NY Times & Med Mal
Yesterday's New York Times (reg. req'd) had an interesting article on med mal. The article mentioned a number of studies (no footnotes or links), but it repeats the same old arguments about why med mal insurance prices are so high. To be fair, the authors are now saying it more accurately. No longer is it poor investments by the insurers that leads to higher prices, but it is poor investment returns--which is more accurate. However, when there was good investment returns, people weren't complaining about how low their insurance prices were.
Another, slight problem is how the NY Times itself and some economists frame the problem. The NY Times produced a graph which showed the claims payments increasing and the premiums increasing (at a greater rate over time).
This graph purports to show that premiums are going up faster than claims costs. However this may not be the real picture depending on how one views claims costs. The way insurance companies work is that they take premiums now to cover losses to be paid in the next few years which actually occur during the contract period. For example, a physician makes a mistake on January 1, 2005. The probability that a claim will be closed (and fully settled) within the year is close to 0. Depending on the injury it could take 3-7 years to close the claim. Thus, the proper claim for 2005 is the estimated present value of future claims. So, depending on how the AM Best and the NY Times classify claims, this graph is not relevant for the point they are trying to make. Essentially, insurance company claims are based on past contracts not current ones for these so-called "long-tailed" lines.
This same problem occurs in the paper by Katherine Baicker & Amitabh Chandra (NBER working paper sub required). Chandra is quoted in the last section of the NY Times article as saying "Surprisingly, there appears to be a fairly weak relationship [between premiums and claims]." This may be because he estimated regressions like this .... prems = a + B*claims +c*other things. Current year claims for long-tail lines do not relate well to current year premiums. The relationship should have in it an estimate of future claims, future investment returns, future expenses etc --not current ones. Looking at the NY Times graph, a better idea of the problem is to look horizontally rather than vertically. At 1980 draw a horizontal line from premiums to claims payments--they intersect around 1986--thus one can see something more like how insurance companies price. It takes years to determine whether a contract is profitable--and the longer it takes the more risky the line of business becomes, and the higher the price of the insurance.
Update: Walter Olson also has more to say at Pointoflaw where he covers the slopes of the premiums and claims in the above graph. He also explains what the graph is telling us as about the apparent profitability of the med mal line. One thing to note is that profits attract entry. So if med mal insurance is such a great business opportunity, where is the entry? What I have heard is that some firms such as AIG are writing new business, but they can set their own price. This is a temporary phenomenon, however. As reinsurance premiums fall (which they are doing), as investment returns stabilize (as they are doing), and as states adopt tort reforms that reduce the frequency of claims (which they are doing), then med mal premiums will also stabilize.
Exactly right, as usual, Professor Grace. Ted Frank was thinking just the same thing, and he also has a take on the entry question, in a humorous vein, over at PointOfLaw. (see http://www.pointoflaw.com/columns/)
Posted by: Jim Copland | February 23, 2005 at 04:35 PM