Asymmetrical Information

Damn but you're naieve. The problem is the cost of insurance, not the cost of malpractice awards. Are you under the impression that the latter is the cause of the former? Think again, the size and frequency of awards has gone up FAR more slowly than the cost of insurance in the last decade.

It's the insurance companies that are the real problem here, not the tort system.

Oops, left out the cite:

http://www.wsba.org/barnews/2002/02/letters.htm

Frequency alone is a poor measure of the cost to insurers. Frequency (number of cases) has indeed hardly budged, but severity (size of awards per case) has skyrocketed. So, yes, awards are a major factor in the cost of insurance.

I know many of the state medmal (PIAA) companies, and many of them have been mismanaged. Nonetheless, size of awards has driven costs of insurance up.

The other problem is the way rates DEcreased in prior years due to competition from commercial companies. Even with rates up 50% in the last year, that does not necessarily put them above rates in the early 1990s.

It takes substantial naivete to blame insurance companies for the costs of our tort-happy society.

Nonsense. The size of awards has NOT skyrocketed, as my cite demonstrated. If you have some facts to back up your assertion, please present them.

http://www.insurance.state.mo.us/reports/medmal/sect1/I_pg8.htm

General Cologne RE thinks so too -

http://www.genesismanagers.com/GCR.nsf/Doc/MedMal

Off to the office (where I have all the annual NAII reports on disk if this goes on...)

Increases in insurance premiums are probably related more to insurance company losses on the stock market than to increases in malpractice claims.

http://www.consumerwatchdog.org/insurance/rp/rp002793.pdf

With the excitement surrounding the stock market bubble of the 1990s, insurance
companies put policyholder premiums and money reserved to pay losses at greater risk
by increasingly investing in private corporations. Typically, insurance industry
executives assert that company portfolios are largely tied up in municipal and other
government bonds, with only limited exposure to corporate America. However, by
2001, the particularly disgraced energy, high-tech and telecom sectors figured heavily in
insurance companies' portfolios."

"The 15% to 30% rate hikes common to many insurance consumers these days are not
attributable to the reported rise in claim costs, as the insurers argue, but are due to the
significant investment losses sustained by insurers in recent months."

Well - you can check the portfolio claim yourself with this handy tool -

http://snapshot.bbh.com/aastudy/

As you will see, medmal companies have equity exposure in the range of 10% of their portfolio. Consumer Watchdog makes several leaps to justify their case (not the least of which is they fail to note that these companies and the industry in general only made money from their investment portfolios, never on underwriting, in the first place), but in any case they are talking about the industry in general, not medmal. None of the companies they cite - USAA, Liberty, Allstate, State Farm, Farmers's, Nationwide - are active in Medmal. These are large multi-state property companies, not state medmal insurers.

Be sure to limit your universe to Medmal, as this is a specialized sector. Most of the companies are mutuals/trusts/reciprocals or de-mutualized formerly doctor-owned organizations (such as SCPIE, Doctor's and Norcal in California, MAG in Goergia, FPIC in Florida, COPIC in Colorado, Utah Medical, TMLT in Texas). Boards are still made up of practicing physicians. One of the reasons they have been able to raise rates in the last year is St. Paul's (one of the only big commercial companies active in primary medmal over the years) exit from the business in several states. Why did St. Paul exit? Rising severity and unpredictability.

Incidentally, one of the mistakes reporters and "watchdogs" make while looking at insurance industry aggregate data is not to exclude Berkshire Hathaway. Berkshire's stock portfolio is so huge that it skews the numbers for the industry as a whole. In general, it is mostly the largest companies that have larger equity exposure.

Why have Munis decreased in medmal portfolios? Because they aren't making money. If you don't have profits, munis make no sense. Most of our clients have gotten out of the sector entirely.

