Medical Professional Liability/
Claims-Made Reserving
Casualty Loss Reserve Seminar
September 29,
1998
Agenda
A Brief History
Reserving issues
Claims-Made
Self-insurance
Tort reform
Healthcare evolution
2
A Brief History
Mid-1970s – Malpractice Crisis I
Tort system less predictable; long tail emerges
Frequency/severity increases
Insurance affordability/availability crisis
Response
self-insurance
claims-made form
tort reforms
3
A Brief History
Late 1970s
Frequency/severity trends subside
Competition/cash flow underwriting begins
Capacity increases
Early 1980s
Erosion of tort reforms
Double digit frequency/severity trends
4
A Brief History
Mid-1980s – Malpractice Crisis II
Interest rates drop
Insolvencies/capacity shrinks
Response
rate increases
more self-insurance
more tort reforms
5
A Brief History
Late 1980s/1990s
Frequency decline
Loss ratios decline
Increased capacity/price competition
6
General Liability and Medical Malpractice
Loss Ratios 1949–1997
160
140
120
Loss Ratio
100
80
60
Medical Malpractice
General Liability
40
1953
1955
1957
1959
1961
1967
1971
1975
1977
1981
1985
1989
1991
1993
1995
1949
1951
1963
1965
1969
1973
1979
1983
1987
1997
Years
7
Comparison of Calendar Year/
Accident/Report Year Loss Ratios
Based on Schedule P Data
131% 131% 128% 127%
119% 126%
150% 110%
100% 122%
107%
86% 81% 85% 78%
50% 82%
0%
1991 1992 1993 1994 1995 1996 1997
Calendar Year Accident/Report Year
8
Reserving Issues
Claims-made products
Coverage triggers/extended reporting endorsements
DD&R
Self-insurance
hospital accounting issues
Tort reform
impact on reporting
impact on ultimate costs
Healthcare evolution
loss portfolio transfers
new/evolving exposures
9
Claims-Made Products
Coverage triggers/extended reporting
endorsements
Not all claims-made coverage triggers are alike
“demand for payment” form
“incident reporting” form
In most instances, insurers are required to offer
extended reporting coverage, with a maximum
limit set on the price.
The different coverage triggers and the
extended reporting endorsements that are
available mean that insurers are still subject to
reporting lags; i.e., IBNR has not been
completely eliminated.
10
Claims-Made Products
DD&R
Most claims-made policies for medical
practitioners provide for free, unlimited extended
reporting of claims in the event of death,
disability, or retirement of the insured.
The disability provision requires that the insured
be permanently and totally incapable of the
clinical practice of medicine.
The retirement benefit normally vests, based on
the age of the practitioner and number of years
insured by the company. For example, a common
provision requires that the insured be 55 years of
age and with the company for 5 years, or any age
and 10 years with the company.
11
Claims-Made Products
DD&R (cont.)
The DD&R provision is essentially a promise
that future insurance coverage will be
provided under a specific set of
circumstances.
The retirement benefit, specifically, is one
that accrues over a multi-year time horizon.
As such, NAIC accounting guidelines require
that a liability be established to recognize
the expected future benefit that has been
promised the policyholder.
12
Claims-Made Products
DD&R (cont.)
According to the NAIC’s Accounting Practices and
Procedures Manual for Property and Casualty
Insurance Companies:
“... a reserve is required to assure that amounts
collected by insurers to pay for these benefits are not
earned prematurely and that an insurer with an aging
book of business will not show adverse operating
results simply because an increasing portion of
insureds is earning the benefits for which it has paid.”
Also, according to the NAIC, this is most appropriately
treated as part of the Unearned Premium Reserve, but
may be included as unpaid losses if approved by the
insurance commissioner of the state of domicile.
13
Claims-Made Products
DD&R (cont.)
factors which should be considered in estimating
the DD&R reserve:
loss trends
time value of money
non-renewal rates
age and tenure eligibility requirements
age and tenure demographics of insured
population
mortality
morbidity
other factors that impact the value of future
benefits
14
Claims-Made Products
DD&R (cont.)
Two papers which discuss extended reporting
liabilities and specifically DD&R:
McClenahan, “Liabilities for Extended
Reporting Endorsement Guarantees under
Claims-Made Policies,” in Evaluating
Insurance Company Liabilities, CAS, May
1988.
Walker and Skrodenis, “Death, Disability,
and Retirement Coverage: Pricing the ‘Free’
Claims-Made Tail,” in CAS Forum, Winter
1996.
15
Claims-Made Products
DD&R (cont.)
