Unfunded Self-Insurance

The simplest alternative to traditional third party insurance is unfunded self-insurance, often called "going bare." While this option has been adopted by many physicians and some hospitals, it can be very risky. There are two areas of potential financial loss when "going bare." The first is obvious: an adverse judgment with a resulting cash loss. The second is the losses resulting from the cost of litigation.

Defending a malpractice claim is expensive and time-consuming. Attorneys are expensive and the cost of having key administrative personnel tied up in court proceedings is high. There are situations where the best economic strategy is to pay the claim rather than to fight it, even if it could be beaten eventually.

Consider the situation where a person is brought in after being badly injured in automobile accident. The patient is sent to the x-ray department for extensive emergency x-rays. The orderly in the x-ray department inadvertently puts the patient in an x-ray room that has been closed for repairs. The patient is found dead in the room several hours later by a janitor. The subsequent autopsy findings show that the patient suffered a massive intracranial bleed and was probably brain dead before being sent to x-ray. In no event could medical treatment have influenced the patient's death.

To win a malpractice case based on these facts, the plaintiff must prove:

* that the defendant had a duty to care for the patient properly;

* that the defendant violated this duty;

* that the patient was injured; and

* that the patient's injuries were due to the violation if the duty to care for the patient.

Since the patient had been admitted to the hospital, it is clear that there was a duty to care for the patient. While there may be a dispute over who should have cared for the patient, it would have to be a hospital employee or agent. The patient's injuries are also clear. The stumbling block in this malpractice suit is trying to prove that the negligent actions, which violated the duty to care for the patient properly, were the cause of the patient's injuries. In this case, it is clear that the hospital was grossly negligent, but did this cause the patient's death?

In this situation, the hospital could eventually win the lawsuit if it could prove that the patient's death was not caused by its employee's or agent's negligent actions. The plaintiff, however, can prove that the hospital was grossly negligent in the treatment given the patient. If the hospital fights the suit, it will incur large legal costs and very adverse publicity. The adverse publicity may deter patients from seeking care at the facility and may influence potential financial contributors to support other facilities. The hospital thus may decide that settling the lawsuit (usually for much less than amount sued for) is the best course. Unfortunately, in an unfunded scheme, there is no cash reserve from which to pay a settlement. The hospital may be trapped into fighting the lawsuit because it cannot raise enough cash for a settlement.

The risk of an adverse judgment must not be minimized. A large one-time loss could closed the doors of many facilities. If the health care provider decides to fight a suit and loses, the judgment could be in the millions of dollars. This is the most important reason for a hospital or clinic not to "go bare." While an individual physician may want to risk bankruptcy, it can be very detrimental to an entire community to have the local hospital become insolvent. Even a facility that can afford to pay the potentially adverse judgment may find that the pending lawsuit hampers the raising of capital. In an unfunded scheme, the pending lawsuit must be mentioned in the bond prospectus for any bond sales. If there is no insurance or trust fund to offset this potential claim, the bond buyers may worry that a judgment against the hospital will impair the ability of the hospital to pay off the bonds.

The precarious nature of single-provider unfunded coverage can be mitigated somewhat by pooling resources with several other providers. This is often done by hospitals with common ownership, whether proprietary chains or religious orders. The hospitals gain financial stability because the pooled resource base makes it less likely that any single claim will bankrupt the system. The hospital can also offset pending claims against the other facilities' assets, making it easier to sell bonds for capital additions. Difficulties arise because these schemes usually require all participating institutions to agree to share in the payment of sizable claims. This can make it difficult for an attorney defending a claim to negotiate effectively. It is particularly troublesome if one of the cooperating institutions is in financial trouble and does not have the cash necessary to pay its share of the claim. If the other facilities do not settle the claim on their own, they may face a much larger judgment that the troubled facility will be even less likely to be able to pay. If they do settle without the authorization of the troubled institution, they must pay more than their fair share of the claim. To recover this extra payout from the uncooperative facility will require litigation and an addition to the expense of the claim and is likely to increase friction among the facilities.

Flexibility in the settlement of lawsuits is increasingly important as jury settlements rise to million-dollar levels. When a jury awards a plaintiff a million dollars, the defendant, after appropriate appeals, must pay that million dollars a single lump sum payment. This lump sum is very difficult for the defendant to raise and often does not serve the needs of the plaintiff. Most million-dollar settlements involve injuries that require continuing medicare care and/or persons that require continuing support. In either case, the plaintiff's need is for a continuing source of income over a prolonged period, not a one-time payment. The experience of most people who receive large lump sums, either through judgments or contest winnings, is that the money will be spent in less than five years. This may leave medical bills to pay, children to educate, and other continuing expenses unpaid. The plaintiff's need for a steady income, coupled with the defendant's desire to pay out as little cash in present dollars as possible, has led to the development of structured settlements.

A structured settlement usually gives the plaintiff a guaranteed income, payment of any medical bills, and a small lump sum payment. The value of this to the plaintiff is that it provides a tax-free income (usually for life) and protection from rising medical costs. The cost to the defendant is the cost of the annuity. This cost is much less than the lump sum judgment would have been. Like all settlements, however, a structure settlement demands that the defendant have the financial resources to allow the defense attorney to make the plaintiff a fair offer. Unfunded self-insurance, or "going bare," leave the defense attorney unable to negotiate effectively when the defendant provider does not have enough available cash to pay a fair settlement. An extrinsic factor that makes "going bare" economically untenable for most institutions is that there is a limit on Medicare/Medicaid reimbursement for the share of overhead attributable to uninsured losses. This is a public policy decision that reflects the importance of keeping hospitals from being driven into insolvency.