contribution of an endogenous, Our research establishes the contribution of an endogenous, strategic decision – the decision to offer CMR or OCC policies strategic decision – the decision to offer CMR or OCC policies – to the performance of the medical malpractice industry. – to the performance of the medical malpractice industry. The potential influence of this decision on malpractice crises The potential influence of this decision on malpractice crises will be the subject of future work.will be the subject of future work.