2. © 2005 Towers Perrin ©Towers Perrin Status of the Medical Malpractice Marketplace Jeremy Brigham, FCAS, MAAA 2005 Casualty Loss Reserve Seminar – Boston, MA September 13, 2005

3. 2 Introduction The Medical Malpractice Environment Commercial Insurance Market Response Healthcare Industry Response Legislative Response

4. 3 Late 1970s Most private insurers exit the market, causing availability/affordability crisis for health care providers “Bedpan” mutuals formed Emergence of physician-owned insurers in response to “availability crisis” The medical malpractice insurance market has undergone significant change over the past three decades 1970s 1980s Mid-1970s Period of “crisis” Rising claims Inadequate rates Wage/price control guidelines Stock market falters CA doctors strike Mid-1980s Period of crisis for health systems Significant rate increases (20%+) Reduced reinsurance capacity “Affordability crisis” Mid-1980s Effort to ease exploding claims cost Increased diagnostic testing Improved peer review Focus on risk management Companies consent to claims made Second batch of tort reforms Market Conditions Evolution of the Medical Malpractice Insurance Market Competitive Responses Late 1970s Initial tort reforms Malpractice frequency/ severity subsidies Early 1980s Soft market conditions Erosion of early tort reforms Late 1980s Inflation declines; loss cost trends ease; frequency declines Second wave of provider-owned companies emerge to provide needed coverage Captive formation accelerates RRG/PG legislation passes

5. 4 The medical malpractice insurance market has undergone significant change over the past three decades 1990s 2000 Today Early – Mid-1990s Low inflationary period Loss cost trends — low and stable Managed care attacks medical cost inflation Prolonged soft market conditions Late 1990s Period of “crisis”? Rising claims Inadequate reserves Managed care backlash Mid-1990s Flood of companies into the market To compete, prices driven down/mispricing common 2000 – today Several insurers exit market New capacity emerges Provider-owned companies’ capacity diminishes and rebounds Accelerated movement toward alternative risk financing (i.e., captives, self-insurance trusts) Market Conditions Competitive Responses Evolution of the Medical Malpractice Insurance Market Early-Mid 2000s Low inflationary period Concern over claims “severity” Large rate increases

6. 5 The Medical Malpractice Environment Claim frequency is generally flat

7. 6 The Medical Malpractice Environment However, claim severity has been escalating…

8. 7 The Medical Malpractice Environment …and premiums did not keep up with claim costs Total claim costs Premiums Rate increases reflect “catch up”

9. 8 Malpractice Jury Awards Began an Upward Spiral in 1998

10. 9 Comparison of Large Awards – Top 10 1997 $27,570,327 $23,530,746 $19,275,466 $18,924,000 $15,700,000 $15,317,000 $15,000,000 $14,460,000 $12,381,670 $11,500,000 $173,479,209 2000-2001 $269,000,000 $108,000,000 $100,000,000 $75,000,000 $60,686,150 $49,594,684 $41,444,531 $32,767,410 $31,100,000 $30,000,000 $797,492,775 Total Source: Jury Verdict Research

11. 10 Where are the Most Troubled Claims Occurring? Radiology – failure to diagnose OB/GYN Emergency Medicine Neurosurgery/Orthopedics Bariatric surgery Batch claims

12. 11 Medical Malpractice Awards, 1997-2003 Source: Jury Verdict Research

13. 12 Variable by Locale Healthcare is local Malpractice is local Chicago, Philadelphia, Miami difficult for everyone Indiana, Wisconsin, California less difficult Problems and solutions are different

14. 13 AK CT TX NM AZ NV UT CO OR ID WY MT WA KS NE SD ND LA OK AR MSAL TN KY OH MO IA MN WI ILIN MI FL GA SC NC VA WV ME NY MA RI NJ DE MD DC CA PA VT NH HI Effective reforms halting crisis * States showing problem signs States in crisis States currently OK May 2005 © 2004 American Medical Association. All rights reserved. The American Medical Association Crisis Map, while copyrighted, may be reproduced and distributed, without modification, for non-commercial purposes so long as all information and copyright notices are included.Commercial use requires permission. *In addition to a cap on non-economic damages, Texas voters passed a constitutional amendment. Source: AON American’s Medical Liability Crisis: A National View

15. 14 Commercial Market Response Recap of financial results Commercial market response Where are we in the cycle now?

16. 15 General Insurance Industry Trends Source: A.M. Best, January 2005

17. 16 Medical Malpractice Results Medical Malpractice Combined Ratios – A.M. Best Crisis I Crisis IIICrisis II

18. 17 Medical Malpractice Loss Reserve Development Millions Favorable Development Adverse Development

19. 18 Increasing claim severity has affected reinsurers results more adversely than primary carriers Source: A.M. Best.

