Professional liability insurance: A market overview
By David Teuscher, MD
One of the most important decisions orthopaedic surgeons make in their practice operations is purchasing professional liability insurance.
Issues to consider include: coverage decisions (standard risk transfer, reporting endorsements, deductibles and coverage limits); the type of entity to purchase coverage from; and whether to contract with the insurer directly or through a broker. In selecting your insurer, you are forming a relationship that you hope you never need, but want it to work well should the need arises.
Insurance is premised upon a spread of risk from the individual to the group, assuming that income meets or exceeds operating and claim expenses. Claim expenses include losses (settlements and jury verdicts) and legal costs (defense attorneys and experts). Operating expenses include administration, underwriting, marketing and commissions. Income is derived from two sources—surplus investment income and policy premiums. These principles generally apply to all types of insurance, except for self-insurance where the physician chooses to practice without insurance (go bare) and assumes all risk.
Today, claims-made policies are the most common type of coverage; occurrence and claims-paid coverage are less common options. Claims-made policies must be in force on the date that the claim is reported. When a claims-made policy expires or is cancelled, the physician no longer has coverage for events that have occurred but have not yet been reported.
Occurrence policies provide permanent coverage for events that occur during the policy period, even if reported after the policy expires or is not renewed. The permanence of occurrence coverage generally makes it more expensive than claims-made coverage. This cost difference narrows as the claims-made policy “matures” in subsequent renewal years.
Claims-paid coverage is an uncommon option, which bases premiums on claim experience and near-term expectations, making the physician liable for capital assessments after policy termination.
Physicians who want protection after their claims-made policy expires must purchase supplemental coverage. A reporting endorsement, also known as “tail coverage” may be purchased from the previous carrier. Some carriers may waive tail coverage in cases of death, disability, retirement or years of coverage. An alternative to a reporting endorsement is prior acts coverage, commonly referred to as “nose coverage,” which is purchased from the new insurance carrier. This provides coverage for future claims on acts that occurred while the previous claims-made policy was in force.
Types of insurance companies
The various insurance entities are organized differently, based on capital investment, ownership, responsibility for uncovered losses and regulation. In theory, companies with higher capital surplus, greater reserves and more regulatory oversight provide greater protection, although potentially with increased premiums.
Admitted carriers are traditionally general property/casualty stock insurance companies. For these commercial carriers, medical liability insurance is only one of multiple lines. These companies are regulated by the various states where they offer coverage. The state insurance departments have strict oversight of reserves and rate setting. Carriers licensed in several states offer the advantage of portability, because a physician can move to another state without needing to purchase tail or nose coverage.
Financial stability is the primary advantage of purchasing coverage from an admitted carrier. However, these companies are not immune to financial difficulties, and state regulators have had to intervene (not always successfully) when a company is in receivership. Some states have established a guaranty fund that provides an extra measure of protection, but only for those physicians insured by admitted carriers.
Stock companies have a duty to generate profits for investors and potentially may aggressively set rates to capture the market. Later, the company may leave the state and/or abandon the market. In defending a claim, these carriers commonly exercise greater control with less input from the physician defendant.
Physician-owned companies now insure more than half of U.S. physicians. Introduced in the 1970s, there are now more than 40 physician-owned companies writing medical liability insurance in more than 30 states. Most function as admitted carriers and must conform to the same regulation as stock companies. Some are organized as mutual or reciprocal companies or have an alternate structure.
Mutual companies are organized as physician-owned companies; profits are either used to strengthen the company’s financial position or paid back to policyholders as dividends. Mutual companies have grown significantly as many property/casualty companies withdrew from the medical liability market.
To establish financial solvency, mutual companies commonly require policyholders to make an initial capital contribution as security for surplus and reserves to cover potential future claims. The insured physician may also be required to make additional capital contributions to maintain coverage, if the company experiences excess claim losses and reserves prove inadequate. Financially sound mutual companies can apply for regulatory approval in their home state, enabling them to issue non-assessable policies without capital contribution obligations.
A reciprocal insurance company or inter-insurance exchange is an unincorporated association whose assets are owned by the members/policyholders. The fundamental difference between mutual and reciprocal companies is that reciprocals must be operated by an attorney-in-fact who functions on behalf of the policyholders.
Risk retention groups (RRGs) are formed under the Federal Risk Retention Act of 1986, which allows a group to form as an insurance company and requires that it follow the insurance laws of at least one state. Though governed by its home state, an RRG can write policies in other states without their regulation and oversight. The decreased regulatory scrutiny makes the RRG model potentially vulnerable to insolvency if the company does not have an adequate capital and premium rate structure.
Physicians who join an RRG must commonly make a capital contribution in addition to the first-year annual insurance premium. Some RRGs have become insolvent, so the physician who is considering this option should first review the company’s financial statements and the regulatory climate in the domiciliary state.
Risk purchasing groups (RPG) were also created with the Risk Retention Act of 1986. An RPG is an association of insurance buyers with a common identity, such as a medical specialty society, who form an organization to purchase liability insurance as a group. The RPG purchases coverage from an insurance carrier, so members are not required to make capital contributions. The insurance company is not required to be licensed in every state where coverage is offered, but must file an annual statement reporting premiums generated by the purchasing group in each state. Physicians considering this option should investigate the underlying financial strength of the insurance company providing the coverage.
Trusts are an increasingly common alternative to insurance companies. Trusts may offer claims-paid coverage, and frequently require an initial capital contribution as well as payments for a defined period if not indefinitely after the policy terminates. Not all states regulate trusts and insureds are not covered by a state guaranty fund in case of insolvency. Obtaining coverage after exiting the trust can be a serious, potentially expensive issue.
Joint underwriting associations (JUA) are state-sponsored programs for physicians who cannot obtain professional liability insurance from any other source. JUAs are typically insurers of last resort and more expensive than other options. The JUA can continue to assess physicians for losses incurred by the organization during prior years of insurance activity, resulting in potentially significant and unpredictable financial obligations.
Captive insurance programs provide significant self-insurance with a limited amount of risk transferred to a reinsurance company. Many captive programs are formed off-shore, although they are permitted in Vermont, Colorado, and a few other states. On-shore captive companies are subject to some regulation but are not licensed by states or eligible for guaranty funds.
Operating as not-for-profit entities, captive insurance programs have the potential advantages of owners’ oversight of the loss-control function and claims administration, as well as potential premium stability protection. Financial risk and competition for premiums exists just as with all carriers. Off-shore captives operate under less regulation and oversight, with potential to leave the insured without coverage in the case of unsound or unscrupulous management.
Captives operate by funding a surplus that is actuarially significant enough to purchase coverage from a reinsurance carrier. Advisors typically recommend a minimum $1,000,000 initial investment to operate a private captive. Surplus funds are invested and available for claims management and first-dollar claim coverage up to a defined level per claim and/or in aggregate. The reinsurance contract is for claim losses exceeding the “deductible” amount that the captive reserves cover, commonly $250,000 or more.
Many academic medical centers and hospital chains have formed single-owner captives to cover all of their medical facilities and the health-care professionals who work there. A surgeon who is covered by an institutional captive company must ensure the extent of coverage for any individual activity outside the facility. Group captives typically are owned by an association and provide coverage for a group of corporations or individuals that possess similar business interests.
An upcoming issue of Orthopaedic Risk Manager will further examine how to assess the financial strength of potential liability insurance choices, what questions to ask and the answers you should to expect when you shop for coverage.
David Teuscher, MD, is chairman of the Professional Liability Committee. He can be reached at firstname.lastname@example.org