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Underwriting Standards

In a booming financial market, an insurance company can make a high return on invested reserves. Companies lower underwriting standards to get more money to invest, but since claims are often paid years later, this amounts to borrowing against the future. When investment income declines and claims begin to come in, the companies raise rates and cancel policies, again without proper concern for underwriting standards. This manipulation of underwriting standards underlies the irrationality of medical malpractice insurance rating schemes.

Medical malpractice insurance is rated by medical specialty, the procedures performed, and geographic location. Except in rare circumstances, there is no individual rating of physicians, although a company may decline to insure a particular physician.[23] Unlike automobile insurers, malpractice insurers do not charge differential rates based on individual physician loss histories or risk factors. This lack of individual ratings puts responsible physicians at a financial disadvantage; they must cross-subsidize the legally high-risk individuals in their specialty.

For example, in most states obstetricians who limit their practices to the number of women they can personally care for and deliver pay the same rates as physicians who accept many more women than they can care for properly. The cost of malpractice insurance is much more significant for these physicians than it is for high-volume practitioners who generate much larger cash flows. Insurance companies have not chosen to determine whether high-volume practitioners pose a greater risk per woman delivered. It seems obvious that they pose at least the same risk per delivery, and thus a much higher aggregate risk than smaller practices.[24]

A major political issue in underwriting is using premium differentials to subsidize certain specialties. Again, obstetrics is a common example. In many states family practitioners have lobbied the insurance commission to force insurers to give them preferential rates for delivering babies. Without any evidence that family practitioners have a lower risk of malpractice, some insurance commissions have acceded to their demands for lower insurance rates than for obstetricians.

A more subtle subsidization occurs when insurance commissions limit the rate classes that an insurance company may offer. Sometimes referred to as rate or class compression, the result is to limit the insurance companies' ability to target rates narrowly. Limiting the insurance companies' pricing options forces physicians in lower-risk categories to subsidize the practices of their higher-risk colleagues in higher-risk specialties.

Medical malpractice insurance generally extends to all legal procedures that a physician performs on patients. The carrier may sometimes have to pay for an illegal action, such as sexual assault, because the action was hidden behind legitimate procedures. The difficult rating decisions involve unnecessary procedures, vanity procedures, and unproved procedures.

Insurance companies do not like to set medical standards. If the company refuses to set standards, more conservative physicians have to bear the cost of unorthodox treatments. As a policy matter, it is not in the public interest to squander the limited resource of malpractice insurance on unorthodox treatments. The clearest example is the litigation risk of vanity procedures. Radial keratotomies have made some ophthalmologists rich, but the cost of paying the associated malpractice claims is staggering. Liposuction and cosmetic laser surgery promise the same cycle: enormous profits in the early years, followed by enormous litigation losses four to six years later. The losses are shared by the practitioners who did not provide this sort of care.

[23]Schwartz WB; Mendelson DN: Physicians who have lost their malpractice insurance: Their demographic characteristics and the surplus-lines companies that insure them. JAMA 1989; 262:1335-41.

[24]Miller AR; Moreland T; Donovan G; Richards EP: Birth Clustering. 1990 American Statistical Association Proceedings of the Social Statistics Section pp. 245-252.

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