As seen thus far, the total risk of the insurance portfolio affects the probability of insurer bankruptcy. Insurers may offset an increase in bankruptcy risk by increasing the amount of surplus or equity they hold. To the extent that purchasers of insurance recognize a change in the probability of ruin, at least in the idealized world of competition, this will affect their willingness to pay for the insurance. (more…)
Insurers also face risk in their investments. They may earn more or less than expected on any particular asset and even on their entire portfolio. Insurers with relatively risky insurance portfolios tend to earn higher returns in compensation, but by definition are subject to greater inter-period fluctuations in losses. If investment earnings fall too far below the expectations used to set premiums, the insurer may go bankrupt. One way to decrease the probability of bankruptcy is to hold more equity (or retained surplus) that can be used to cover an unanticipated increase in underwriting loss (or fall in investment return). (more…)
We turn now to the risks assumed by malpractice insurers when they underwrite policyholders’ liability and by investors who contribute capital to the insurance firm— classically, the stockholders in a for-profit firm. A distinction is often made on whether a risk is diversifiable or non-diversifiable. Diversifiable risks occur largely independently of one another, like successive flips of a coin. Thus, pooling individual risks reduces the risk. When enough risks are pooled, variation in outcome is diversified away and aggregate experience becomes highly predictable, like the percentage of heads in many tosses of a coin. (more…)
Several states have set limits per year and per claim on the amount of liability of health care provider can incur. Compensation in excess of the limit is provided by a state-operated patient compensation fund. Funding for the PCF typically comes from a surcharge on malpractice insurance premiums, as in Indiana, or from general state revenues, such as in Kansas. In some states, the Patient Compensation Funds liability is limited, but in others, it is open-ended. This is another mechanism for indirectly cross-subsidizing physicians with relatively high claims costs. Several Patient Compensation Funds have had difficulty maintaining solvency, and states appear to be moving away from the Patient Compensation Funds approach.
As a reaction to the malpractice insurance crisis of the mid-1970s, many states authorized joint underwriting associations as a standby on a mandatory basis. In 1987, 13 medical malpractice JUA were offering coverage to health care providers. The 10 active JUA’s in existence for more than a couple of years have market shares ranging from 3 to 80 percent. Where operational, Joint Underwriting Association require participation by at least all insurers that write medical malpractice insurance and frequently by all property-liability insurers that write insurance in the state. The purpose of these organizations is to be the insurer of last resort—that is, to cover providers who cannot obtain coverage from other sources. One carrier operates the pool on behalf of the state, collecting premiums and paying claims. Joint Underwriting Association operate as mandatory assigned risk pools similar to risk pools established for automobile insurance. As documented, the Joint Underwriting Association insure a substantial proportion of physicians in a few states. As of 1988, 12 Joint Underwriting Association offered coverage to health care providers.
If joint underwriting associations premium income is insufficient to cover losses and expenses, each member company is assessed pro rata to make up the shortfall. To this extent, there is an enforced cross-subsidy that, in competitive insurance markets, must be recovered from the insurer members’ customers in some way. The cross-subsidy introduces another “residual claimant,” namely, the beneficiary of the cross-subsidy. This claimant is paid before the owners of member insurers. Suppliers of equity to a stock company will not want to supply capital for less than the competitive, medicare risk adjustment rate of return. Thus, the cross-subsidy must be reflected in higher premiums to regular customers, who in a state with a joint underwriting associations have no regularly insured source of coverage that does not bear the “JUA tax.” In the case of insurance ownership like mutuals or reciprocals, the policyholder and equity holder roles are combined. Then it is the combined policyholder-equity holder that bears the tax. Since the tax is typically spread over many types of insurance, most of the burden is borne by the public at large.
The stated purpose of Joint Underwriting Association is to assure availability of malpractice insurance coverage to health care providers at “affordable levels”. Thus, by design, the Joint Underwriting Association often sets premiums below what the market will bear. Premiums are monitored by a combination of “pressure from physicians” and premium regulation. In states where Joint Underwriting Association have become major malpractice insurers, it appears that physicians have taken advantage of an enforced alberta blue cross premium subsidy. Most Joint Underwriting Association are not allowed to withdraw from the market even in response to rate denials by the state insurance department. As of 1986, a number of Joint Underwriting Association had serious deficiencies in their reserves.
Having professional liability coverage is vital to modern medicine, for a physician very often cannot secure hospital privileges without it, even if such insurance is not statutorily encouraged or required. Physicians obtain an appreciable part of their earnings from inpatient services. Also, physicians unable to admit sick patients to any hospital might experience difficulties attracting patients to their office practices. (more…)
The stock company provides the benchmark against which the other organizational forms may be compared.The functions of owner-risk bearer, manager, and policyholder are separate. Inefficient firms may be bought out by others that can make money by improving the firm’s performance. Conflicting incentives between equity-holders and managers can be controlled by tying the manager’s pay to the performance of the company’s stock, appointing some of the managers to the company’s board, promoting and increasing the salaries of the good-performing managers, and/or placing restrictions in the company charter to limit managerial discretion. (more…)
In the context of insurance conflicts, there are not two but three parties of interest: managers (agents), owners-risk bearers (principals), and policyholders (principals). Managers run the business; they set premiums, invest the premium income, market the product, and manage claims and litigation. The owners supply equity capital to the firm and, in turn, have a claim on residual profits, once contingent claims due to the policyholders have been paid. Policyholders pay premiums and, in return, are promised payment in the event that certain specified losses are incurred. (more…)
Alternative organizational forms involve different mechanisms for managing the company and controlling the managers. In almost any enterprise, one or more persons, the principals, engage another person or persons, the agents, to act on their behalf. In the simplest case, the principal delegates some decision-making authority to the agent by means of a contract. Principals and agents often have conflicting insurance incentives, and such conflicts are controlled at a cost. Agents with more latitude may be more likely to act in their own rather than in the principals’ interest. Yet monitoring the agents is costly to the principal. Some organizational forms are likely to be more efficient in monitoring and controlling insurance incentive conflicts among the parties than others. (They may have other advantages as well.) (more…)
Almost all insurance is organized on a state-by-state basis, for insurance regulation is traditionally a function of state government, and firms must generally be state licensed to do business. Typically, however, insurers operate on a regional or larger scale. Here, too, malpractice is unusually state specific, especially the physician companies, almost all of which operate only in their home states (PIAA 1987). Several explanations beyond state licensure exist. (more…)
” class=”index-image” width=”120″ />
Most insurance risks involve natural phenomena, as mediated by human behavior. Thus, life and health insurers cover losses from death and sickness, thought to be in most ways objective occurrences beyond the control of insureds and hence insurable. Similarly, much property-casualty insurance covers damages from accident, fire, or natural disasters. However, all malpractice insurance (and much other insurance) covers only the naturally occurring damage deemed legally the responsibility of the insured policyholder. The extent of damages, too, is ultimately determined by legal rules, not by policy provisions. The law of “tort” (civil cases for damages wrongfully caused) varies by state and can change markedly over time. (more…)