CAS Annual Meeting EMERGING ISSUES IN MEDICAL MALPRACTICE THE ROLE OF THE ACTUARY IN ALTERNATIVE INSURANCE MARKETS November 16, 2004 Richard B. Lord, FCAS MAAA Milliman, Inc.

Risk Retention Group Liability insurance company formed under the Risk Retention Act (RRA) Liability insurance company formed under the Risk Retention Act (RRA) Company owned by it’s members Company owned by it’s members RRA: Federal law passed in 1981 for products liability RRA: Federal law passed in 1981 for products liability Liability Risk Retention Act Amendments (LRRA) of 1986: broadened RRA for medical professional liability Liability Risk Retention Act Amendments (LRRA) of 1986: broadened RRA for medical professional liability

Risk Retention Group Risk retention group (RRG) domiciled in a state Risk retention group (RRG) domiciled in a state Governed by Federal law Governed by Federal law Able to write business in any state Able to write business in any state Primary regulatory enforcement by state of domicile Primary regulatory enforcement by state of domicile

Number of Risk Retention Groups Source: Risk Retention Reporter

Annual RRG Premium ($Millions) Source: Risk Retention Reporter

Medical Malpractice Risk Retention Groups by Type Source: Risk Retention Reporter

Medical Malpractice RRG 2004 Premium ($Millions) Source: Risk Retention Reporter

Why Form a Risk Retention Group (Advantages) Availability/Affordability Availability/Affordability Possible stability across insurance market cycles Possible stability across insurance market cycles Niche market Niche market Selective underwriting Selective underwriting Loss control/risk management Loss control/risk management

Role of the Actuary Initial rate development Initial rate development Economic feasibility study Economic feasibility study – Expected case – 90 th percentile case Statement of opinion on loss reserves Statement of opinion on loss reserves Ongoing rate evaluation Ongoing rate evaluation

Risk Retention Group Funding Initial capital contribution Initial capital contribution Rate development Rate development

Rate Development Expected Loss and LAE Pure premium Expected Loss and LAE Pure premium Contribution to policyholder surplus Contribution to policyholder surplus Management fee Management fee Other expenses: Other expenses: – Auditing – Actuarial – Federal income tax

Pure Premium Development Primary Data Sources: Primary Data Sources: – Entities being underwritten Secondary Data Sources: Secondary Data Sources: – Insurance carrier rates filed in state – Industry studies – State insurance department data collection programs – Other insureds in the state

Development of Pure Premium Primary Data Collection Primary Data Collection – Claims Listing: Occurrence Date Occurrence Date Report Date Report Date Paid Loss Paid Loss Loss Reserve Loss Reserve Defense Costs Defense Costs – Exposure Counts By Category By Category By Year By Year

Feasibility Study Pro forma Income Statement Pro forma Income Statement Pro forma Balance Sheet Pro forma Balance Sheet Leverage Ratios Leverage Ratios – Premium to Surplus – Reserves to Surplus

Pro Forma Income Statement Year 1 Year 2 Year 3 Year 4 Year 5 1. Net Premium 2. Expenses 3. PY Ultimate Loss and ALAE 4. Underwriting Profit: (1)-(2)-(3) 5. Investment Income 6. Federal Income Tax 7. Net Profit After- Tax: (4)-(5)-(6)

Pro Forma Balance Sheet Year 1 Year 2 Year 3 Year 4 Year 5 Assets 1. Cash and Investments Liabilities 2. Unpaid Loss and ALAE Capital & Surplus 3. Beginning of Year Capital 4. Capital Paid in 5. Unassigned Surplus: (1)-(2)-(3)-(4) 6. Total Capital & Surplus: (3)+(4)+(5)

Pro Forma Leverage Ratios Year 1 Year 2 Year 3 Year 4 Year 5 1. Net Premium 2. Capital 3. Premium to Capital Ratio: (1)/(2) 4. Unpaid Loss and ALAE 5. Reserve to Capital Ratio: (4)/(2)

Statement of Opinion Statutory annual financial statement loss and ALAE reserve opinion Statutory annual financial statement loss and ALAE reserve opinion Requirements vary by state Requirements vary by state

Risk Retention Group Concerns Volume of premium vs. limits of losses Volume of premium vs. limits of losses Emerging phenomenon Emerging phenomenon Insolvency rate vs. P/C insurer Insolvency rate vs. P/C insurer No guaranty fund coverage except perhaps for policyholders in state of domicile No guaranty fund coverage except perhaps for policyholders in state of domicile