An example of calculating the level funding
necessary to cover DD&R liabilities, which can
then be used to establish an unearned premium
reserve or loss reserve.
Assumptions:
representative death, disability, retirement
statistics
interest rate of 8% used for discounting
annual loss trend of 5%
annual lapse rate of 6%
ERP premium is 157% of mature claims-made
rate
16
Claims-Made Products
DD&R (cont)
Hypothetical Cohort Beginning at Age 27
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Age at Effective Total Expected
Beginning Years # of Disability Mortality Retire Retire Expected DD&R Lapse
of Year Insured Insureds Rate Rate Rate Rate DD&R Utilized Rate
27 0 100,000 0.166% 0.193% 0.041% 0.000% 400 359 6.0%
28 1 93,624 0.159% 0.191% 0.041% 0.000% 366 328 6.0%
29 2 87,662 0.155% 0.191% 0.041% 0.000% 339 303 6.0%
. . . . . . . . . .
. . . . . . . . . .
73 46 657 3.188% 5.338% 9.434% 9.434% 118 118 6.0%
74 47 507 3.329% 5.736% 9.434% 9.434% 94 94 6.0%
75 48 388 3.470% 6.167% 90.363% 90.363% 388 388 6.0%
(10) (11) (12) (13) (14) (15) (16) (17) (18)
Age at Expected Loss Ratio of
Beginning Number of Trend Discount Tail Premium PV Prem DD&R PV DD&R DD&R to
of Year Lapses Factor Factor Factor Collected Collected Utilized Utilized Premium
27 5,976 1.000 1.000 1.57 100,000 100,000 564 564 0.56%
28 5,595 1.050 0.926 1.57 98,305 91,023 540 500 0.55%
29 5,239 1.103 0.857 1.57 96,647 82,860 525 450 0.54%
. . . . . . . . . .
. . . . . . . . . .
73 32 9.434 0.029 1.57 6,201 180 1,749 51 28.20%
74 25 9.906 0.027 1.57 5,021 135 1,458 39 29.04%
75 0 10.401 0.025 1.57 4,039 100 6,342 158 157.00%
Total 1,067,713 13,272 1.24%
17
Claims-Made Products
DD&R (cont)
Hypothetical Cohort Beginning at Age 40
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Age at Effective Total Expected
Beginning Years # of Disability Mortality Retire Retire Expected DD&R Lapse
of Year Insured Insureds Rate Rate Rate Rate DD&R Utilized Rate
40 0 100,000 0.221% 0.303% 0.134% 0.000% 658 524 6.0%
41 1 93,381 0.239% 0.332% 0.134% 0.000% 658 533 6.0%
42 2 87,160 0.259% 0.363% 0.134% 0.000% 659 542 6.0%
. . . . . . . . . .
. . . . . . . . . .
73 33 1,559 3.188% 5.338% 9.434% 9.434% 280 280 6.0%
74 34 1,203 3.329% 5.736% 9.434% 9.434% 222 222 6.0%
75 35 921 3.470% 6.167% 90.363% 90.363% 921 921 6.0%
(10) (11) (12) (13) (14) (15) (16) (17) (18)
Age at Expected Loss Ratio of
Beginning Number of Trend Discount Tail Premium PV Prem DD&R PV DD&R DD&R to
of Year Lapses Factor Factor Factor Collected Collected Utilized Utilized Premium
40 5,961 1.000 1.000 1.57 100,000 100,000 823 823 0.82%
41 5,563 1.050 0.926 1.57 98,051 90,788 879 814 0.90%
42 5,190 1.103 0.857 1.57 96,094 82,385 938 805 0.98%
. . . . . . . . . .
. . . . . . . . . .
73 77 5.003 0.079 1.57 7,802 616 2,200 174 28.20%
74 59 5.253 0.073 1.57 6,318 461 1,835 134 29.04%
75 0 5.516 0.068 1.57 5,082 344 7,979 540 157.00%
Total 964,606 27,526 2.85%
18
Claims-Made Products
DD&R (cont)
Hypothetical Cohort Beginning at Age 57
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Age at Effective Total Expected
Beginning Years # of Disability Mortality Retire Retire Expected DD&R Lapse
of Year Insured Insureds Rate Rate Rate Rate DD&R Utilized Rate
57 0 100,000 1.036% 1.423% 1.869% 0.000% 4,328 2,459 6.0%
58 1 89,932 1.137% 1.549% 1.869% 0.000% 4,096 2,416 6.0%
59 2 80,685 1.247% 1.690% 1.869% 0.000% 3,878 2,370 6.0%
. . . . . . . . . .
. . . . . . . . . .
