Medical Professional Liability for Physicians–

Current Actuarial Challenges

Midwestern Actuarial ForumSeptember 24, 2003

Kevin Dyke, FCAS, MAAAAmerican Physicians Assurance

Corporation

Topics to be Covered

Company BackgroundCoverage overviewTort reformCapacity ShrinkingRetentionFrequency/severity trendsInvestment incomeOccurrence coverageFree tail (DD&R) pricing and reserving

American Physicians At a Glance

Founded in 1975 as Michigan Physicians19th largest medical professional liability insurance provider in U.S.*Headquartered in East Lansing, MIFocused on solo practitioners and small physician groupsA- rated by AM Best and S&PCompleted IPO in December 2000American Physicians Assurance Corporation is a subsidiary of APCapital (NASDAQ: ACAP)

*Source: Thomson Financial/OneSource

Coverage Overview

Coverage variationsOccurrenceClaims madeTailHybrid products (e.g. Prepaid tail)

Physicians rated by class, territory, specialty, number/types of proceduresDeath Disability and Retirement

Free coverage in event of aboveVesting periods for retirement

Tort ReformPending or enacted legislation at both the federal and state levels.Benchmark is California’s MICRA reforms

Key is $250,000 cap on non-economic damagesAverage premiums are lower in California than in other states

Common provisionsLimiting non-economic damagesStatutes of limitations/reposeCaps on attorney fees

PitfallsMany attempts at previous tort reform have been overturned by the courts as unconstitutional.Need to monitor conservative/liberal tendencies of courts.

Tort Reform (cont)

Quantifying tort reformAsk the experts (claims)Select lower trend factorsRate selection < Rate indicationAdjust step factors - earlier steps will be affected more than othersWait for results to emerge

Courts have overturned tort reform in the pastOhio is on it s 3rd attempt at tort reform.

Capacity ShrinkingCarriers exiting markets (some by choice)

St. Paul exited line in 2001.American Physicians exited Florida in 2002MIIX, PHICO, PIE, Legion, Frontier, Reliance

Some new capital entering marketRRGs being formed by physician groups and hospitalsInsurance companies being formed in KY, FL, NV

Actuarial challengesWho picks up the pieces?

Existing carriers already facing capacity constraints due to rate increases

Prior acts coverage on insolvent/exiting markets

Rate Changes Impacting Retention

Carriers out in front of rate changes may suffer from retention woes

Most research and modeling for personal lines companies

Actuarial needs to monitor retention to ensure mix of business not materially changingMay also want to develop diagnostic tests on new and renewal business (e.g. frequency)

Physicians Loss Trends

Conning and Co. trendsFrequency flat or decliningSeverity increasing 50% from 1997-2001

American Physicians average trends vary by state and policy limit

Frequency trend is flatMichigan requires only 200K/600K limits. Severity trends are modest (3-4%)Patient compensation funds limit severity trend to direct writer (e.g. IN, NM)States with $1M/$3M limits have trends in the 6-8% range

Need to monitor on both a traditional coverage year basis and on a calendar (settlement) year basis

Investment IncomeTort reform opponents say stock market losses have led to insurer lossesQuite the reverse – insurers invested in bonds at higher interest rates and have achieved greater returns than stock marketPricing considerations

Monitor investment yields net of capital gainsRising cash positionsNeed about 4% additional rate for every 100 basis points reduction in interest rate.

Peer Investment Returns

5.00%5.20%5.40%5.60%5.80%6.00%6.20%6.40%6.60%6.80%7.00%

2001 2002

Investment Yield

Investment Yieldexcl RealizedCap GainsBond Yield

Bond Yield exclRealized CapGains

Only fixed income investments are considered.

Source: Thomson Financial OneSource, Internal analysis

Cash Position Growing…

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

4Q00 1Q012Q013Q014Q011Q022Q023Q024Q02

Cash and Short Term Assets as a % of Fixed Income Investments - Peer Group

Source: Thomson Financial OneSource, Internal analysis

Occurrence coverageDuring the soft market, carriers were offering both occurrence and claims made productsIndustry wide, occurrence represents 25-30% of total med mal premium.Often pricing on occurrence products were less than 5% above the mature claims made rateNow, carriers are scaling back their occurrence offerings.

Why not occurrence?

Both frequency and severity unknown for yearsYears pass before a difficult risk and can be identifiedLonger investment horizon -> more investment income but greater interest rate risk

Occurrence Challenges (cont)

Difficulty in predicting ultimate losses more uncertainty in the company loss reserves

Development methods highly leveraged in loss development factor

Claims made 12 months – ultimate: less than 2.0Occurrence 12 months – ultimate: greater than 7.0

Frequency/severity approaches highly dependent on ultimate severity

Carriers have traditionally understated severity

Hypothesis: Less incentive for doctor to report claims under occurrence than under claims made

Do doctors report more slowly on occurrence covers?

Report and Settlement Lag AnalysisIncidents from 1987 - 2000

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Years from incident to initial report

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Occurrence

Source: American Physicians internal data

Contrast with claims made…Report and Settlement Lag Analysis

Incidents from 1987 - 2000

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Years from incident to initial report

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ent Occurrence

Claims Made

Source: American Physicians internal data

Lag Observations

Medical malpractice claims have a long tail. Reporting can occur 15-20 years following the incident (e.g. birth related).Average settlement lags longer than report lagsPhysicians under occurrence policies report slightly later than those under claims made policies

But…the gap is narrowing in recent years.

DD&R CoverageProvides “free” coverage for claims reported after a physician dies, becomes disabled, or retires.Free tail at retirement typically requires a vesting period (e.g. 5 years).Cost of coverage typically included as an expense in calculating the target loss ratio (commonly 5%).Cost vary by entry age but fairness considerations dictate a flat charge to all physicians

DD&R ReserveNAIC requires companies to maintain a reserve for the promised future benefits.Actuarial calculation of DD&R reserve

( PV of future benefits –PV of future premiums )

Assumptions required forRetention Premium trendLoss cost trendMortality, morbidity, retirement

Similar to a pension funding model

DD&R Reserve (cont)

Actuarial considerationsDeclining retention less insureds are vested for retirement benefitsAge of doctors displaced by existing markets older doctors require higher accrualsEarly retirementBe careful using % of unearned premium to accrue DD&R reserve Rate increases will increase the adequacy of the UPR