Medical Malpractice
Insurance Market Entry
and Exit: 1994-2006
1
Yu Lei
2
Mark J. Browne
Abstract
A prominent characteristic of the medical malpractice insurance market of the
1970s, 1980s and late 1990s was the withdrawal of insurers. The current study
examines the movement of insurers into and out of the medical malpractice
insurance market between 1994 and 2006 and tests hypotheses on market
participation decisions, including both the effects of states enacting tort reform and
of states implementing alternative market mechanisms—Joint Underwriting
Associations and Patients’ Compensation Funds—to address perceived market
failure.
Our state-level analyses suggest that the number of insurer exits from a state is
lower in states with caps on non-economic damages. Exits are also less frequent in
states where the market share held by mutual companies, reciprocals and risk
retention groups is greater. The mean and standard deviation of the combined loss
ratio for the medical malpractice industry is shown to be associated with both
market entry and exit. We find that states in which insurers are more specialized in
writing medical malpractice insurance attract less entry, whereas states with
insurers that are more geographically concentrated see fewer exits. States
experiencing increasing losses are also associated with less entry, other things
equal.
1. Assistant Professor of Insurance, The Barney School of Business, University of Hartford,
200 Bloomfield Ave., West Hartford, CT 06117. Phone: (860) 768-4682. E-mail: [email protected].
2. Gerald D. Stephens CPCU Chair in Risk Management and Insurance, School of Business,
University of Wisconsin – Madison, 975 University Avenue, Madison, WI 53711. Phone: 608263-3030. E-mail: [email protected].
© 2009 National Association of Insurance Commissioners
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Journal of Insurance Regulation
Introduction
Significant increases in the price of medical malpractice insurance beginning
in the late 1990s and continuing through the early years of the new century raised
concern that physicians in some specialties in some states may not be able to
afford insurance protection and consequently might restrict the medical services
they provide (e.g., GAO, 2003).3 Large price increases in medical malpractice
insurance had raised similar concerns in the mid-1970s and mid-1980s. In
response to these earlier market crises, some states enacted tort reforms (such as
caps on awards for non-economic damages and shorter statutes of limitations) that
limited physician liability and insurer uncertainty, thus reducing both the need for
and cost of liability insurance. Other approaches states took included increasing
the supply of medical malpractice insurance by creating either a Patients’
Compensation Fund or a Joint Underwriting Association (Danzon et al., 2004).
While the price increases resulted in financial hardship for physicians and led to
regulatory reforms, a study of medical malpractice insurance by Hoyt and Powell
(2006) finds no evidence of overpricing.
Accompanying the premium price increases in the 1970s and late 1990s was
an exit of major writers from the medical malpractice insurance market, most
notably St. Paul Travelers, which was the nation’s second largest writer of medical
malpractice insurance when it left the market in 2001.4 Danzon et al. (2004) report
that malpractice insurance markets evolved following these shocks. In particular,
physicians formed new insuring entities—physician-owned mutuals, reciprocals
and risk retention groups—in response to the price spikes of the 1970s and 1980s
in order to replace the coverage previously offered by the stock insurers that left
the market.
The most recent malpractice insurance crisis in the late 1990s raises the
question whether these state-initiated reforms and the market driven changes in
insurer structure have resulted in greater stability in state medical malpractice
insurance markets. In the current study, we examine the decisions of insurers to
enter and exit state medical malpractice insurance markets during the period 1994
to 2006. We are interested in finding out whether these reforms are associated with
market entry and market exit.5
In addition to state reforms, we also study the effect of the formation of
physician-owned insurers. According to organizational theory, firms organized as
3. Encinosa and Hellinger (2005) write that physicians who are unable to acquire liability
insurance may decide to either migrate to states where they can find insurance at reasonable
premiums or reduce or close practices.
4. See Mello et al. (2003), “The New Medical Malpractice Crisis,” New England Journal of
Medicine.
5. Our examination of the impact of state reforms aims to enhance our understanding of
how the reforms we study have impacted the medical malpractice insurance market. While we
focus in this study specifically on the medical malpractice markets in each of the different states,
our methodology could be adapted to other insurance markets as well.