As a matter of pure mathemetical fact, either severity is up or Medmal companies are over-reserving, given the numbers they have posted. If you look at history, medmal companies have never over-reserved. In fact, development has been negative at most companies. Furthermore, large companies can ill afford to take extra reserves in the face of downgrades for excessive leverage - SCPIE and FPIC, for instance, have both been downgraded for this reason.

Conning & Co. publishes the most exhaustive study in this sector. It costs quite a bit of money (or business with them), unfortunately. Here is the press release summarizing it -

http://www.conning.com/irpstore/PressReleases/010517.asp

You can make a case that the commercial property insurers are being opportunistic (although nobody noticed when rates went down consistently from 1994 to 2000), but Medmal is in a state of pure crisis.

Bones --

First of all, that report is conflating equity and bond holdings in order to make it all sound more scary. These companies didn't take a bath on the stock market; they held some corporate bonds that went south. If they were only invested in municipal bonds, your premiums would be much, much higher, since the rate of return on tax-free munis is low, requiring a larger asset base.

But even if these companies had been widely exposed to the stock market, which I am under the impression they are forbidden to do by law in most states, unless all the insurance companies in the United States flagrantly violated everything we know about portfolio theory (unlikely), or only started buying in in 200 (also unlikely), all this would tell us is that rates were too low in the nineties, and have to do a little mean reversion, since the 15% annual appreciation would have artificially lowered premiums as much as the depressed stock prices have raised them.

There's also no indication of the overall size of the portfolios from which the losses are being cited, but I know some people who do portfolio work for insurance companies, and from talking to them my bet is that they are a tiny percentage of overall asset holdings.

Overall this it's a shoddy report: numbers given without reference to the overall size of the pool fro which they're drawn; deliberately grouping categories together, such as stocks and bonds, in order to claim that one of the categories is larger than it is; failing to provide important background information (such as the decline in government debt issuance that precipitated the general market movement into corporate bonds), etc. A textbook example of how to lie with statistics. Once you see a couple of those tricks together, you know that the author is grinding an axe, and you can't take anything they say seriously. Since I decline to fact check the entire thing, I'm prone to ignore it.

Mindles D. and Jane G. - Fantastic job!

When I read this post, and then the first comment to it, I was already settling in to write a long explanation of how insurance companies operate (I work for one) and how the investment portfolio functions within the company (I am the portfolio manager).

Fortunately, I didn't have to. You guys are ALL OVER IT! Very impressive.

By the way, Bones -

http://www.actuary.org/newsroom/pdf/medmal_17july02.pdf

According to a July Insurance Information Institute report, the size of the median jury award rose to $1 million in 2000 – a jump from roughly $475,000 in 1996.

http://www.wsma.org/Tort_reform.pdf

The average loss and loss adjustment expense paid on claims underwritten by the medical malpractice industry experienced a compound annual growth of 6.9% during the decade of the 1990s (compared to the average annual rise in general inflation which was 2.6%).21 Between 2001 and the first half of 2002, the average paid claim at Physicians Insurance rose 48.5%.22

http://www.ama-assn.org/ama/upload/mm/363/trend418.pdf

by $137,092, accounting for 76% of the costs associated with paid claims. While general inflation averaged 3.2% per year over the period, average annual growth in indemnity payments per paid claim was more than double, at 6.9%. The annual growth rates for expenses per paid claim and per closed claim were over 8%. These data provide evidence support of claims that premium growth is driven primarily by increases in average indemnity payments and secondarily by increases in average litigation expenses.

....median awards for malpractice claims grew at 7 times the rate of general inflation, while negotiated settlement payouts grew at nearly triple the rate of inflation. While median jury awards and settlements for alleged malpractice grew at 18.4% and 7.4% per year, respectively, from 1994 to 2000, the rate of general inflation was only 2.5% per year over the same period.

And look at the charts here - http://www.plusweb.org/Events/Mpls/materials/2001/Source/Article%201.1.pdf

Now that's Asymmetrical Information! Great work, folks!

