Brian Alvers, ACAS, MAAA Aon Re Services Midwestern Actuarial Forum Fall 2003 September 24, 2003 Medical Malpractice: State Of The Line

 Business Climate And Liability Tort Reform Section 1  Industry AnalysisSection 2  Reinsurance And DFA ConsiderationsSection 3 Agenda

Section 1 Business Climate And Liability Tort Reform

1 Medical Malpractice Crisis  Insurers  Increasing Loss Costs  Inadequate Loss Reserves  Poor Investment Results  Hardened Reinsurance Market  Insureds  Availability Problems  Affordability Problems Aon Re Inc. Copyright 2003

2 Insurer Actions Taken  Base Rate Increases  Reduction Of Schedule Credits  Reduction Of Other Discounts (e.g., Claims-Free)  Reduction In Limits Offered  Increase In SIRs For Excess Business  Exit States/Territories With Poor Experience  Exit Line Of Business Aon Re Inc. Copyright 2003

3 Insured Actions Taken  Physician Owned/Operated Insurers  Self-Insurance, Captives  Limit Services  Retire Early  Move To Other State/Territory  Practice Defensive Medicine Aon Re Inc. Copyright 2003

Medical Malpractice Business Climate Year 2002 In Crisis Crisis Brewing No Crisis Source: AMA Member Communications - July 17, Aon Re Inc. Copyright 2003

5 Medical Malpractice Business Climate Year 2003 In Crisis Crisis Brewing No Crisis Source: AMA Member Communications - July 9, 2003 Aon Re Inc. Copyright 2003

6 States Actions Taken  Florida  SB 2-D Passed  Still Needs Governor’s Signature  Michigan  HB 4980 and SB 633 Proposed  Texas  Proposition 12 Approved Aon Re Inc. Copyright 2003

7 Florida SB 2-D Caps On Non-Economic Damages  $500K From Individual Doctors/Defendants, Not To Exceed $1M From All Doctors/Defendants Regardless Of Number Of Claimants  $750K For A Single Hospital, Not To Exceed $1.5M From All Hospitals  $150K Cap For Emergency Room Physicians Aon Re Inc. Copyright 2003

8 Florida SB 2-D Rates Reflecting Savings  Med Mal Insurance Rates Approved On Or Before 7/1/2003 Remain In Effect Until A New Rate Filing Is Made Reflecting Savings Under The New Act  New Filing No Later Than 1/1/2004  The New Rate To Apply To Policies Effective Or Renewed After Effective Date Of The Act (8/14/2003)  Requires Insurers To Provide A Refund Aon Re Inc. Copyright 2003

9 Michigan HB 4980 And SB 633  Identical Bills Proposed From House And Senate  Make It Easier To Recover Economic And Non- Economic Damages Based On “Loss Of Opportunity”  Currently, Recovery Can Not Be Had Unless The “Loss Of Opportunity” Is Greater Than 50% Aon Re Inc. Copyright 2003

10 Texas Proposition 12  Constitutional Amendment Capping Non-Economic Damages In Jury Awards To $250K In Cases Against Doctors And Health Care Providers  Approved By A 51% To 49% Margin On 9/13/2003  Only 10% Voter Turnout Aon Re Inc. Copyright 2003

11 States With “No Crisis”  California, Colorado  $250K Non-Economic Damages Cap  Louisiana  $500K Total Damages Cap  Indiana  $1.25M Total Damages Cap  Wisconsin  $410K, $500K For Minors  New Mexico  $600K Cap Excluding Punitive Damages Aon Re Inc. Copyright 2003

12 States “In Crisis”  FL, TX  Reform Passed  NY, IL, PA, NJ, GA, NC, WA, CT, KY, OR, AR, WY  No Caps  OH, WV, NV, MS  Various Caps  $250K to $500K  Missouri  $557K Cap  $250K Non-Economic Damages Cap Vetoed By Governor Aon Re Inc. Copyright 2003

13 Are Caps The Answer?  Weiss Ratings, Inc. (  No  Far More Important Factors  Median Annual Payment Up More In States With Caps (48.2% Versus 35.9% From 1991 To 2002)  The PIAA (  Says Weiss Makes Numerous Errors In Assumptions  Total Claim Payouts Increased 52.8% In Cap States Versus 100.1% In Non-Cap States Aon Re Inc. Copyright 2003

14 Are Caps The Answer?  GAO Report (GAO )  Losses Appear To Be Primary Driver Of Medical Malpractice Rate Increases  No Clear Policy Recommendations  Other Factors Cause Increases  Lack Of Comprehensive Data  Especially Economic Versus Non-Economic Aon Re Inc. Copyright 2003

15 Are Caps The Answer?  Caps May Precipitate More Doctors Being Named In Suits To Obtain Multiple Recoveries  Reinsurers Not Factoring In Reduction In Claim Cost  Just Too Early To Tell  Little Impact On Modeling For A Couple Of Years  Same True For Many Insurers Aon Re Inc. Copyright 2003

