No Crystal Ball: Soft Market Continues as Medical Malpractice Insurance Industry Faces Rapidly Changing Fundamentals
by Michael Matray, editor of Medical Liability Monitor
All segments of the insurance industry experience cyclical periods where the availability and cost of coverage rise or fall. When availability is plentiful and premium costs shrink, it is referred to as a “soft market,” and when losses cause insurers to tighten their underwriting standards and premiums begin to rise, it is considered a “hard market.”
Since 1975, the medical malpractice insurance industry has navigated several hard/soft market cycles. The most recent hard market ended in 2006, and since then the medical malpractice industry has been stuck in its longest soft market on record.
Because – historically – a hard market has inevitably followed each soft market, medical malpractice thought leaders have spent considerable thought trying to predict exactly when premiums might start to climb again.
In their executive summary to the 2015 Medical Liability Monitor Annual Rate Survey, Paul Greve and Susan Forray conjecture that the medical malpractice insurance industry can sustain two to two-and-a-half years of reserve releases before adequate pressure on insurers’ bottom line builds for premiums to inch upward.
Complicating the predictability of the next hard market has been the shrinking number of independent physicians, which has reduced the demand for primary medical malpractice coverage and increased the competitiveness of medical malpractice insurance rates. Greve and Forray expressed concern that this increased competition could incite insurers to continue releasing reserves beyond the point at which reserve levels are adequate, which could cause the soft market to extend beyond the two-and-a-half years they predicted and influence greater consolidation amongst insurers.
A recently published special report by Fitch Ratings, titled U.S. Medical Professional Liability Insurance: Weaker Market Fundamentals Challenge Future Profits, appears to agree with Greve and Forray. According to the report, net written premium volume for the U.S. medical malpractice insurance industry fell for the eighth-consecutive year with a 2.5-percent decline in 2014, while loss ratios on an accident-year basis have increased and reserve redundancy is anticipated to continue diminishing. Despite these challenges, the medical malpractice insurance industry posted another year of profitability and appears ready for an increase in insurer consolidation.
The Fitch report attributes shrinking net written premium to the Patient Protection & Affordable Care Act of 2010, which incentivizes healthcare providers to opt for employment within larger groups and hospitals, and how these “market changes are reducing the overall MPLI [medical professional liability insurance] exposure base and fostering price competition as insurers face greater challenges in retaining existing policyholders.” This trend is changing purchase and coverage preferences for MPLI, as large groups are more likely to self-insure and use captive or alternative risk programs, reducing the demand for primary MPLI coverage.
Boasting an impressive average combined ratio of 89 percent from 2005 to 2014, the calendar-year combined ratio for the medical malpractice insurance industry was up to 94 percent last year. According to the Fitch report, “MPLI underwriting results have benefited from persistent favorable loss trends with steadily declining claims frequency and relative stability in severity, attributable in part to MPLI-related tort reform initiatives passed in a large number of states over the last decade. Also, substantially favorable calendar-year loss reserve development from prior underwriting periods has reduced MPLI loss ratios by approximately 20 percentage points or more in each of the last eight years.”
The Fitch report argues that the changing healthcare market and the ample underwriting capacity in the MPLI market point toward further weakening of medical malpractice insurance market fundamentals and a continued gradual decline in premium rates. At the same time, the medical malpractice insurance industry’s calendar-year results will continue to benefit from a substantial favorable loss reserve development that averaged 22 percent of annual earned premiums for the last eight years. This level is anticipated to diminish, as favorable development from recent accident years, which account for the largest proportion of all medical malpractice insurance insurers’ reserves, has been materially lower relative to past years.
Fitch acknowledges that most medical malpractice insurance insurers still have strong capital positions and low operating leverage, but limited opportunities for business expansion due to a lack of underwriting expertise in other markets. This is likely to encourage larger medical malpractice insurance companies to expand via acquisition rather than entering new markets via expansion.
The acquisitions of medical malpractice insurance companies were relatively few in recent years, but merger activity in the broader property/casualty market quickened in the first half of 2015. According to the Fitch report, “larger market participants have continued interest in gaining scale and offsetting fundamental revenue pressures through acquisitions of other MPLI writers.” This can be attributed to a heightened expense pressure from a declining revenue base coupled with profit erosion from weaker underwriting results and depleted reserve redundancies that could spur an expansion in MPLI transactions going forward.
When will the medical malpractice insurance soft market turn hard? And how will this extended soft market affect the fundamentals and direction of the industry as a whole? The crystal ball is hazy, but all signs point to increased challenges for the medical malpractice insurance industry.