A more fundamental question: Why should doctors need malpractice insurance? If we had an effective system to weed out bad doctors (they are licensed by the state(s) -- why not immunize them from suits? We do it now for doctors acting as good samaritans. Surely this would drastically bring down medical costs and likely improve medical care.

Robert Mendelsohn, in his book "Confessions of a Medical Heretic" documents several instances where strikes by doctors led to massive decreases in the death rate. Maybe Pennsylvania and West Virginia should try to drag this dispute out as long as possible. For the children and the sick!

> The problem is the cost of insurance, not the cost of malpractice awards.

Ah yes, the nasty insurance companies.

Insurance is an "easy" business. All you need is a modest amount of capital, the ability to manage it, and the ability to appropriately charge for risk.

We have no shortage of good folk who know how to do these things better than the existing evil companies. Moreover, stealing and gouging merely drive up premiums, so playing fair&good is a competitive advantage.

Yet, these good folk never bother to use what they know to drive the thugs out of biz. They just talk when they could do so much good (and, if they choose, make money that will let them do even more good).

Why is that?

What is the point of comparing medical malpractice settlements to general inflation? The CPI is a very poor proxy for the change in the cost of living for people who have been injured by medical malpractice; for a start, they consume more medical services than the mean, and medical costs have risen faster than CPI (I am aware of a certain circularity here).

It would be more obvious to compare the rise in settlement costs with the rise in premia: does anyone have these figures?

From what I can glean from the references above, the premium for a general practitioner rose by 5.4% over the period 1997-2002 (calculated from the number "29% over the last five years" from the link http://www.wsma.org/Tort_reform.pdf above). This would suggest that the insurance companies have not been profiteering, given that the lowest estimate of claims cost growth is 6.9% "over the 1990s". However:

a) we would really need to get numbers for the same time period; the fact that one company reported a 48.5% increase 1H02 on 2001 suggests that this is very lumpy data which will be sensitive to the start point

b) it is probable that the cost growth figures will be driven by settlements relating to obstetrics and surgery, and I couldn't find anything that would let me calculate the premium growth for these specialists.

So I think that the case can't be decided one way or another, and the numbers 6.9% and 5.4% are close enough that Bones' claim might be in with a chance. In general, the insurance industry is competitive enough that any wedge between claims and premiums is likely to be the result of incompetence rather than profiteering, but we can't say for sure unless someone can find the comparable data.

I note in passing that controls on the ability of solicitors to work on a contingency fee basis is a regulation which commands a lot of support from unlikely quarters. And, perhaps more mischieviously, that however one chooses to fund healthcare, it is difficult to justify the civil lawsuit as the most cost-effective means of adminisration ...

Pursuant to Andy's point, is this bleeding wreck the portrait of a greedy industry enjoying the spoils of overcharging? Simple facts, folks, medmal lost the insurance industry almost $4 billion in 2001.

btw D-Squared:

What your analysis is missing is the inadequacy of rates a few years ago, as is made plain in the pop-up chart posted above.

As I noted before, rates could go up another 50% and only reach 1996 or 1997 levels as a percent of liability assumed. The late 1990s was a very soft market in medmal despite rising losses. There was too much capital in the industry.

>>What your analysis is missing is

A vast amount of things!

Seriously, is there any industry body which produces the raw data for premium rates, costs and claims, or can we only get them in processed form from a gang-load of special interest sites? If there's a good source of aggregate data, I can calculate a combined ratio myself, but for the time being, I am happy in my ignorance.

YES! - my graph (the "bleeding wreck" above) comes directly from the NAIC (National Association of Insurance Commissioners) data (via OneSource). Every regulated company in the U.S. has to file an extensive amount of financial data annually in a big book (in property& casualty it is known as the "yellow peril" from its cover color). This is why the PIAA data is accurate - it comes straight from the NAIC filings. When reading opinion pieces, be sure to look for that as a source. In addition, the Casualty Actuarial Society (the source for some of the data in other links) is also highly credible in my opinion. Finally, A.M. Best generates solid data from their ratings reviews.

