Testimony of T. Michael Preston,
MedChi Executive Director

The proposed 28% rate increase is painful but necessary. Quite simply, we have learned that this rate increase is necessary in order to keep at least one healthy malpractice insurance company operating for Maryland physicians. Medical Mutual is owned by the Maryland physicians who are its policy-holders. They are also, in large measure, MedChi's members. They are the doctors who provide most of the medical care in this state. It is in the interest of Maryland physicians and Maryland patients alike that Medical Mutual remain financially healthy for the long term. The alternative is exactly what they've got in neighboring West Virginia and Pennsylvania: a medical community with no viable malpractice insurance carrier and huge portions of the population with impaired access to essential medical services. Medical Mutual today is virtually alone as an active underwriter, compared to six years ago when there were fourteen companies writing malpractice insurance in Maryland. We have come to understand that the companies which are now gone failed to price their product at sustainable levels to pay the ever-growing, and indeed rapidly-accelerating malpractice awards that every doctor and every company faces. In contrast, MedChi has observed that Medical Mutual's pricing has consistently been conservative. This means that in years past when malpractice insurance markets were competitive, the company continued to charge rates that would pay for the claims, and it avoided the discount pricing practiced by the companies which are now defunct. In other words, Medical Mutual was willing to lose business to competitors who discounted their prices because, in order to survive over the long term, rates have to be high enough to pay the claims which eventually arise. Today, those competitors have bitterly proved this point by going out of business. Medical Mutual's conservative pricing history tells us that the proposed 28 percent rate hike, is not driven by a need to "catch up" for inadequate pricing in prior years. Instead, it is driven by a need to pay for the claims which will come in future years.

The situation is even worse than it looks. Both Mr. Anderson and Medical Mutual's own actuaries have calculated that the "indicated rate level change" is at least 38 percent, not the 28 percent rate actually requested. This is important for several reasons. First and foremost, it means that the data on which the actuaries base their view of what should be the rate are worse than the requested 28 percent rate would suggest. Actuarial analysis is an important tool in managing an insurance business. It is not merely an academic exercise, so the actuaries' views cannot be ignored. But recognizing that the adverse trends seen by the actuaries could potentially take an unexpected turn for the better, a financially strong insurer can hedge its bets and elect not to hew strictly to the actuaries' scenarios. It can do so by electing to take less than the full actuarially indicated rate and subsidizing current policy-holders rates out of capital surplus earned in prior years. This is the second important point about the difference between Medical Mutual's requested 28 percent rate and the actuaries' 38 percent indicated rate: that the company is in a financial position to take less than the 38 percent rate speaks well of its management. It means that the company has been managed prudently in past years, preserving its capital surplus so that today, in an extraordinarily difficult environment, it can afford to use some of that surplus to subsidize current policy holders and mitigate the swings in premium rates. There is a down side to this approach, which of course appears if the trends seen by the actuaries do not improve in the coming years. In that event, the company cannot keep subsidizing policyholders out of its capital without jeopardizing its long term health. Thus, if the actuaries are right and the trends keep moving in an adverse direction, the decision to take less than the full 38 percent this year increases the likelihood that next year the company may require yet another rate hike comparable to this year's request. Ultimately, if there is good news in a 28 percent rate hike, it is only that the rate could be higher. But in this case, that is also true.

Growth in claims severity is driving costs up. As Mr. Anderson has testified, the real driving factor for the increase in rates-now and over time-is the trend rates for the severity of claims. In other words, it's the big malpractice awards that's diving the numbers. In their testimony the actuaries discussed the long term trend rate for claims severity and they discussed the more recent adverse experience. According to Mr. Anderson's report, the long term annual rate for growth in claims on the basic limits ($250,000 policy) is 5.6 percent, which means that the size of the average claim doubles about every 13 years. More to the point, however, it is the total policy limits that are normally at risk in a claim, so it is the rate of growth applicable to the full typical $1 million policy limit that applies. According to Mr. Anderson's report, the long term rate of growth for policy limits exposures is 6.4 percent, meaning that the average claim size doubles about every 11 years. And for the more recent period of 1996-2001, the rate of growth in claim severity is 11.5 percent, a rate at which the average claim size would double about every 6.5 years. It is this inexorable march in growth of claims size that is driving costs up, especially the recent acceleration in growth. At our request, Mr. Anderson performed a "sensitivity analysis" showing the effect on his indicated rate of hypothetical changes in various key factors. The importance of recent acceleration in claims growth is illustrated by the fact that simply holding the growth in claims severity to the long-term levels (i.e. no consideration is given to the surge in malpractice awards in recent years) reduces Mr. Anderson's rate indication more than 10 percentage points, to 27.1 percent from 38.6 percent. In other words, the recent acceleration in the growth of claims size has a large impact on the rate indication. This makes sense, because if the recent trend holds and claims growth continues at over 11 percent per year, then the insurance company will need to collect more and more money every year in premium in order to pay claims which are growing larger and larger every year.

Wall Street woes are not driving up Medical Mutual's rates. Working with Mr. Anderson and talking to Medical Mutual management has helped us understand the relatively small role played by the investment climate in affecting the company's rates. In particular, we have come to understand that troubles in the stock market in recent years have had practically no impact on rates. The company has had very little capital invested in the stock market, and for nearly the last two years it has had no money in equities. Instead, like most insurance companies, Medical Mutual invests policyholders' money in the bond market. Interest rates on bonds, we have learned, do make a difference in rates-but not a major difference. For rate-making purposes, Medical Mutual uses the so-called "new money rate" for projected investment income. This means that it sets its premium rates for the coming year based on current interest rates (usually the three-year T-bill rate), not based on some historical or hypothetical average. For the coming year, therefore, it is the interest rates that are being paid today that are used for purposes of determining the new premium rates. In effect, for pricing purposes, each policy year is treated as if it were a separate trust account, with the money collected in premium for that year being invested in bonds at that year's prevailing rates. There is simply no relationship between the rate-making process, which is the subject of this hearing, and the company's past investment experience. Thus, regardless whether Medical Mutual's investment performance in the past was good or bad (it happens to have been good), that past performance is simply irrelevant to today's discussion. Mr. Anderson's sensitivity analysis illustrates the relatively small impact of interest rates on the calculation of the indicated premium rate. His report demonstrates that even if we assume that interest rates suddenly jump all the way up to 6 percent from their current 3-to-4 percent range, the indicated rate level would be 31.6 percent, still well above the 28 percent rate actually requested.

Back to Top