73 16 5,889 3.188% 5.338% 9.434% 9.434% 1,058 1,058 6.0%
74 17 4,541 3.329% 5.736% 9.434% 9.434% 840 840 6.0%
75 18 3,479 3.470% 6.167% 90.363% 90.363% 3,479 3,479 6.0%
(10) (11) (12) (13) (14) (15) (16) (17) (18)
Age at Expected Loss Ratio of
Beginning Number of Trend Discount Tail Premium PV Prem DD&R PV DD&R DD&R to
of Year Lapses Factor Factor Factor Collected Collected Utilized Utilized Premium
57 5,740 1.000 1.000 1.57 100,000 100,000 3,861 3,861 3.86%
58 5,150 1.050 0.926 1.57 94,428 87,434 3,982 3,687 4.22%
59 4,608 1.103 0.857 1.57 88,955 76,265 4,102 3,517 4.61%
. . . . . . . . . .
. . . . . . . . . .
73 290 2.183 0.292 1.57 12,854 3,752 3,625 1,058 28.20%
74 222 2.292 0.270 1.57 10,408 2,813 3,023 817 29.04%
75 0 2.407 0.250 1.57 8,373 2,095 13,145 3,290 157.00%
Total 641,535 64,319 10.03%
19
Claims-Made Products
DD&R (cont)
Death, Disability, and Retirement Coverage
Summary of All Age Cohorts
And Determination of Level-Funding Rate
55&5 or Any/10
% of Required Funding
Age Insureds (% of Mature CM)
27 0.86% 1.24%
28 0.86% 1.30%
29 1.15% 1.37%
. . .
. . .
. . .
40 3.64% 2.85%
41 3.67% 3.07%
42 3.67% 3.30%
43 3.67% 3.55%
44 3.67% 3.83%
. . .
. . .
. . .
70 0.69% 22.69%
71 0.69% 12.95%
72 0.69% 13.53%
73 0.69% 14.08%
74 0.69% 14.62%
75 0.97% 15.13%
Total 100.00% 5.89%
20
Claims-Made Products
DD&R (cont.)
The DD&R funding load can be used to carve
out a portion of the premium to remain as
unearned premium reserve.
Annually the insurer can review the level of
this additional unearned premium reserve,
and as insureds terminate their claims-made
coverage the portion held as UPR can be
earned.
An IBNR reserve would then be established
to correspond to the UPR that was released
into income.
21
Claims-Made Products
DD&R (cont.)
In addition to the previously listed factors, the
appropriate level for DD&R reserves can be
impacted by:
Competition: Insurers are liberalizing the
vesting schedule (some now use Age 55 and 1
year with company) or grandfathering the
retirement vesting for insureds new to the
company.
Changing Demographics: There is some
evidence that physicians are retiring earlier,
some citing frustration with practicing medicine
in a managed care environment as a reason.
22
Self-Insurance
Hospital accounting issues
SOP 87-1/AICPA Healthcare Accounting
Guidelines
trust funds
captive insurance companies
claims made tail
hospital specific vs. industry data
23
Tort Reform
Impact of tort reform on claim reporting
The Michigan example
non-economic caps
expert witness standards
statute of limitations
affidavit of merit
Effective April 1, 1994
Technical correction April 1, 1996
24
Tort Reform
Michigan Hospital Professional Liability
Adjusted Report Year Claim Frequency
0.400
0.350
Claim Frequency
0.300
0.250
0.200
0.150
0.100
0.050
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
Report Year
25
Tort Reform
Michigan Hospital Professional Liability
Occurrence Year Pure Premiums
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
1987–88 1988–89 1989–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97
Occurrence Year
26
Tort Reform
Reserving issues
potential acceleration in reporting prior to
implementation
observe lags
impact on claims made form greater than
occurrence form
27
Healthcare Evolution
Loss portfolio transfers
Health care institutions which retained some
portion of their professional liability risk
(through a trust fund, captive, etc.) can
transfer the remaining liabilities from past
occurrences through a loss portfolio transfer.
The loss portfolio transfer can be for either
known outstanding claims, IBNR claims, or
both.
28
Healthcare Evolution
Loss portfolio transfers (cont.)
Reasons for purchasing this coverage:
The consolidation of the healthcare industry leads
some institutions to remove uncertainty from the
balance sheet in preparation for, or upon
completion of, a merger or acquisition.
Soft insurance market pricing presents the
institution with the opportunity to discharge past
liabilities, which were retained when insurance
prices were high, below the cost of continuing to
retain the liabilities.
In recent years the marketplace has seen proposals
for LPTs ranging in size from the very small to excess
of $100M. Several eight figure deals have been
bound.
