Philadelphia Reflections

Directly Reforming Malpractice Insurance Is a Blind Alley

Defense lawyers frequently suggest reforms of the law which would make their job easier

Dr. Fisher

It seems entirely possible that malpractice insurance, by creating an irresistibly attractive "deep pocket", might well be the root cause of the malpractice crisis. Insurance can certainly cause harm, at times. It can induce people to do unnatural things, like using their own brother. Graphically termed "the moral hazard of insurance," perverse incentives create a principle: society must be vigilant against insurance benefits becoming more attractive than the covered event. It's unsafe to assume people will never sink ships or torch houses to collect insurance. If they are over-insured there is still a greater temptation. Meanwhile, salesmen have a commission incentive to sell more coverage. Frightened physicians would buy unlimited malpractice coverage if they could get it.

So, it is legitimate to wonder if excessive malpractice insurance might actually have stimulated malpractice claims, converting over-insured physicians into attractive targets. One of the clear duties of insurance regulators is to forestall such effects. That can be achieved by imposing top limits on insurance coverage, regardless of outcry to buy more, or eagerness of insurers to provide it. In the past thirty years, however, state insurance commissioners have undoubtedly turned away from their traditional goal of preventing insurance company default, and now somewhat adopt the role of consumer advocate, holding down premiums. By itself, the resulting impairment of insurance reserves may have contributed to waves of market exodus during dips in the premium cycle. Permitting unwisely higher levels of coverage to be sold to worried customers may then have been an extended consequence. Regardless of the causative effect of these changes, however, they are too politically charged, too difficult to prove, and too far advanced to reverse in any reasonable time, for relief of the present malpractice difficulties.

A number of other problems exist in the malpractice insurance mechanism, which will be discussed next. However, they all are too intertwined with conflicting issues to have realistic hope of fixing them. Compared with a mandatory cap on pain and suffering, insurance tinkering is unlikely to have a useful effect very soon.

Mandatory Coverage. Unfortunately, many states have sought to create more insurance coverage, not less, an unfortunate stimulus if overgenerous insurance is already creating enticement to sue. The commonest method is to make insurance coverage mandatory for those holding a license to practice. Using the self-defeating argument that the public needs to be promised restitution, mandatory coverage surely dispenses with sales resistance. It imposes premium charges on people whose personal assessment is they don't need insurance, and raises the potential limits of coverage on those who feel they can't afford more. It thus spreads premium costs from people truly at risk, out to bystanders. But ensuring people unnecessarily may itself create a risk of their now becoming the target of suit.

The claims-made type of policy. Under this a system, there are really two policies -- one for any claims made (filed) during the current year, and a second "tail" policy for claims that straggle in later. Whether by genius or accident, malpractice insurance companies introduced this technical "reform" on their own devising, and like most solutions, it generates new issues. The idea revolves around a peculiarity of professional liability insurance: few malpractices claims are ever filed during the first year after the event.

That makes the premium charged for the first year pretty arbitrary. Potentially, it's a loss-leader to attract new sales, or an emergency solution for some political crisis. Therefore, "claims-made" policies obscure underlying cost trends. Deferring the rest of the premium into a second ("tail") policy reduces the amount available for investment, and therefore increases the final total cost. Those are the bad features, which are emphasized by discovering instances when the tail is more than four times as large as the "basic" policy.

On the other hand, the risks for the insurance company are greatly reduced by the potential to adjust most of the premium in retrospect. An industry subject to demolition every thirty years surely needs some reduction of risk. It's true that much of the risk is transferred from the company to the doctors, but ultimately the customers to pay for all costs of any vendor. By smoothing out unexpected volatility in the court environment, the legitimate costs of financing this lottery are actually reduced, although it is not known by how much. Since 60% of malpractice insurance is sold by companies owned by medical societies, the reduction of company cost probably mostly comes back to the doctors.

