Last week Americans for Insurance Reform (AIR) released a "study" claiming the med mal crisis is over. AIR examined the number of rate increase requests for a small number of states with damage cap limitations and a small number of states without damage cap limitations and concluded that tort reform was a waste because neither group of states saw any recent increases in premiums. This conclusion is as faulty as if a physician told a patient to take two aspirins for a headache — which later turned out to be something more serious.
One of the underlying issues of the AIR in the past is that the liability crisis is never caused by litigation, expansive judicial interpretation, or bad science. Instead, it is caused by mismanagement or greed by insurers. Insurers mismanage their investment returns and this is why there is a med mal crisis. Or, insurers lowered premiums too much because of mismanagement and now have to raise them. Again, mismanagement caused the crisis. However, after reading Tom Baker's papers they have switched to the underwriting cycle as a potential culprit. Thus, according to the AIR the med mal crisis will be over when the cycle is stabilized. The argument now becomes: The cycle is not caused by lawsuits, but by some external insurance market peculiarity. Therefore, tort reform was a waste as the insurance market will come back by itself. Again, this argument avoids the litigation and judicial behavior side of the equation. It also avoids the state of the state med mal insurance markets.
The question we need to answer is what does the market look like after a “recovery”? Are the same problems still in existence and did tort reform have an effect on these underlying problems? Merely because the market is recovering (as measured by the one-dimensional index of rate increases) does not necessarily imply it is well. This is an area that will be useful to examine in the future.
One of the problems with the way the AIR thinks about the problem concerns the cycle. The insurance cycle is not really a cycle at all (see e.g. Harrington and Cagle $). A cycle is something that appears with regularity, has a nice set of mathematical properties, and is measurable and potentially manageable. What the insurance industry experiences is not a cycle, but a reaction to a shock. The shocks are not predictable. While we have had three shocks that correspond to the med mal crisis of the past (1970's oil price shock), (1980's judicial changes to well settled liability law), and (9/11), the industry has returned to some level of “profitability and stability” after the effects of the shock wear off. The question that needs to be addressed is this a fragile stability or something more permanent?
Kenneth Abraham wrote an interesting paper back in 1991 called the “Once and Future Crisis” ($) that might shed some light on future discussions. In it he predicts a future crisis because the underlying problems of liability markets are really only temporarily masked by the post shock recovery. In fact, Abraham lists the reasons why a future crisis is inevitable. These items he mentioned in 1991 are perhaps still present and provide a guide for further discussion.
First, there is “tort cost push” due to (1) increased frequency and severity of losses and (2) increases in very large awards. During the last crisis we saw a number of indicators of increased frequency and severity. Anecdotally, we did see a number of cases involving cerebral palsy allegedly due to OB/GYN delivery room errors. It does not take a case like this in every jurisdiction to raise OB premiums nationwide. Just the possibility that it could be employed in another state is enough to increase the risk of a lawsuit and raise premiums. Further, what is interesting about these kinds of cases is that if there was a true relationship between c-p and delivery methods, physicians could learn safer techniques to deliver babies. Malpractice costs would decrease and everyone would be happy. However, since there is arguably no relationship —all we add is costs to the system.
Further, Aon examined its claims and found that severity of med mal claims has been growing at a rate of 7.5% over the period 1995–2005. Over time we see more awards breaking the million dollar barrier (see DOJ BJS Study esp Table 3). This is enough to raise premiums nationwide even if we focus on just one state.
Another aspect of the tort cost push is that physicians attempt to finance their insurance in different ways. No longer do we see for-profit companies selling insurance, but a mixture of for-profit and non-profit (mutuals) as well as risk retention groups selling insurance. The for-profit company has a problem. In order to attract capital to back insurance policies it must promise to pay investors a risk adjusted return on their investment sufficient to attract capital. If the industry is perceived as extra risky, the cost of capital increases. This translates into higher insurance premiums. To avoid paying this risk premium to investors, many physicians are insured by mutual companies which return excess premiums to the policy owners if it the extra premiums are not needed. Further, because of the high cost of risk capital, many insurers have left the business voluntarily like St. Paul-Travelers or involuntarily through bankruptcy. So, the question that needs to be asked is the medical malpractice market in a better position to manage a shock in the future? Has tort reform helped the long run viability of the medial malpractice market? I do not think anyone knows the answer to this question yet.
Another issue that Abraham addresses is the increased legal uncertainty in the market. Legal uncertainty influences state markets in more ways than just higher or lower insurance prices. In fact, a major rationale behind tort reform is to reduce legal uncertainty. If one looks at common reform proposals such as damage caps (reduce upper loss limit for punitive or non-economic damages) or venue limitations (restrict forum shopping) they tend to focus on reducing uncertainty. In addition to lowering premiums, reducing uncertainty makes a particular state potentially more inviting to physicians. (See Encinosa and Hellinger Health Affairs ($) and Klick and Strattman at SSRN) More doctors have a beneficial impact on the community especially if the tort system is being blamed for physician shortages.
Abraham also points to new causes of action in tort especially if those changes reduce the standard to prove causation. He also notes problems with a few large verdicts or settlements and how this influences insurance pricing. If we think about insurance pricing, price =expected losses + expense+ cost of risk. We know that as the expected losses increase the premiums go up, but as cost of risk increases, premiums go up too.
Finally, Abraham discusses the potential problem caused by expansive judicial interpretations of insurance policies. Thus, individuals only tangentially related to a risk may be responsible for the entire risk. Some of the tort reforms recently enacted go after this problem by reducing the effect of joint and severable liability. What is interesting is this particular problem does not necessarily have to be related directly to medical malpractice. For example, suppose judges in the Gulf states raked by Katrina decide that homeowners insurers are responsible for a specifically excluded loss (water damage). This decision will have an effect on homeowners markets nationwide, and it will also effect all lines of insurance as insurers will perceive insurance contracts will always be subject to ex post judicial revision. Reinsurers will perceive this as a risk and increase prices to compensate. Reinsurance costs will rise for all insurers no matter the line of business.
The AIR believes that malpractice insurers are price gougers and deserve to lose money. However, they did not complain when prices were being lowered like they were in the mid 1990s. AIR forgets that insurance is a voluntary business based on risk assessment. It also believes that all regulators have to do is wave a magic wand and prices will be reasonable. For stock companies the owners need to be compensated for taking risks. They can not charge “unreasonable rates” as there still is some competition with mutuals and risk retention groups who act like non-profits. In turn, it is hard to envision the managers of a non-profit trying to raise insurance prices just so they can give back bigger dividends to their physician owners. The non-profits’ motive is to make sure that they charge sufficient premiums to stay solvent rather than extort premiums from their policy holders.
Tort reform has attempted to reduce uncertainty whether through limitations on losses or limitation on legal standards. One will not be able to determine until the next shock occurs how well the medical malpractice insurance market has fared. However, given the evidence from the past I would not conclude the crisis is over, the markets are stable and tort reform was a waste. The weight of the evidence suggests we will not know how well the system will work until the next shock.