1. 1 Claims-Made and Reported Policies and Insurer Profitability in Medical Malpractice Patricia Born California State University at Northridge M. Martin Boyer HEC Montr é al First-of-five

2. 2/17 Claims-Made and Reported Policies and Insurer Profitability in Medical Patricia Born, California State University at Northridge M. Martin Boyer, HEC Montr é al Abstract. The liability crisis of the 1970s led to the introduction of a new type of insurance policy designed, according to Doherty (1991), to reduce the un-diversifiable 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 eighties not only in medical malpractice, but also in the general liability arena. Under 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, 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 (1973) of the medical malpractice insurance industry by focusing on the 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 exposure in the medical malpractice insurance industry whereas in other lines of insurance, only one exists primarily.

3. 3/17 Bone and flesh of paper  Structure, conduct, and performance analysis paper à la Joskow.  Originality lies in the comparison, withing the medical malpractice insurance market, of two contracts that co-exist: Claims-made and reported (CMR) versus Occurrence based (OCC); –Doherty (1991) says CMR contracts exist because insurers face an important undiversifiable risk, and CMR contracts allow to pass along to the policyholder this risk; –Boyer and Gobert (2006) say it depends on the policyholder’s discount rate.  Introduction of a new organisational structure, the risk retention group or RRG.  In the end, we want you to wonder what explains the coexistance of the two contract forms in a given market.

4. 4/17 Contract penetration Premium earned by type of contact for selected lines of business, 1995-1998. In millions of current dollars. Line of businessContract1995199619971998 Medical malpracticeOB$ 1,560$ 1,501$ 1,469$ 1,532 CMR$ 3,358$ 3,455$ 3,573$ 3,686 CMR/OB2.152.32.432.4 Product liabilityOB$ 1,573$ 1,553$ 1,467 CMR$ 189$ 243$ 262$ 165 CMR/OB0.120.160.180.11 Other liabilityOB$11,278$11,012$11,720$11,183 CMR$ 5,100$ 5,833$ 5,653$ 5,985 CMR/OB0.450.530.480.54 Source. NAIC Research Quarterly, July 1999 page 20.

5. 5/17 Contract penetration Table 1. Premium earned (in millions of current dollars) in medical malpractice insurance by type of contact, 1990-2005. yearCMROCC Ratio of CMR to OCC 19902,915,1771,235,5502.36 19912,863,4821,178,3492.43 19922,943,1841,173,7192.51 19933,116,5201,181,5862.64 ………… 20003,490,4821,861,0441.88 20014,061,6361,718,9082.36 20026,726,9722,430,3792.77 20035,806,0582,496,6782.33 20046,639,5182,145,0383.10 20056,563,6212,065,9083.18 1990-20055.56%3.49% 2001-200512.75%4.70%

6. 6/17 Contract 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% 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)

7. 7/17 Contract type and ownership form Table 3. Number of Firms by Ownership Structure, Contract Type for Selected years (1992, 1998 and 2005) StockMutualReciprocalRRGOtherTotal 1992 Any MM Policies2843321107355 OCC Policies239281656294 CMR Policies183201994235 1998 Any MM Policies3063519168384 OCC Policies232281684288 CMR Policies2312516156293 2005 Any MM Policies24529 903396 OCC Policies1512320213218 CMR Policies2172729862361

8. 8/17 Concentration Table 4. Industry Concentration (Premiums Earned Market Share) by Contract Type, Selected years: 1992, 1998 and 2005 Top insurerTop-4 insurersTop-8 insurersTop-20 insurers 1992 CMR contracts0.160.290.430.64 OCC contracts0.140.430.610.82 Overall0.120.280.390.61 1998 CMR contracts0.100.250.380.62 OCC contracts0.180.450.590.80 Overall0.080.240.380.62 2005 CMR contracts0.080.220.350.58 OCC contracts0.180.560.680.86 Overall0.070.240.380.60

9. 9/17Entry Table 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 Yearnew CMRnew OCCnew eithernew CMRnew OCC 199252123821 199348127 19942113332918 19951514252726 19961022271424 19971412192215 19981918332420 19992625313027 20001824322030 2001816242639 20024828616834 20034223614931 20045813616019 2005195211915

10. 10/17Exit Table 6. Number of firms exiting the medical malpractice insurance line of business by type of contract, 1990-2004 Writing both types of contractsWriting only one type yearStopped all Stopped CMR only Stopped OCC only Stopped CMRStopped OCC 1992139539 19931630313 19941611413 199524171311 199625117223 1997218858 1998441013925 1999693233329 20001802117 2001412327128 2002205696 2003622130835 20042617 54

11. 11/17 Economies of scope Table 8. Average share of total P/L business in Medical Malpractice (selected years) 19921998200120022005 Writes OCC only0.0910.0900.0770.1510.173 Writes CMR only0.5030.3100.3300.4390.568 Writes both0.3470.3830.3280.3550.542

12. 12/17 Performance: Loss ratio Table 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 ratioCMR versus OCC 1990 0.7180.8280.719Yes 1991 0.9140.7680.778Yes 1992 0.8771.0000.880Yes 1993 0.7950.8800.840No 1994 0.7080.7490.666No 1995 0.7780.7060.717No 1996 0.8730.7070.798Yes 1997 0.7700.7320.731No 1998 0.7750.7000.737Yes 1999 0.8900.7950.857Yes 2000 0.8820.8040.848Yes 2001 0.8740.8080.854Yes 2002 0.7230.6780.682Yes 2003 0.7540.6320.725Yes 2004 0.6950.6710.684Yes 2005 0.6920.5530.684Yes 1995-20050.7910.7080.756Yes

13. 13/17 Performance: Combined ratio

14. 14/17 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 onlyOCC only Writing both CMR versus OCC 1 (initial year)0.5660.7100.660No 20.6810.6900.684No 30.7270.7500.726No 40.7520.7600.783No 50.7300.7030.750Yes 60.8150.6950.763Yes 70.8170.6810.774Yes 8 (fully developed)0.8150.7300.768No

15. 15/17 Loss development

16. 16/17 Conclusion 1. There is little evidence of the extent to which claims-made and occurrence policies are distributed over time, across states, or across firms. One benefit of our analysis is to provide an up-to-date assessment of the use of these policies. 2. Although claims-made policies may be less risky than occurrence coverage for insurers, it is not clear that this translates into a higher risk-adjusted profitability. 3. We hypothesize that firm and market characteristics jointly explain the use of claims-made versus occurrence policies. While claims-made policies provide an opportunity for insurers to control long term exposures, we suspect that certain types of medical providers demand occurrence coverage due to the nature of the risks they face.

17. 17/17 Conclusion 4. We note a significant movement toward the claims-made and reported insurance contracts as well as an increase in the participation of risk retention groups, a new organizational form of insurance regulated under a federal charter. 5. Finally, our results highlight differences in the loss development, but no robust differences in overall financial performance of insurers who resort to a particular strategy for providing medical malpractice coverage. Our research establishes the contribution of an endogenous, strategic decision – the decision to offer CMR or OCC policies – to the performance of the medical malpractice industry. The potential influence of this decision on malpractice crises will be the subject of future work.