The problem is you have to be a subscriber (I am, hence the chart). OneSource CDs cost about $20,000 a year. A.M. Best studies are also pricey.

Money should not be used as a substitute for jail time. That sterile word malpractice hides enormous pain, loss and grief.

I see. Just for completeness, could you add a third line to that chart showing the underwriting profit/loss?

It takes substantial naivete to blame insurance companies for the costs of our tort-happy society.

We could argue numbers, blah blah blah profit blah blah blah sue-happy blah blah blah why is there a knife still in my intestines, etc, but here's a better question: why doesn't the market clear? Expensive malpractice insurance wouldn't be a strike-worthy problem if doctors could pass the costs on to their customers, would it? In a ideal market, they would; why can't they in the market for medical services we actually have?

One possible suspect is managed care exerting power due to their control of large chunks of the market, decreeing rates for services; I'm sure everyone else can suggest others.

Simple facts, folks, medmal lost the insurance industry almost $4 billion in 2001.

But Mindles, it's much more important to note that State Farm lost $74 million on Enron and Worldcom. That's $74 million they wouldn't have lost if the insurance commissioners and state legislatures had been consulted before the investments were made... at least, that's what bones' Consumer Watchdog cite seems to be saying.

There's a lot that I would change if I ran the insurance industry. But it is certainly competitive enough that, if companies were raking in the bucks on medical malpractice, there'd be more firms looking to get into that line of business.

> But Mindles, it's much more important to note that State Farm lost $74 million on Enron and Worldcom. That's $74 million they wouldn't have lost if the insurance commissioners and state legislatures had been consulted before the investments were made...

Huh? Since when do insurance commissioners and/or state legislatures have special expertise in distinguishing good investments from bad? And, if they're so good, how come various state run retirement funds made the same mistake?

It's easy enough to avoid losses on investments but doing so without also avoiding gains is tough.

Not just HMO's; Medicare and Medicaid play a part in this as well.

But Jason, the market is clearing. That is, the cost of providing services is going up; therefore the quantity supplied is going down. If the price increases could be passed to the consumer, the quantity demanded would go down -- but we have an awful lot of legal mechanisms and programs to keep that from happening. The buyer power of the corporationst that are the major consumer of insurance is exerted on the HMO's, which turn around and exercise it on the physicians. But it's not like quantity would remain unaffected if customers had to pay an extra 10K for their angioplasty out of their own pocket. Though it is perhaps more affected by the current structure, because corporations and HMO's are very interested in whether consumers get good care; they only want healthy consumers to think that they will get good care, which is why employer provision of health insurance is so retarded.

Another thing to consider is that jury awards are exogenous to the market system, so there's no feedback system to keep them well correlated with the ability of the market to bear it. The states and counties with the biggest and most unpredictable verdicts are also the poorest ones. Since the market has limited ability to raise prices either directly, through health insurance, or through state subsidy, the market is clearing the physicians the hell out.

Andy, my comment was sarcastic. I don't really think that insurance commissioners or state legislatures have special expertise in investing; in fact, quite the opposite.

But bones' Consumer Watchdog people apparently do think investment wisdom resides in the ICs.

Accourding to the studies I've read, most malpractice is caused by a small percentage of
doctors. Shouldn't it be like car insurance, where those at higher risk of causing problems pay higher premiums?

A friend of mine’s dad is a retired OB/GYN. He said that he pities any young OB/GYN trying to make a go of it today. In the last few years of his practice he saw a huge increase in malpractice claims and large awards that really shouldn’t have been awarded.

Sometimes a baby is born with problems through no fault of the doctor’s. This has been going on since the dawn of mankind and probably always will...childbirth is still an inherently dangerous and serious occurrence.

