The Professional Liability Insurance Crisis

Traditionally, most health care providers purchased insurance policies to cover losses due to professional negligence (malpractice insurance). These policies were inexpensive for hospitals because there was little risk of a significant judgment. Malpractice insurance was somewhat more expensive for physicians, but it was still only a minor part of the cost of doing business. While there were successful malpractice suits against physicians in the late 1800s, such suits were rare and the settlements were small.

The cost of malpractice insurance did not become a problem for practitioners until the 1970s. The early and mid-1970s saw an enormous increase in the cost of medical malpractice insurance. This was due to the nature of the rating system that was used to determine the premium that a health provider must pay for a given amount of coverage. The rating system was based on a type of policy called an "occurrence" policy. Under this type of policy, the insurance company must pay an claims that are based on incidents that occur during the period the policy is in force. These claims may be made during the period of the policy or at any time in the future, subject only to the statue of limitations. This type of policy is called an occurrence policy because it covers any incidents that occur during the policy period. With this type of policy, the insurance company must charge enough to pay both current claims and any claims that occur during the long "tail" of the policy. This type of coverage becomes very difficult to rate if changes in the incidence of claims make it difficult to project future losses.

In the early 1970s, increasing number of malpractice cases were filed and increasingly large settlements were made. However, given the growing number of people seeking increasingly complex medical care, the absolute number of lawsuits filed remained small, and so did the number of large settlements. The percentage increases in lawsuits filed and in large settlements were exceptional because the baseline level of litigation was so low. For example, an increase from 5 to 25 lawsuits a year is only 20 lawsuits a year, but it is a 400 percent increase.

While this is a large percentage increase, the real problem arises when it is projected into the future. The insurance company assumes that the new rate of increase (400 percent a year) will continue indefinitely into the future. For example, if there are 5 lawsuits in 1970, at a 400 percent annual rate of increase there would be 25 lawsuits in 1971, 125 lawsuits in 1972, 625 lawsuits in 1973, 3,125 lawsuits in 1974, and so on. The assumption of a constant rate of increase thus will predict extremely large numbers of lawsuits and resultant claims in the future. Since the current premium on an occurrence policy must also cover future losses, if the method for calculating future losses predicts extremely large losses, the premium must be set very high. On the other hand, under a "claims-made" policy the premium has to cover only the losses for the period of the policy. The premium will rise to reflect the initial 400 percent increase in lawsuits, but it does not have to reflect the projected increases for the next five years.

Thus, the malpractice insurance "crisis" occurred for two reasons: (1) a sudden increase in suits filed and judgments rendered (even though the actual numbers were small), and (2) the prevalence of occurrence policies rather than claims-made policies. These two factors combined to drive malpractice insurance premiums to high levels, before many dollars were actually paid out. This overall increase in malpractice insurance rates was a shock to hospitals and physicians.

Another problem-the most important one with regard to the growth of quality control-is that malpractice premiums are not based on the experience of the individual institution or provider. The rates for a given group (say, 100 bed hospitals or general surgeons) are the same for all members of the group. The careful surgeon who does few procedures pays the same premiums as the impaired surgeon who does hundreds of cases and has suffered large litigation losses. The hospital that devotes time and effort to controlling risks pays the same rate as the sloppy hospital. This has led to hospitals with excellent claims records paying insurance premiums that approached the amount of coverage purchased. The resulting inequity has stimulated interest in alternative means of insuring against financial losses due to medical malpractice suits.