Although malpractice caps have lower premiums, they may counter long-term goals

Malpractice insurance premiums in states that cap awards are 17.1% lower than in states that don’t, according to a study by Kenneth Thorpe, health policy professor at Emory University in Atlanta.

However, he added, there is concern about whether such a short-term solution to the malpractice crisis promotes the long-term goals of the U.S. liability system.

In an on-line Health Affairs report, Mr. Thorpe said the malpractice crisis relates to both rising premiums and a reduction in the firms offering coverage to hospitals and doctors. Depending on the specialty and state, the medium increase in malpractice insurance premiums ranges from 15% to 30%.

In some states, such as Pennsylvania, 2003 rate increases ranged from 26% to 73%. In addition, the company that was the largest malpractice insurer during most of the 1990s, the St. Paul Companies, stopped writing policies during 2002. Other large regional carriers also have left the market.

"The crux of the debate focuses on the underlying causes of the most recent rise in premiums," Mr. Thorpe wrote. "Providers point to a rise in jury awards and rising costs of defending malpractice claims [rising severity]. They also highlight the role that contingency fees paid to attorneys play in creating incentives for frivolous suits. Some consumer groups, however, believe that rising rates can be traced to lower returns on investments received by the medical malpractice carriers and a downturn in the economy."

Mr. Thorpe found the most important drivers of recent rate increases are: 1) severity (awards, settlements, and administrative and defense costs); 2) frequency (claims per insured physician); and 3) changes in investment income. In combination, he said, these factors largely determine expenses and, when compared with premiums earned and investment income, are an indication of overall profitability.

When he looked at trends over time in the broad combined ratio, which measures claims payments, reserves for potential future awards settlements, and defense and administrative costs as a percentage of earned premiums, Mr. Thorpe said the ratio has risen since 1999; and in 2002, there was $1.29 in total expenses, awards, and settlements for every $1 collected in premiums. Historically, malpractice carriers offset such underwriting losses with investment income, but starting in 1995, investments as a share of premiums decreased sharply, falling 30% by 2002.

According to Mr. Thorpe’s analysis, several factors likely account for medical malpractice carriers’ deteriorating financial condition, and the issue becomes whether the most recent trends he cited reflect the traditional underwriting cycle that eventually will regress to mean profits in the industry or a permanent upward increase in average losses and premiums.

While to physicians facing significant increases in their malpractice premiums the current situation is a crisis, Mr. Thorpe pointed out the jury is out on the broader functioning of the insurance market.

"Rising claims costs may reflect a rise in underlying negligence," he added. "If true, the system may be functioning as designed and the spike in premiums may provide stronger incentives for physicians to improve the quality of care provided. On the other hand, we may be observing a permanent rise in claims payments and costs unrelated to trends in physician negligence. At issue is the extent to which the underlying factors generating higher premiums are following a traditional cyclical insurance pattern, or whether a structural change has occurred in severity and frequency."

Mr. Thorpe’s analysis rests on a statement of the goals of the liability system as:

  • providing financial incentives to deter substandard medical care;
  • compensating those who are injured by such care.

"There is some evidence," he declared, "that the current system performs poorly on both counts. First, program administration — defense and underwriting costs — accounts for approximately 60% of total malpractice costs, and only 50% of total malpractice costs are returned to patients. These costs are high even when compared with other tort-based systems, such as automobile litigation or airplane crashes, that determine fault and compensate victims. Moreover, most patients who receive negligent care never receive any compensation. . . . Second, deterring substandard medical care is a major rationale for using a tort liability system for medical malpractice. There is a considerable theoretical literature examining the potential of a tort-based system for optimally promoting safety. Several empirical studies have also been conducted to evaluate whether the tort system deters medical errors. Overall, the literature is mixed."

In Mr. Thorpe’s analysis of the impact of damage caps, he combined the experiences in states that cap either economic or noneconomic damages or cap both into a composite award cap measure covering 24 states by 2001.

"The empirical results indicate that the caps on awards adopted by several states were associated with lower loss ratios and lower premiums," he wrote. "However, other than states with discretionary offsets [which can reduce an award based on the amount a person will receive from other sources such as health insurance], other tort reforms were not associated with lower premiums or improved profits. Loss ratios in states capping awards were 11.7% lower than in states without caps. In addition, loss ratios were 13.3% lower in states with discretionary collateral offsets. Loss ratios were 25% lower in states that adopted both reforms."

While Mr. Thorpe said his analysis showed capping payments from malpractice carriers is associated with lower premiums, there are questions about how these results should be interpreted. "At issue, is whether we should adopt short-term stopgap solutions to slow the growth in premiums or use the recent experience to more fundamentally evaluate and perhaps reform the liability system."

If the recent spike in premiums is a signal that the liability system isn’t achieving its goals of deterrence and compensation, Mr. Thorpe explained, the question is what changes can be made so goals will be better met.

He said his results indicate that capping awards may improve the profitability of malpractice carriers and reduce premiums.

"Whether this is socially desirable or improves the goals of deterrence and compensation is an open question," he cautioned.

According to Mr. Thorpe, another key question for policy-makers and reformers to consider is the extent to which the most recent premium spike is simply a reflection of the insurance cycle and changes in market structure and competition. Or the recent trends also might reflect a structural and secular rise in the severity of awards that, absent reforms, will permanently change the traditional insurance premium cycle.

While experience across states varies, according to the analysis, he said the data seem to indicate a long-term increase in awards and settlements per paid claim. If that is true, he added, doctors could be facing several more years of rising premiums.

More research needed

"Surprisingly, we know very little about trends in the rates of negligent adverse events over time," Mr. Thorpe stated. "The two most cited studies, from California in the 1970s and New York in the 1980s, suggest that these rates have been constant. More recent studies from Colorado and Utah conducted in the 1990s produced similar results. Clearly, more work in this area is required," he added.

[To read the entire report, go to: www.healthaffairs.org.]