14 April 2011

Malpractice Self-Insurance -- Why would you want to, and why you might not

I wrote at some length yesterday about the prerequisites for a medical group to self-insure. What I didn't go into in detail was the why -- the benefits and the risks. I'm going to tackle that a bit today.

Potential Benefits to self-insurance 

Those who have been around a few years can testify that the medical malpractice insurance market is highly cyclic. It seems that about once a decade a crisis hits. Whether this is a rational market is another question entirely. Some have attributed these crises to macroeconomic factors, like the market crash of 2002, after which insurers had to recoup investment losses, or hurricanes and natural disasters in which insurers cost shifted onto other product lines. Other obervers cite skyrocketing medical malpractice losses as the driver of these intermittent price spikes. I don't pretend to know the reason, but it's a reality that prices go up, and sometimes rapidly so, for no apparent reason. Additionally, during these times of market disruption, it's common for carriers to drop clients, leave states they perceive as too risky, or leave the med mal market altogether.

One big advantage of self-insurance is that you can control your own destiny and insulate yourself from these market forces. You set your own premium and it only has to go up if you deem it necessary and prudent. You have a carrier that can is guaranteed to issue a policy, and that will never leave the market. These are not small considerations. I know a group that liquidated because their insurer dropped them and they could not find insurance; a contract management chain picked up the contract. I know several groups whose insurer stopped writing med mal and they were left high and dry. They had to purchase a group tail at an exorbitant mark-up and scramble on very short notice to find a new carrier, whcih was excruciatingly stressful. So to have carrier permanence, guaranteed issue, and premium stability is a huge benefit of self-insurance.

Owning your own insurance carrier is also nice because you get total flexibility over your plan. You want to offer D&O insurance? You want to cover your walk-in clinic, too? Do your docs provide medical back-up at the local marathon? You want to set your policy limits obscenely high? No problem. You have to price it in, of course, but the option is yours.

Of course, you are not going to take on the whole risk yourself. You will, as your own insurer, gain access to the reinsurance market. You have the flexibilty to decide how much of each claim you will handle in house, and what financial level you will outsource the risk. Reinsurance, as a rule, is much cheaper than first-dollar insurance, so you can gain significant savings here. As your company matures and your loss reserves grow, you can adjust the reinsurance limits upward and save yet more. On the other hand, if you are inherently cautious and prefer not to take on too much risk, you can keep the limits lower, for a price, and have peace of mind. 

You have complete flexibility to determine where your premium will be. This is a dangerous freedom, by the way. You do need to be prudent and to ensure that you are funding the plan adequately. But you can fiddle with the numbers -- your actuarial confidence level, your reinsurance level, the amount you want to keep in your loss reserves -- from year to year to at least keep the premium stable. However, this is where excess risk tolerance might not be a good idea. If you starve the plan to keep your premiums low, that can kill you should claims materialize. But properly and carefully managed, the ability to maintain your premium at a consistent level is great for running your business.

Another beneift is the ability to actualize the returns on investments. A self-insurance company maintains capital reserves, loss reserves, and incurred but not reported reserves. This money needs to be invested carefully, but will generate returns over time. Your carrier gets that profit under commercial insurance, but as a self-insurer, you will be able to have your money working for you. There are also many esoteric tax benefits involved in your own insurance company, but they are highly dependent on plan design and other variables, and I am utterly unqualified to do more than note their existence.

As your own insurer, you also have the ability to develop your own approach to claims management. You can decide which cases you will internally review, and which will be outsourced to expert reviewers. You have the autonomy to take a stinker of a case and offer to settle up front before the lawyers get involved. You can ensure that your docs will have the power to consent before any settlement (or the converse, if you prefer). You may find your partners take a much more calculating apporach to the settle-or-fight question, when it is their money to defend a case. But how aggressive you want to be is also under your control. The CW is that plaintiff's attorneys are less enthusiastic about suing a self-insured doc, since they expect more defensive engagement and fewer easy settlements, but that's anecdotal. There are, of course, third-party administrators who will coordinate and assist in claims management. And the claims experience you have, and the information you develop from it will inform your prospective apporach to risk management in your practice.

All this I already cited, of course, is gravy, but not the real killer reason to consider self-insuring. Presuming that you do have exceptional risk management, and that you really can manage your practice such that your claims experience will be better than the actuaries expect, you will have the ability to recapture your premium costs. Commercial malpractice insurance is like life insurance: a gamble in which if you are unlucky enough not to die, you lose your bet and forfeit the premium. Only the lucky stiffs who croak get their money back. Similarly, in the commercial med mal market, if you are unlucky enough to not get sued, you still lose your premium dollars. But if you insure yourself, and you do well in the claims department, you get to keep the premiums as profit. You can do what you like with it -- issue dividends to your partners, reduce future premiums or even take a premium holiday. 

Having said that, my definition of success for a self-insurance med mal plan is more modest; if you can go five years with no significant increase in premiums, you are probably ahead of your brethren in the traditional professional liability market. If you recapture your premium investment, that's like winning the lottery.