Section 2 Industry Data Analysis

16 Industry Data Analysis  Industry 2002 Schedule P (OneSource)  Parts 1-4F  Sections 1 (Claims-Made) And 2 (Occurrence)  Develop Industry Losses And DCC To Ultimate  Use Paid, Incurred Loss Development Methods  Compare Ultimate Losses To Earned Premium Aon Re Inc. Copyright 2003

17 80% 90% 100% 110% 120% 130% 140% Loss and DCC Ratio Industry Loss and DCC Ratio Aon Re Inc. Copyright 2003

18 Industry Loss and DCC Ratio  Exposure  Number Of Licensed Physicians  Pros:  Easy To Get (Medical Marketing Services, Inc.)  Reasonable Estimate Of Exposure  Cons:  What About Hospitals?  What About Tail And DDR?  What About Trend To Self-Insurance? Aon Re Inc. Copyright 2003

19 Industry Loss and DCC Ratio Loss and DCC Ratio Loss Per Physician Premium Per Physician Aon Re Inc. Copyright 2003

20 Industry Loss and DCC Ratio  1994 – 1998  Loss Per Physician Increased 36%  Premium Per Physician Decreased 4%  Exponential Trend In Losses Per Physician  Trend Rate = 6.82%  R 2 = 98.4%  Actual Trend Rate Higher, As Denominator Is Licensed Physicians, Not Insured Physicians  Generally Assume 7.5% - 10% Aon Re Inc. Copyright 2003

21 Peer Company Analysis – Top 20 Writers Capital Adequacy Aon Re Inc. Copyright 2003 Source: AM Best And The National Association Of Insurance Commissioners

22 Peer Company Analysis – Top 20 Writers Earnings Adequacy (5-Year Average) Aon Re Inc. Copyright 2003 Source: AM Best And The National Association Of Insurance Commissioners

23 Peer Company Analysis – Top 20 Writers Average Increase In Net Leverage = 28% Aon Re Inc. Copyright 2003 Source: AM Best And The National Association Of Insurance Commissioners Year-End 2001 Year-End 2002 A++A-B++ Or Lower AM Best Rating Net Leverage = (NPW + Net Liabilities) / Surplus A

24 Aon Re Inc. Copyright 2003  Remaining Medical Malpractice Writers Are Capital Constrained  Opportunity To Sell In Hard Market Hampered By Poor Capital Adequacy As Measured By A.M. Best  Poor U/W Results Reduced Reported Surplus  Net Capital Required To Support Rating Increasing Substantially  Rising Net Premiums Through Increased Market Share And Rising Rates  “Excessive Growth” Compounding Increased Required Capital  Assumed Reserve Deficiency A.M. Best Capital Adequacy Issues

Section 3 Reinsurance And DFA Considerations

25 Reinsurance Market Dynamics  Past Results Reflect Inadequate Primary Rates  Significant Increase In Severity And Frequency  Severity Increases Have Greater Effect On Excess Reinsurers  Reinsurance Market Response  Reinsurers Require Projected U/W Profit  12% - 18% ROE  Perform Extensive Actuarial Analysis  Huge Concern Over Severity Trend, Reserves  Restricted Capacity  May Increase Rate At Renewal Despite Rate Increases And Exposure Reduction By Cedant Aon Re Inc. Copyright 2003

26 Reinsurance Market Dynamics  Reinsurer Focus Points  Quality Of Business Plan/Underwriting Discipline  Purchasing Philosophy Of Buyer  Cedants Extremely Leveraged  Higher Primary Rates, Surplus Down  Pressure On Rating (AM Best, S&P)  Pressure On Capital Adequacy (BCAR, S&P CAR, RBC)  But Reinsurers Will Not Do Quota Share  Consider Non-Traditional, Structured Program, And/Or Lower Excess Of Loss Retention Aon Re Inc. Copyright 2003

27 Reinsurance Considerations In Medical Malpractice  Take Into Account Effective Rate Action  Not Just Base Rate Increases  Change In Schedule Credits/Debits  Change In Increased Limits Factors  Take Into Account Changes In Exposure  Limit And Attachment Profile  State/Territory Mix  Classification/Specialty Mix  Docs: OB/GYN, Cardiac Surgeons, Neurosurgeons  Hospitals: Teaching Versus Not, Size, Rural/Urban  Coverage  Not Just Per Claim (Per Doctor)  Watch Out For Clash, ECO/XPL Aon Re Inc. Copyright 2003

28 DFA Considerations In Medical Malpractice  Split ALAE Only From Indemnity And ALAE Claims  Could Be 80/20 Split  Lognormal Works Very Well For Severity  Both Indemnity And ALAE  Watch For Clustering  Correlation  Indemnity And Settlement Lag  Indemnity And ALAE  Don’t Forget Parameter Uncertainty  Coefficient Of Variation Worst Of All 10-Year Schedule P Lines Aon Re Inc. Copyright 2003