29
Healthcare Evolution
Loss portfolio transfers (cont.)
If the LPT is written as a reinsurance contract
(e.g., reinsurance of a captive):
Statutory accounting principles prohibit the
use of normal premium and loss accounting
and require that special deposit accounting
treatment be used by both the ceding and
assuming enterprises.
GAAP also require the ceding enterprise to
use deposit accounting, but the assuming
enterprise is not required to mirror the
cedant’s accounting treatment.
Both GAAP and SAP are silent on the issue of
‘retroactive insurance.’
30
Healthcare Evolution
Loss Portfolio Transfers (cont.)
An example:
A hospital has self-insured its general and professional liability exposure, subject to the following per
occurrence and aggregate limits:
Report Date Per Occurrence/Aggregate
1/1/86-87 $2 Million / $6 Million
1/1/87-88 $2 Million / $6 Million
1/1/88-89 $2 Million / $6 Million
1/1/89-90 $4 Million / $12 Million
1/1/90-91 $4 Million / $12 Million
1/1/91-92 $3 Million / $9 Million
1/1/92-93 $3 Million / $9 Million
1/1/93-94 $3 Million / $9 Million
1/1/94-95 $3 Million / $9 Million
1/1/95-96 $3 Million / $9 Million
A trust fund has been established to fund these liabilities. Several layers of claims-made excess insurance
attached above the self-insured retentions.
Beginning 1/1/96, the hospital purchases first dollar claims-made insurance with a 1/1/96 retroactive date
and an extended reporting period option for the excess policies.
Effective 2/28/97 the hospital liquidates the trust fund and uses a loss portfolio transfer to transfer all
outstanding and unreported liabilities for this layer, subject to an overall aggregate of $30M, to an insurance
company.
31
Healthcare Evolution
Loss Portfolio Transfers (cont.)
Example Continued:
At the time that the LPT was transacted, the following payments and case reserves
were recorded within the insured's retention.
Payments Case Reserves
Report Date through 2/28/97 as of 2/28/97 Per Occurrence/Aggregate
1/1/86-87 2,250,000 0 $2 Million / $6 Million
1/1/87-88 2,150,000 50,000 $2 Million / $6 Million
1/1/88-89 4,500,000 1,500,000 $2 Million / $6 Million
1/1/89-90 3,375,000 2,100,000 $4 Million / $12 Million
1/1/90-91 4,305,000 2,620,000 $4 Million / $12 Million
1/1/91-92 2,890,000 2,435,000 $3 Million / $9 Million
1/1/92-93 3,250,000 1,600,000 $3 Million / $9 Million
1/1/93-94 1,740,000 2,680,000 $3 Million / $9 Million
1/1/94-95 1,630,000 1,200,000 $3 Million / $9 Million
1/1/95-96 875,000 850,000 $3 Million / $9 Million
After 1/1/96 190,000 400,000 $3 Million / $9 Million
Total 27,155,000 15,435,000
32
Healthcare Evolution
Loss Portfolio Transfers (cont.)
Example Continued:
At subsequent valuation dates, actuarial reserve estimates of the total needed reserve will change as open
claims close out, and as new claims are reported. For example, the data as of 12/31/98 might look like:
Payments Case Reserves
Report Date through 12/31/98 as of 12/31/98 Per Occurrence/Aggregate
1/1/86-87 2,260,000 0 $2 Million / $6 Million
1/1/87-88 2,150,000 0 $2 Million / $6 Million
1/1/88-89 5,500,000 500,000 $2 Million / $6 Million
1/1/89-90 4,025,000 1,600,000 $4 Million / $12 Million
1/1/90-91 5,500,000 1,000,000 $4 Million / $12 Million
1/1/91-92 3,450,000 2,425,000 $3 Million / $9 Million
1/1/92-93 3,500,000 1,750,000 $3 Million / $9 Million
1/1/93-94 2,430,000 2,600,000 $3 Million / $9 Million
1/1/94-95 2,100,000 1,750,000 $3 Million / $9 Million
1/1/95-96 1,475,000 1,405,000 $3 Million / $9 Million
After 1/1/96 260,000 1,020,000 $3 Million / $9 Million
Total 32,650,000 14,050,000
Because the remaining available aggregate as well as the per occurrence retention vary by year, it will be
necessary to segment future development in supplemental development on known cases versus true
IBNR development in order to properly credit the program for expected recoveries from excess insurers.
33
Healthcare Evolution
New/evolving exposures
managed care, telemedicine, home health
little data, rely on pricing assumptions?
long-term care
divergent trends, review separately
34
