Asymmetrical Information

Using NAIC terminology, earned investment income is a value exclusive of realized capital losses or gains; investment gain is a value inclusive of realized capital gains.

Hmm, a little misleading. The only way I can see these numbers working is if the insurance companies have been taking capital gains on their corporate bond holdings as interest rates declined. Since these gains are a one-time thing (at least until interest rates go back up and then come down again), this level of investment income can't be sustained.

Apparently, they haven't been "realizing" the capital gains, but they are still counted as investment income on the books. (The gap between Investment Income Earned and Investment Gain would be the _realized_ capital gains, though other items may be in there, too.)

And since the bonds with the largest capital gain (or potential capital gain) are those with the highest face yield compared to current yield, the companies interest income will be lower for years to come. (Ie, a company may have revalued a, say, $10 million bond yielding 6% as a $12 million bond yielding 4%; this is perfectly legitimate if similar bonds now yield [approx] 4%. This produces a $2 million investment gain, but the firm is now only earning 4% on the investment.)

Both the unsustainability of the gains and the lower real interest yield are good reasons for the investment department to tell underwriting to raise premiums.

The only way I can see these numbers working is if the insurance companies have been taking capital gains on their corporate bond holdings as interest rates declined. Since these gains are a one-time thing (at least until interest rates go back up and then come down again), this level of investment income can't be sustained.

Apparently, they haven't been "realizing" the capital gains, but they are still counted as investment income on the books. (The gap between Investment Income Earned and Investment Gain would be the _realized_ capital gains, though other items may be in there, too.)

And since the bonds with the largest capital gain (or potential capital gain) are those with the highest face yield compared to current yield, the companies interest income will be lower for years to come. (Ie, a company may have revalued a, say, $10 million bond yielding 6% as a $12 million bond yielding 4%; this is perfectly legitimate if similar bonds now yield [approx] 4%. This produces a $2 million investment gain, but the firm is now only earning 4% on the investment.)

Both the unsustainability of the gains and the lower real interest yield are good reasons for the investment department to tell underwriting to raise premiums.

Logical aside, based on my own experience, I find it comic to consider an insurance company investment executive telling the underwriters to do anything with rates (other than a finite risk company). That's just a personal observation.

Remember the point: investments did not cause this. The relative magnitude in changes in experienced or prospective investment income are dwarfed by the changes in loss experience.

This reminds me to post a datum from a friend of mine in the business: The average per-claim cost to a medmal insurer of a claim that involves no payment (i.e. the case is deemed to be frivolous, is thrown out or the claimant gives up) is $90,000. There are lots of ways to take that figure (and I'll try to locate the reference), but think about the resources going into investigation, adjustment and litigation. This is a major part of the problem, and it doesn't involve the amounts awarded in successful lawsuits. Target for reform?

Dang. Let me re-state those numbers now I have them in my hand:

Mean Indemnity Payment $310,215

Mean Expense Payment $ 28,801
-Defense Verdict $ 85,718
-Plaintiff Verdict $ 91,423
-Settled $ 39,891
-Dropped/Dismissed $ 16,743

The indemnity payment is what goes to a winning/settled plaintiff. The numbers below relate purely to the expenses of defending/processing the claim. It's the defense verdicts that raise the pure expenses to almost 90,000 (i.e. the costs of going to trial). Still, even dropped claims cost $16,ooo+ on average.

I have a copy of the presentation where the PIAA Data Sharing project discussed these number, but I don't know if I can post it.

I'm not an investment sophisticate but the whole argument about investment losses raising medical malpractice costs has bothered me. After all, if the insurance companies are losing money on investments wouldn't they spread the loss to all their policy holders, not just one select subgroup, doctors. Second point, if it's investment losses why should some subspecialities like obstetrics and neurosurgury be singled out for large increases and not, say, family practice?

False. In non-investment companies, gains are only taken into investment income when sold, paid as income or matured.

Well, that's what I thought, but then how do you explain the increase in "Investment Income Earned", which Ramachandran specifically says "is a value exclusive of realized capital losses or gains"? By the graphs, this value is not as dramatically due to Corp Bonds as the Investment Gain is, but it's still significant, and rose in 2001.

The only alternate explanation I can see is that companies are madly buying corp bonds (including junk?), and so seeing increased yields over the government and munis they were holding.

You raise a good point- and the source for much of the confusion on this topic.

Most of the medical malpractice in this country is written by specialist companies, not the large commercial companies you've heard of. These are generally companies founded in each state as "reciprocals" or "mutuals" where the policyholders own the company. Many, like MAG Mutual in Georgia and TMLT in Texas are still organized this way. Others have gone public (SCPIE Group in California) but still have boards made up of doctors who own significant stakes. So this is doctors' raising their own rates, at heart. The medmal insurance lobby and doctor lobby overlap substantially.

The long decline in rates in the 1990s was precipitated by the entry of some large multi-line companies, most notably St. Paul and Frontier. This crisis is triggered, at least in part, by their withdrawal. Frontier basically went bust because of their medmal book and St. Paul just decided to withdraw.