These days when a child is born with a problem, a weasel lawyer beams into the new mother’s hospital room and makes all kinds of promises of money if he can take the case.

The doctor can either settle out of court or take his chances.

In court, the lawyer trots out the poor sick child for sympathy points and then goes to work by painting the doctor as some heartless rich playboy who spends his time sailing his forty foot yacht from Hawaii to Bermuda or racing his Mercedes to Monte Carlo when he’s not butchering poor helpless women like his client who have to work 26 hours a day at Wal-Mart to pay for little Billy’s special needs.

The Oprah-ized jurors tearfully award a multi-million dollar judgement against Snidely Whiplash M.D. for lifetime care of little Billy...the lawyer takes a third to a half (sometimes more) and the doctor is stuck with even higher malpractice fees.

It’s getting to the place where less and less doctors want to go anywhere near a maternity ward. What will happen when there simply aren’t any more doctors willing to do it?

> Accourding to the studies I've read, most malpractice is caused by a small percentage of
doctors. Shouldn't it be like car insurance, where those at higher risk of causing problems pay higher premiums?

And we know that it's not that way because insurance companies are stupid....

As I asked before, if you know how to do it better, why aren't you doing it?

>>Sometimes a baby is born with problems through no fault of the doctor’s. This has been going on since the dawn of mankind and probably always will...childbirth is still an inherently dangerous and serious occurrence.

Hmmm, "inherently dangerous and serious", you say. Sounds like the sort of thing that should be covered by insurance.

Mumblix and Dsquared,

Childbirth is not a disease. It is hardly ever dangerous or "serious". Actually it should be joyous and wonderful. Women giving birth aren't under attack. They're performing the most natural of functions, continuing life. The Victorian view of childbirth - "going down to the door of death" - stems from sexual repression and guilt. Childbirth only gets dangerous and grim when doctors get involved. And only because doctors are involved is insurance necessary. No doctors, no malpractice, no insurance.

I have not forgotten this thread. A close friend of mine (and actuary and insurance expert) is working on a more complete discussion of the topic. I look forward to linking it soon.

D-Squared: that (the line ending at -3.9 billion) is the underwiting profit, no investment earnings included. I don't believe the aggregate numbers break out a combined ratio on individual lines, but I'll check.

But Jason, the market is clearing.

See, this doesn't make sense to me: doctors describe the situation as a nightmare; but if they were just passing along costs, why the hell would they describe it that way?

I can't even figure out how an increase in production costs in a (largely) inelastic market screws the producers. Either the market isn't inelastic (which flies in the face of evidence; purchases of medical services sure aren't dropping), or something else is going on here.

I'm not sure what you're thinking of when you say the market is not clearing. Rising costs have moved the supply curve, meaning that a lower quantity is supplied at the given price. That's still a clearing mechanism, just as would be the price moving while the quantity stayed constant. In this case, buyer powe and regulatory intervention have made the price inelastic so that the quantity is changing, but the market is still clearing -- there is no excess supply left on the market.

Here's a study showing that jury awards in malpractice cases are increasing at the same rate as other medical costs, but malpractice insurance rates correlate with the bond market.

http://www.insurance-reform.org/StableLosses.pdf

So I guess I should not be expecting you to back up your claim that the reason for increases in insurance costs is runaway litigation?

I looked at your cites, so far there's nothing there that proves your point. (Not that this is surprising) Only blind faith in the truthfulness of insurance company's PR departments would lead anyone to believe tort reform is necessary to reign in medical costs.

Bones, all of your cites come from advocacy groups which have, as I and others have shown, a tenuous grasp on financial markets and a tendency to lie. Mindles, on the other hand, is looking directly at the data from the insurance regulatory commissions, for which he has provided citations (although they are hard to access, some people on this site clearly could call him on it if he were misleading us.) I find it particularly interesting that you are now claiming that insurance premiums are correlated with the bond market, when in your last post, you were telling us that the reason the insurance companies are in trouble is that they were speculating on the stock market. Do you believe all these things simultaneously?