Down side to Self-insurance

It ties up your capital. When you buy insurance from a traditional insurer, you are essentially renting the use of their capital and bond rating. As a self-insured group, you need to set aside the capital yourself. You may even need to pay a fronting insurer to provide the rated bonds to satisfy your hospital that your insurance is sound. Depending on how robust your cash flow is, this can be a small burden or a substantial one.

You are also at risk of needing to recapitalize your self-insurance company. A capital call is not the end of the world, not even the end of your self-insurance program. But it is an indication that something is not going as planned, and an excess expense at a time when you may not have planned it.

You are dependent on contractors. Your self-insurance plan will need a plethora of consultants: a captive manager and prgram manager, actuaries and lawyers, auditors and claims managers. It's symbiotic. You are their meal ticket, but your livelihood depends on their getting their job done right, and you have no way of evaluating how well they are doing their job. It's scary. You need to carefully select the people you are working with based on price as well as quality and reliability. Badly done, your plan will be more costly than it need be and may never pay off the dividends you hope for. Worse, it puts you at risk for plan failure.

One thing which is a very small risk but tends to assume an outsize importance in the eyes of many docs is the possibility of a huge verdict -- the newspaper-headline $5- and $10-million jury awards. This really worries docs, that a single lightning strike could wipe out the whole plan. That is, in actuality, not impossible but so improbable that it's barely worth consideration. So long as your insurer (which is you) defends your doc in good faith, its exposure ends at the plan limits, just like a commercial insurer's would. If you are insured by AIG and you lose a case for $10 million, the plan pays to $1 million or $2 million or whatever the policy limit is, and the doc is on the hook for the rest (or the hospital, or other co-defendants). A big award can't come in and wipe out your entire loss reserves. Better yet, of the $1 or $2 million that you are on the hook for, most will be paid by reinsurance. Say you have configured the plan to have re-insurance kick in at $150K, and you get hit by the big verdict. The reinsurer pays $850K and you pay $150K. So your loss reserves and capital are well-insulated from the single big case.

Conversely, the little-appreciated risk is that of numerous small-dollar cases. Four smallish cases where you spend $100K in defense and payouts are much more injurious to your plan than the one big one. In this event, all the money is being paid out under the "deductible," so to speak, and the re-insurance is never kicking in. All of that comes out of loss reserves.

Now if you have losses which exceed expectations, this will result in higher future premiums. You need to recapitalize your loss reserves, maybe recapitalize the plan. Your actuaries will take the losses into account in setting future premiums. Your reinsurers will charge you more in the future if you have cost them a lot. But -- and this is the key point -- the exact same thing applies in the commercial market. If you have losses, the insurer will hike up your premium just as AllState will if you get a speeding ticket. So while it is a risk, it is not a risk unique to the self-insurance market.

Similarly, if the markets tank and you experience investment losses, you also are exposed to that. Hopefully prudent investing will mitigate that risk, but ultimately it cannot be completely avoided.

 

I alluded to this above, but the decisions you make in the plan design can impose excess risk of failure on your plan. For example, when you fund your loss reserves, the actuaries are going to say "we think your losses this year will be $200,000. The 75th percentile confidence level is $325,000, and the 90th %ile is $500,000." And so one. That means that out of every four years, one year will have losses of >$325K, and out of every ten years, one will exceed $500K. You need to decide in advance how much money to set aside for losses. There's a huge spread between the expected loss and the 90th%ile. It's tempting to try to low-ball the plan, and go with a cheaper confidence level for cheaper premiums early on. But if that one year out of four is the first year, you're dipping into capital right away. The set-point for reinsurance is also important. The higher the point where reinsurance kicks in the cheaper it is, and that makes a huge difference in your costs. But if you don't account for the higher deductible in your funding, you can get wiped out with a series of smallish cases.

Summary

The whole basis for self-insurance is that you are accepting risk which has previously been outsourced. Overall, the benefits far outweight the risks (which is why insurance companies exist and are profitable). As long as your group is large enough to encompass the risk, practices solid medicine and is otherwise ready to take on the challenge, it should be a no-brainer. The obligate risks of self-insurance can be mitigated with good plan design, adequate funding, and may well exist even in the traditional insurance market. Moreover, if the whole thing blow up, you can always walk away and re-exit to the commercial market. Self-insuring does not mean that you have to self-insure forever. If there are wrap-up costs, however, they may not be avoidable. but in the end, if your medical risk management is not there and you are getting sued and losing left and right, you were probably not right for self-insurance in the first place.

I've beaten this to death enough for today. I've covered the "who" and the "why," so tomorrow, if I have time, I'll tackle the "how." Meaning I'll address the practical considerations of plan design and implementation.

1 comment:

VinceRN said...

I've worked around and hung out with ER docs for the last 22 years, and gotten quite a few insights into how their business works. This is by far the most fascinating look into the business of medicine that I've ever seen.