However, that may be too complacent a view. Individual doctors come and go as customers and an opportunity to game the system is potentially created. Long-term deferral of true costs can be adjusted to some degree, creating a temptation to market-time investments but prove wrong in the timing. Timing of these revenue flows can be used to out-guess the tax system and creates the opportunity to squeeze out competitors who have less capital. Since the tail is seldom accumulated as a single payment but is rather fed out in partial surcharges to future basic premiums, the companies have the latitude to forgive the tail completely if they happen to choose. Since the companies are comparatively small, the potential is there for intergenerational cost-shifting, or cross-specialty subsidies, raising an issue of how the officers are chosen. In short, this complicated obscurity can get doctors involved in considerations they do not understand, making decisions for which they have no training, amateurs playing poker with professional card sharks. For emphasis, throw in some tricky accounting, with GAP for one set of books and SAP for another, and you begin to wonder why you ever got involved. It's a way to lose your shirt, ending up with the blame for ruining your own respected profession.

The insurance company antitrust exemption. Considerable uneasiness revolves around the position of the insurance industry and its federal antitrust exemption, effectively established in 1945 by the Scarring Ferguson Act. No federal agency (the Justice Department and the Federal Trade Commission in particular) may interfere in the business of insurance except "to the extent such business is not regulated by State law." All states passed regulatory laws, but for twenty years there were loopholes of one sort or another, gradually closed. We now face the fact that repeal of this law, which is generally an undesirable one, would very likely generate another long period of loophole closures. Whatever the merits of repeal in other fields of insurance, the potential for regulatory turmoil in professional liability insurance seem to outweigh the desirability of introducing this issue. In particular, the repeal might lead to subsidies of states with unsatisfactory court systems, by states with good ones. No one would claim that repeal of the Act would solve the malpractice problem, or that passage of the law caused it. There's quite a difference between noticing the existence of insurance created a very tempting target and hoping the correction of flaws in insurance management, however numerous, would help very much.

Linking Malpractice Insurance to Health Insurance: Don't Even Consider It.

While tinkering with insurance cannot rescue this problem, one wrong kind of tinkering could utterly disrupt the three professions in conflict. From time to time, a lawyer will suggest to a physician that we could all be friends again if we just got health insurance companies to pay malpractice premiums as a "pass through." The lawyers would then have a direct pipeline into the insurance companies or better still Medicare, and the physicians wouldn't have to care how much the awards were. Strictly no hard feelings, and we all march arm in arm to the bank. Such proposals actually do get floated in medical society meetings, and there are people so desperate they actually consider them. However imperfect other proposals may be, they do not compare with this one in betrayal of the public.

Don't get to the root of it, please. If we were writing a scholarly thesis about the root causes of the malpractice crisis, instead of just trying to keep it from wrecking the health delivery system, the surmises might go as follows. The malpractice insurance business is inherently cyclic and tends to drive nearly every insurance company out of the field, about every thirty years. That strongly suggests the insurers are undercapitalized, unable to accumulate adequate reserves for severe downturns in the lean years. And the reason for this is probably political. The reserves needed to withstand cyclic downturns cannot be accumulated during the fat years when state governments (in the form of the Insurance Commissioners) experience strong political pressure to force premiums down. State involvement in the Medicaid system possibly provides special incentives to hold down overhead costs like malpractice premiums, and competition from insurers based outside the state boundaries may provide another. If this analysis is near the correct explanation, unraveling it entails an impossibly complex agenda. At a time when straight-forward limitation of non-economic awards is probably adequate for the purpose at hand, a top-to-bottom insurance reform would involve the repeal of the McCarran Ferguson Act, higher premiums in the face of huge existing reserves, a reversal of attitudes by fifty state governments, revision of the Medicaid financing process, and patient re-education of the public to accept all this. Such an agenda is so ambitious it amounts to a decision in advance to do nothing effective about the problem.

Furthermore, the internal problems of the insurance industry are probably only part of the main causes for instability.

Pointing fingers and blaming others is considered counter-productive in solving problems, but that's not always so. "Getting to the root of it" is often quite a good way to isolate a single simple cause to be remedied. In the case of medical ability, the root cause may well have been the creation of malpractice insurance, but that analysis leads nowhere. Physicians eagerly purchased the insurance when it was cheap, and would now quit practice rather than go without it. Placing a cap on pain and suffering awards is not only politically achievable, but it also has a proven record of success in California and Indiana. At the moment, we are more in need of something which will work than something which advances the borders of justice. If we get twenty years of respite, perhaps pell-Melli medical progress will slow down so we can learn whether the drugs in common use have unanticipated good or bad effects, and how best to use them. Or perhaps some genius will devise a fair and reasonable judicial approach. In football, that's what is known as playing for the breaks. An insurance approach to what may well be mostly an insurance problem is not presently visible.

