Hospital Captives

As we have seen, societal, legislative and market forces have in recent years worked together to encourage hospitals to take hospital-employed physician insurance in-house. Let's stop for a moment and briefly analyze the commercial medical professional insurance market in order to understand if the commercial marketplace is a suitable arena to obtain insurance coverage, or whether there are tipping points that drive business away from these markets and into the hospital captives.

The commercial medical malpractice marketplace is a $10 billion per year industry that has seen several consecutive years of historically low losses and reserve releases. This has been coupled with a severe impairment to investment income, which has shifted insurers' focus back to underwriting profitability. Thus, the industry is in the midst of an extremely “soft market,” characterized by excess supply and not enough demand. There is a greater level of competition than ever before, and insurance rates for physicians are at an all-time low. This is a radical change in the environment from the one we saw during the 2000-2005 shift toward hospital captives, which was plagued by rising insurance costs that were alleged to have driven physicians out of practice. Insurers are now more focused on risk management and loss control, and have excess capital to invest in keeping their infrastructure current.

Despite these market conditions, the majority of hospitals are choosing to insure their newly employed physicians in their captives, collectively with the hospital liability. Hospitals are apparently trying to “beat the market” by charging a lower cost in their captives than they would be paying to commercial markets. The integration of physicians in the captives is providing the hospitals with a bigger risk-versus-reward insurance decision than ever before. Hospital representatives believe that by cutting out the commercial market expenses, they can charge less and also better coordinate a joint defense strategy involving both parties.

All of this sounds like a good strategy, until further analysis is done into the way captives “traditionally” operate. Two major components of insurance ' claims and underwriting ' highlight the concerns.

Claims Issues

Physicians need to be aware that hospital captives have historically shown a lack of focus on protecting physicians' interests during the claims process. Most of the emphasis has been, and will continue to be, on protecting the hospital, its reputation and its constituents. The physicians in most cases are not permanent fixtures of the hospital and can easily be replaced if things go wrong. On the other hand, the hospital's name is enduring.

Hospitals also tend to exert pressure over physicians to settle defensible claims, since trial litigation poses greater potential for exposing the excess layer of insurance. Physicians need to keep in mind that their lack of control over the claims process could harm them, as settlements that go against physicians' interests may hamper their ability to get insurance in the commercial marketplace should they cease being employed by the hospital. On the other hand, hospitals need to acknowledge that the pressure often placed on their employees to see more patients will increase the risk of malpractice suits being filed.

Generally, clams are handled by a third-party vendor, which could give way to increased costs to the captive if claims frequency increases. This cost, along with the reinsurance costs, will increase disproportionately compared with the cost increase that a physician or hospital would see in the commercial market.

Also, the “loss pick” (an actuarial projection made using past losses and exposures) developed by the captive's actuary is based predominantly on hospital exposure units. It is very difficult to predict a proper level of funding with a high confidence level, due to the rapidly changing exposure base. In this case, “expected loss” turns into “unexpected loss.”

The hospital also should consider systemic and shock-loss scenarios involving multiple employed physicians and the hospital. (Systemic loss = excessive losses resulting from gross negligence or willful misconduct; shock loss = loss involving multiple insured's that has material impact on surplus of captive or insurer.) When a physician is insured in the commercial market, he or she usually carries the statutorily required limit ' most often $1 million per occurrence. Employed physicians carry as much as $10 million per occurrence. Experience has indicated that plaintiffs' attorneys generally focus on higher-limit cases, as the lower-limit cases generally settle for policy limits only.