Just on the first page of the report, the organization attributes a weakened economy to the mid-80's (center of a boom), and falling interest rates to the mid-70's (oil shock). It also admits exactly what I said above: to the extent that the industry crisis is powered by investment losses, it will have been powered by investment gains during the soft market, leading to artificially low premiums. Rises in premiums above the cost of inflation cannot be attributed to cyclic investment functions; look at cyclic industries like commodity producers, which experience declining average prices over the long term. No one is disputing that premiums have something to do with asset portfolios; only that over the long run, this effect will wash out and show mean reversion.

Yet if you look at the increases in premiums, we are clearly off the inflationary line. Nor are the insurance companies taking those extra monies as profit. Thus, the driver of higher average prices must be something related to cost -- either increased overhead, or increased malpractice payouts.

The other problem with this is that medical costs are largely insurance driven, often by the same companies that provide malpractice. If malpractice insurance should be driven by medical costs -- and medical costs in part by malpractice -- and both by the hard insurance market -- we should be seeing a vicious feedback cycle that is spiraling out of control. That we are not suggests that payouts are not well correlated to medical costs.

And in fact, there's no reason they should be. Medical costs are but one component of malpractice awards. Other components include economic damage (such as lost ability to work), pain and suffering, property changes (if the sufferer requires a wheelchair, they will also require a wheelchair ramp and other home alterations), home health care workers (who are not themselves a part of the problem of medical cost inflation), occupational training (a steelworker with no legs needs another job), and of course, punitive damages. None of those things are in any way correlated with medical costs, and if they are present, usually form the bulk of awards. (I used to work for a personal injury attorney).

The site you gave us, like all the other sites you've posted from, is full of half-truths, lies, and spurious correlations such as the one between medical costs and malpractice payouts. Its major implication seems to be that the folks at AIR could run a pretty good insurance company if they weren't so busy screaming about the government, and its tone of outrage -- how dare the insurance companies make mistakes! -- is risible. I've no doubt I could find exactly the same sort of hysterical claims from the tort reform side and post them, but why? Those who want to believe, will. Those who want to take the insurance regulator's data that Mindles has provided instead of the word of an advocacy group, will.

But I am going to have fun on Monday pulling their green forms and finding out exactly how much of their money derives from the trial lawyers.

Jane, here's my understanding:

1) The relevant market is surgical operations.
2) Production costs are going way up.
3) The number of operations performed is unchanged.
4) The number of producers is dropping.

The combination of 2, 3, and 4 is what's confusing me. The quantity of operations performed isn't changing, and the cost of operations is going up the same as other medical procedures (isn't it?), so where the heck is the supply shift showing up?

The only thing I can think of is that there's really not a shift in "operations supplied," just a shakeout of all but the most "efficient" surgeons in terms of malpractice, so the few left do all the work. Or something. Not that this makes too much sense, as there's a definite upper bound on the number of operations a surgeon can perform.

Actually, in the effected states, I think you'll find the supply of care has constricted for the highest risk specialties: OB/GYN, inpatient surgery, and trauma care. In many cases it has only shifted across the border, but doctors are starting to retire as well. The cause isn't only malpractice, though that's the largest issue in those specialties, but also the rising effort to comply with reimbursement procedures and declining compensation. The entire system is under a tremendous strain.

I read a couple of Doctor blogs. There are a number of wasteful expenses (paperwork has gone from x dollars per patient to 2.5x in four years, government payments have dropped at least 4% per patient in each of the last two years, etc etc) but malpractice is the 500-pound gorilla they see. When an ob-gyn in West Virginia is told that her insurance is being raised from $94k to $214k in one year, I can't really blame her for thinking very seriously about moving the twenty miles to Virginia where the same coverage - from the same company - is $80k.

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