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.
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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.
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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
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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%

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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%

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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%

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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%

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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

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 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.’
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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

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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