Underwriting Issues

Very little, if any, underwriting is performed by hospital captives. This is particularly concerning since, according to the AON Benchmark Study, several of the fastest growing employed specialties at hospitals are also some of the highest risk specialties for medical malpractice, such as cardiology, radiology and orthopedics. The fact is that the employees of captive insurers generally lack the expertise to properly underwrite the broad variety of risks that are insured under the captives. Hospital and physician risks are highly correlated and influenced by the same set of underlying events, but this often is not taken into consideration during the underwriting process. (By “correlated,” we mean that an act of negligence on the part of the physician usually results in the hospital being named as a defendant (ostensible agency theory).) Quite often, tail exposures and extended reporting periods are absorbed into the captive, leaving them open to adverse development from previous years. For example, most coverage for physicians is “claims made,” meaning the physician has to purchase a tail upon leaving a malpractice carrier for “prior acts” or incidents that have happened but have not been reported or asserted as claims. “Tailing out,” as they call it, can cost as much as 135% of the annual premium; therefore many captives choose not to pay this money to the medical malpractice insurance carrier and instead “pick up” the prior acts and tail in the captive. There is no premium to pay for the losses that may develop from these prior years, thereby making it a gamble that may or may not pay.

Conclusion

The relative calm of the current medical professional liability environment is causing hospital executives and risk managers to overlook the volatility that is inherent in medical malpractice. After all, it was not that long ago that the industry saw double-digit rate increases as a result of loss development. This is exactly the type of market event that hospitals are trying to avoid. However, they may just be the ones to cause the next liability crisis, since the commercial carriers have, once and for all, learned a valuable lesson that may not have been experienced by the captives.

The solution, for the moment, may be in not placing all of the hospital's newly employed “eggs” in one basket. There are physician malpractice carriers that are willing to share risk with the hospital or “carve out” physician exposures from the captive. There are quota-share arrangements, where risk is shared proportionately, and so are premiums and loss. This is a way to spread the risk and mitigate against large losses. It is a hybrid approach that serves as an alternative to insuring all in the captive or all in the commercial market. Such arrangements could give physicians the peace of mind that someone has their back, but is also willing to coordinate with the hospital in the event of a claim involving both parties.

Self-insurance can be scary, and if something can go wrong, past experience tells us that it very well may go wrong. Because of the risks involved in self-insurance, hospitals might be wise to put their liability cost-saving energies into programs that improve the quality of care rather than into the growth of their “insurance businesses.”

Nicholas S. Gaudiosi is the Chief Operating Officer of Healthcare Providers Insurance Exchange (HPIX) and a founding partner of HealthcareSynergies.

As we have seen, societal, legislative and market forces have in recent years worked together to encourage hospitals to take hospital-employed physician insurance in-house. Let's stop for a moment and briefly analyze the commercial medical professional insurance market in order to understand if the commercial marketplace is a suitable arena to obtain insurance coverage, or whether there are tipping points that drive business away from these markets and into the hospital captives.

The commercial medical malpractice marketplace is a $10 billion per year industry that has seen several consecutive years of historically low losses and reserve releases. This has been coupled with a severe impairment to investment income, which has shifted insurers' focus back to underwriting profitability. Thus, the industry is in the midst of an extremely “soft market,” characterized by excess supply and not enough demand. There is a greater level of competition than ever before, and insurance rates for physicians are at an all-time low. This is a radical change in the environment from the one we saw during the 2000-2005 shift toward hospital captives, which was plagued by rising insurance costs that were alleged to have driven physicians out of practice. Insurers are now more focused on risk management and loss control, and have excess capital to invest in keeping their infrastructure current.

Despite these market conditions, the majority of hospitals are choosing to insure their newly employed physicians in their captives, collectively with the hospital liability. Hospitals are apparently trying to “beat the market” by charging a lower cost in their captives than they would be paying to commercial markets. The integration of physicians in the captives is providing the hospitals with a bigger risk-versus-reward insurance decision than ever before. Hospital representatives believe that by cutting out the commercial market expenses, they can charge less and also better coordinate a joint defense strategy involving both parties.

All of this sounds like a good strategy, until further analysis is done into the way captives “traditionally” operate. Two major components of insurance ' claims and underwriting ' highlight the concerns.

Claims Issues

Physicians need to be aware that hospital captives have historically shown a lack of focus on protecting physicians' interests during the claims process. Most of the emphasis has been, and will continue to be, on protecting the hospital, its reputation and its constituents. The physicians in most cases are not permanent fixtures of the hospital and can easily be replaced if things go wrong. On the other hand, the hospital's name is enduring.