With respect to specialties - Intra-line rating is complex, but there are some basic trends. Obstetrics is toxic because you can't win a lawsuit if a baby or Mom is hurt. Juries tend to underweight the risk inherent in operations where the patient is basically dying before the procedure. Hence heart and brain specialties are susceptible to large awards. Finally, there are substantial rate differentials between physician groups (with surgical centers) and hospitals with the former being hosed. Again, settlement and award trends are the main indicator.

Are medmal companies being opportunistic in raising rates? Yes - they are seizing an opportunity to regain the barely profitable premium/loss ratio they used to enjoy eight years or so ago!

There is more than enough money in the system to pay the person who has the wrong leg amputated and still charge a reasonable premium. The problem is all of it went to pay for bullshit lawsuits.

I find the contention that the insurance companies are raising rates to doctors because of their investment loses as not in the least bit relevant. It deserves no more than a "So what?" We are still confronted with the costs of frivolous lawsuits---that one way, or another must be paid for by somebody.

Last post was for Paul. Now PJ:

Junk (below BBB-rated) bond investments in the medmal world were very, very low. Not because their such conservative investors but because regulators allow very limited quantities before deducting from capital.

The answer to your question is in Ramachandran's articles. The first one shows the dramatic shift from municipals to corporate bonds over time (look at the medmal asset allocation graph). Corporate bonds carry a much higher coupon than munis. Why did they shift from tax-preferenced munis? They didn't have any profits and had no tax burden to reduce, so munis didn't make any sense anymore. Investment income is presented pre-tax.

I should have pointed that out before. Thanks for asking.

Also, corporate yields have not fallen the way Treasuryt yields have over the last few years. The "spread" (corp yield minus equivalent maturity Treasury) of corporates over treasuries widened dramatically in 1998 (mostly after Long Term Capital blew up and all the bond dealers got out of the spread arbitrage game). Generally speaking, spreads reached an all-time high on October 9, 2002.

Their, they're...whatever. [sigh]

incidentally, I'm posting today because I'm not at work, which has been crazy.

The fundamental problem is that there is no risk to asserting a bull-sh*t claim, except that the contingency-fee lawyer might get nothing for his time. On the other side, there is both the risk of drawing a jury happy to give away the insurance company's money [1] regardless of the facts, and the certainty that beating the claim in court will cost far more than the average settlement.

An often proposed tort reform is capping the size of jury awards. Restricting "pain and suffering" awards probably is a good idea anyhow, but I doubt it will make that much difference to the malpractice mess. For the plaintiff's lawyer, getting such a verdict is like winning the lottery - after working for months without pay. A sure 1/3 of a $30 or $40K settlement for a few hours work is preferable.

[1] The courts generally don't even allow the word "insurance" to be mentioned in one of these cases, but juries often figure it out anyhow. And they hate insurance companies. One of my professors at engineering school had a sideline in testifying as an expert witness. Usually he would be testifying for the defense, say a power company sued when some kid climbed a 12 foot tall chainlink fence to fry himself on their transformers, and that's an uphill fight. But he says the most unaccountable jury verdict he ever saw was when he was testifying for the plaintiff, an insurance company suing for a faulty appliance that caused a house fire. The fire marshal determined that the fire started right at the back of the washing machine. The metal edge where the power cord went into the machine wasn't rolled like it was supposed to be, so the cord went right across a sharp edge. There were plain and clear arc marks on that edge. A skipped step in the factory, an inspector that didn't inspect it, and a house burned down. If it had been "Mrs. Smith vs. Appliance Corporation", the jury would have found for the plaintiffs as fast as they could write down enough digits. But somehow the insurance company wound up suing in its own name rather than the homeowner's, and no way was that jury going to give any money to an insurance company...

I still don't see how frivolous lawsuits would lead to needing a cap. I mean, is the argument that many lawsuits with no merit are (A) going to trial and (B) giving plaintiffs large awards?

It would seem that if frivolous lawsuits are not being won (let alone going to trial), then a cap wouldn't matter at all. But if they are being won, why is the problem the amount of damages? Doesn't this point to a more fundamental justice problem? Shouldn't we be fixing the source of the problem, not slapping random band-aids on?

And don't judges have the ability to toss out jury verdicts that don't agree with the facts? I seem to recall one particularly hyped case of this in the recent past, but I don't remember what it was.

Finally, this is off topic, but if you believe juries are really that horrible at making judgements, I sure hope you don't advocate the death penalty.

>>The problem is all of it went to pay for bullshit lawsuits.

I think you've taken an otherwise excellent analysis too far here, unless you've got some metric for the bullshitness or otherwise of lawsuits.

Furthermore, surely we need some whole-system thinking here? Insurance companies are not unpopular for no reason, they have not always been unpopular and they did not become unpopular overnight. They are unpopular for the specific reason that in general, the experience of Americans in dealing directly with the insurance industry is an experience of an insurance company trying to avoid helping them financially at a time when they are under great stress. What you're seeing here is a population that wants a social security system and is trying to bring it about using the only levers that it has.

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