Desirable Technical Reforms of the Tort System Itself

This paper takes the position that procedural reforms, whether in the insurance industry or the legal system is not likely to be much help in bringing the disrupted system to prompt stability, or will not do so in a reasonable time. Compared with a cap on pain and suffering, small reforms are not worth the political cost of fighting for them. However, there are a few other reforms that are desirable in themselves, and since they involve money, might just prove to contribute importantly to a quick stabilization.

Pre-trial awards bargaining. Those who might prefer caps on insurance coverage to caps on awards, should be aware of some practices which undercut the practicality of simply limiting total awards without first subdividing them into economic and non-economic components. It is not unusual for both sides in a court case to agree in advance of the trial to setting both maximum and minimum awards. The maximum is usually the utmost limit of insurance coverage, paid if the jury finds for the plaintiff. If the jury rules in favor of the defendant, an agreed minimum amount is nevertheless paid to the plaintiff. This system holds out the promise that the actual award will not attack the defendant's personal assets even if he loses the case, in return for which he agrees to let his insurance company pay consolation awards to the plaintiff and his attorney if they lose. This seemingly the collusive arrangement is justified by arguing that the minimum amount is specifically aimed at the economic damages, leaving the pain and suffering part for the jury to decide.

Unfortunately what it does is increase the willingness of both sides to go to trial, and it drives the award to the extreme upper limits of the policy. It has the additional bad feature of rewarding the plantiff's attorney whether he wins or loses the case, thus creating an incentive to take weak cases to court. Speaking broadly, this system has the effect of letting the insurance limits set the award, and behind that, the insurance commissioner setting the policy limits, artificially high because of the political pressures on him. The objective fact is that plaintiff attorneys are overwhelmingly members of one political party and heavy contributors to it. Election of a governor (who appoints the insurance commissioner) from that party results in a safe prediction of higher coverage limits, awards, and premiums. This subtlety could not continue without at least the tacit permission of the insurance industry to the pre-trial agreements.

Double-dipping true economic damages ( The Collateral Source Rule). Even a quick look at medical malpractice data shows the non-economic awards called "pain and suffering" are as preponderant as they are nebulous. Some describe awards for pain and suffering as capricious and arbitrary, but at the least, they appear emotional. Awards correlate better with the degree of disability than with the degree of negligence. Awards for true economic damages are viewed more sympathetically by the public, who are unaware they are mostly already covered by health insurance, a doubling effect which juries are not permitted to know. Furthermore, in the settlements which determine most of the overall costs of this process, the amount set aside for pain and suffering is traditionally a multiple (seven or eight times) of the "medicals". Since, if you dig into it, it can easily be shown that hospital, drug and equipment charges are already highly inflated above cost, there is a serious multiplier effect at work with the "economic damages".

The outcome of these technical quirks is that both economic and non-economic damages are often excessive, but for different reasons under differing circumstances. For this the reason, it is not a completely satisfactory solution to place a single combined top limit on overall awards, or on insurance coverage limits.

Structured Payment of Damages (Periodic Payments).

The payment of damages is an attempt to put a money value on injuries so that dispute will come to an end. When a plaintiff is disabled, however, it is not possible to know in advance how long he will live, and what he will need. Calculations are therefore made about probable life expectancy and probable costs of long-term disability care. The resulting damage award can sometimes be very large, be paid in a lump sum, and the plaintiff attorney is awarded a third of it. However, the plaintiff has the responsibility to save money and invest it wisely, but that does not always happen. An insurance company is understandably unhappy to pay out an award which is invested to return less money than the insurance company was earning through its own investment department. And the defense side is even more understandably upset when the plaintiff dies in a few months, but his estate retains large sums that were calculated for his care but now will be spent at the pleasure of the heirs. It would be of value to have longitudinal studies of the disposition of these awards, for the guidance of future courts. Current awards could just as easily prove to be too small as too large.

Assuming the money could be placed in safe hands, it seems likely to be invested better and last a longer period of time, if the money calculated to be a certain amount each month, were actually paid out at that rate, month by month, instead of in a lump sum. A the more careful and more efficient system would surely prove to lower costs.

Originally published: Wednesday, June 21, 2006; most-recently modified: Sunday, July 21, 2019