20. 19 Completely Out of the Market Since 1996 Close to $2 Billion in Displaced Premiums Many Additional Companies Have Retrenched Peak Company Peak Year Year Premium PIE Mutual1996$193,210,000 Physicians Reciprocal Group2003$203,782,000 Frontier1997$119,702,000 St. Paul1996$650,361,000 PHICO1998$212,486,000 MIIX1999$241,773,000 Reliance1998$54,217,000 ROA / DIR2002$69,965,000 Washington Casualty2001$28,445,000 Farmers2002$231,074,000 TOTAL $1,950,852,217

21. Other Capacity Issues Notable Downgrades/ Exits: Kemper (gone)- Washington Casualty (1Q-03) TVIR- Church Mutual (LTC mkt.) (1Q-03) Princeton- Royal (LTC mkt.) (2Q-03) OHIC- Farmers (Hospitals, phys) (3Q-03) SCPIE- MCIS, Lex (PEL/HMO Re)(3Q-03) APAC- ERC (PEL) (3Q-03) Zurich ERC Source: A.M. Best Company

22. 21 Top 20 of 1996 - % of Writings at ‘05 Rating of B+ or Less 20% Out of Business or Left Market 39% Still Writing & B++ or Better 41%

23. 22 New Capacity since 9/11 Carrier ACE Healthcare One Beacon Berkley Medical Excess Endurance Specialty Ins., Ltd. AWAC Arch Capital Group Ltd. Darwin Professional U/W Renaissance Re (BDA) Max Re (BDA) Beazley Program Inc Aspen Re

24. 23 Commercial Market Response Significant price increases coupled with increased deductible levels and self-insured retentions Inner aggregate Swing rated contracts Restricting terms and conditions: Most “occurrence” business has converted to “claims made” Carriers imposing specific conditions on the reporting of excess loss and potential excess losses Tail/extended reporting period (ERP) provisions Collateralization for retentions Risk management More exclusions “Follow form” reinsurance of captives less prevalent

25. 24 The “hard market” may have peaked After several years of substantial double digit rate increases and better results, many carriers will be seeking only inflationary increases Price adequacy Market pressure Regulatory pressure Increases in Hospital Professional Liability retention levels seen over the past several years are stabilizing Due to the recent capacity shortages and the market correction, substantial new capacity has entered the market Commercial carriers, provider owned carriers, captives, RRGs, other alternative risk vehicles Tort reform may reduce loss costs Capacity and program structure options are available in all venues ( even difficult ones) Strict underwriting is helping providers with strong and proven risk management programs

26. 25 Physician Market Physician market conditions: Double digit increases still occurring in some markets Sub-standard market the only market for some Significant interest in considering alternative vehicles Hospitals/Systems trying to help physicians with problem Channeled programs Win/Win programs – changing the game!!

27. 26 Healthcare Industry Response Financing Purchasing less limits Alternative risk financing vehicles Risk management/quality control initiatives Focusing management’s attention on quality Claims practices changing —engaging patient at time of incident —mediation —fast settlements when liability exists Quality initiatives designed to fix problem areas Specialty focused (OB, ER, etc.) quality programs emerging

28. 27 Alternative Risk Finance Risk Financing Continuum Guaranteed Cost Deductible Retention Trust Captive RRG Exchange HIGH LOWHIGH Financial Risk/Complexity Administration RRG Reciprocal Small hospital s Low risk States Large Hospitals/ Systems High Risk States Multi-state risks Group program Fronting required For Profit

29. 28 Overview of the Insurance Market Healthcare Captive Formations Estimate that 90% of the top 100 healthcare systems own at least one captive Healthcare Captive Statistics: Active Healthcare Captives at Year-end: 2002 2003 Cayman Islands: 197 212 Bermuda: 110110+ Vermont: 42 62 Hawaii: 13 15 South Carolina: 7 21 Total 369 430 Healthcare RRGs 37 77* (Included above) *81% of RRGs formed in 2003 were HC Sources: CIMA / A.M. Best Captive Reports / Domicile Captive Managers / Risk Retention Reporter

30. 29 Legislative Response – Tort Reform Federal level: House has passed a tort reform bill with caps similar to MICRA, Senate has not yet voted Laws affecting medical malpractice have been passed in many states: Texas Florida Ohio Mississippi Arkansas Georgia Others, and more on the way Impact of tort reform Soft vs. hard cap Will it be upheld? Will plaintiff bar find alternate routes? Before/After