Hospitals also tend to exert pressure over physicians to settle defensible claims, since trial litigation poses greater potential for exposing the excess layer of insurance. Physicians need to keep in mind that their lack of control over the claims process could harm them, as settlements that go against physicians' interests may hamper their ability to get insurance in the commercial marketplace should they cease being employed by the hospital. On the other hand, hospitals need to acknowledge that the pressure often placed on their employees to see more patients will increase the risk of malpractice suits being filed.

Generally, clams are handled by a third-party vendor, which could give way to increased costs to the captive if claims frequency increases. This cost, along with the reinsurance costs, will increase disproportionately compared with the cost increase that a physician or hospital would see in the commercial market.

Also, the “loss pick” (an actuarial projection made using past losses and exposures) developed by the captive's actuary is based predominantly on hospital exposure units. It is very difficult to predict a proper level of funding with a high confidence level, due to the rapidly changing exposure base. In this case, “expected loss” turns into “unexpected loss.”

The hospital also should consider systemic and shock-loss scenarios involving multiple employed physicians and the hospital. (Systemic loss = excessive losses resulting from gross negligence or willful misconduct; shock loss = loss involving multiple insured's that has material impact on surplus of captive or insurer.) When a physician is insured in the commercial market, he or she usually carries the statutorily required limit ' most often $1 million per occurrence. Employed physicians carry as much as $10 million per occurrence. Experience has indicated that plaintiffs' attorneys generally focus on higher-limit cases, as the lower-limit cases generally settle for policy limits only.

Underwriting Issues

Very little, if any, underwriting is performed by hospital captives. This is particularly concerning since, according to the AON Benchmark Study, several of the fastest growing employed specialties at hospitals are also some of the highest risk specialties for medical malpractice, such as cardiology, radiology and orthopedics. The fact is that the employees of captive insurers generally lack the expertise to properly underwrite the broad variety of risks that are insured under the captives. Hospital and physician risks are highly correlated and influenced by the same set of underlying events, but this often is not taken into consideration during the underwriting process. (By “correlated,” we mean that an act of negligence on the part of the physician usually results in the hospital being named as a defendant (ostensible agency theory).) Quite often, tail exposures and extended reporting periods are absorbed into the captive, leaving them open to adverse development from previous years. For example, most coverage for physicians is “claims made,” meaning the physician has to purchase a tail upon leaving a malpractice carrier for “prior acts” or incidents that have happened but have not been reported or asserted as claims. “Tailing out,” as they call it, can cost as much as 135% of the annual premium; therefore many captives choose not to pay this money to the medical malpractice insurance carrier and instead “pick up” the prior acts and tail in the captive. There is no premium to pay for the losses that may develop from these prior years, thereby making it a gamble that may or may not pay.

Conclusion

The relative calm of the current medical professional liability environment is causing hospital executives and risk managers to overlook the volatility that is inherent in medical malpractice. After all, it was not that long ago that the industry saw double-digit rate increases as a result of loss development. This is exactly the type of market event that hospitals are trying to avoid. However, they may just be the ones to cause the next liability crisis, since the commercial carriers have, once and for all, learned a valuable lesson that may not have been experienced by the captives.

The solution, for the moment, may be in not placing all of the hospital's newly employed “eggs” in one basket. There are physician malpractice carriers that are willing to share risk with the hospital or “carve out” physician exposures from the captive. There are quota-share arrangements, where risk is shared proportionately, and so are premiums and loss. This is a way to spread the risk and mitigate against large losses. It is a hybrid approach that serves as an alternative to insuring all in the captive or all in the commercial market. Such arrangements could give physicians the peace of mind that someone has their back, but is also willing to coordinate with the hospital in the event of a claim involving both parties.

Self-insurance can be scary, and if something can go wrong, past experience tells us that it very well may go wrong. Because of the risks involved in self-insurance, hospitals might be wise to put their liability cost-saving energies into programs that improve the quality of care rather than into the growth of their “insurance businesses.”

Nicholas S. Gaudiosi is the Chief Operating Officer of Healthcare Providers Insurance Exchange (HPIX) and a founding partner of HealthcareSynergies.