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Medical Malpractice Insurance Market Entry and Exit
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mutuals (or mutual-like companies such as reciprocals or risk retention groups)
should write lines of insurance where there is little managerial discretion and stock
companies should write lines where there is significant managerial discretion
(Mayers and Smith, 1994; Fama and Jensen, 1983a, 1983b). However, we see a
strong presence of physician-owned mutual and mutual-like companies in medical
malpractice insurance markets. While this runs counter to organizational theory,
physician-owned insurers may have informational advantages in underwriting
medical malpractice insurance. Lei and Schmit (2008) argue that such an
informational advantage may generate from the insurer’s strong connection to the
medical community—often these physician directed insurers are at least partially
owned by the medical society—and its focus on the medical malpractice line of
business. In this study, we examine whether states with higher percentages of
physician-owned carriers experience different rates of entry and exit than other
states.
Entry and Exit in the Medical Malpractice
Insurance Market
The decision of an insurer to write medical malpractice insurance in a
particular state depends on the profits it expects to earn writing the line, the
perceived variability in profits from writing the line, as well as the expected return
and expected variability in other lines of insurance.6 Mike Pickens, 2003 President
of the National Association of Insurance Commissioners (NAIC), expressed this
clearly in a letter to Senator Judd Gregg, Chair, U.S. Senate Committee on Health,
Education, Labor, and Pensions, February 7, 2003, writing, “The reason insurers
are not willing, or are pulling back from medical malpractice insurance, is because
there are many other lines of insurance that offer more opportunities for profit at a
lower risk. The uncertainties and historical return in this line of business lead
many commercial insurers to commit capital in other lines of commercial
insurance.”
6. Physician-owned mutuals are an important organizational form in the medical
malpractice insurance sector. While firms of this type do not necessarily seek to maximize profit,
we expect that their decisions to write coverage are influenced by these factors. Two
organizational forms predominate in the property and casualty insurance industry, stock
companies and mutual companies. Stock companies seek to maximize shareholder wealth by
investing in projects with the greatest expected return for a given level of risk. Mutual
companies, which are owned by their policyholders rather than a distinct class of shareholders,
seek to maximize the utility of their policyholders by providing insurance coverage and service
of that coverage at an efficient price. While empirical evidence indicates that stock companies
and mutual companies will seek different niches in the insurance marketplace, they often
compete head-to-head, and as a result, adopt similar strategies, tactics and practices. For that
reason, we make the simplifying assumption for the purposes of our analysis that stock and
mutual insurers both seek investments to earn maximum returns for a given level of risk.
© 2009 National Association of Insurance Commissioners
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Journal of Insurance Regulation
Studies (e.g., Ilmakunnas and Topi, 1999; Van Kranenburg et al., 2002; and
Roberts and Thompson, 2003) of exit and entry in the industrial organization
literature find that there are three categories of factors that significantly influence
firms’ market participation decisions. The first category includes macroeconomic
factors, such as aggregate demand, the business cycle and monetary conditions.
Firms are more (less) likely to enter (exit) a market when demand is high and the
state of the economy is expected to remain favorable. Similarly, research has
shown that entry and exit rates of firms vary over the business cycle.
The second category includes industry-specific factors, such as industry
concentration, market heterogeneity, competition, sunk costs, industry specific
demand, industry size and industry growth. These factors may present
opportunities for potential entrants, and they may also serve as entry and/or exit
barriers. Often, entry barriers are also exit barriers.
The last category includes firm-specific factors, such as the age of the firm,
profitability of the firm and the firm’s minimum efficient size.
Although entry and exit decisions have been extensively studied in some
industries, this is not the case with medical malpractice insurance. We are able to
identify two important and relevant studies that look into entry and exit. One is by
Danzon et al. (2004). This study investigates medical malpractice premium rate
changes and exits during the mid-to-late 1990s and early 2000s. The authors find
that small firms and recent entrants had much higher estimated exit probabilities.
The second study by Nordman, Cermak and McDaniel (2004) is a report
commissioned by the NAIC. This report on medical malpractice market conditions
assesses the market crisis of the late 1990s and early years of the new century.
In contrast to Danzon et al. (2004), who focus on the movement of individual
insurers into or out of the market for medical malpractice insurance, our interest in
the availability of insurance leads us to focus on the aggregate movement of
insurers into and out of the market. In particular, since a number of state reforms
were enacted in response to the market crises discussed earlier, we are interested in
assessing whether these reforms increased the availability of medical malpractice
insurance, either through reduced rates of market exit or increased rates of market
entry. To exploit the differences in state laws that occurred over time, our analysis
is done at the state level with data covering the years 1994 through 2006. The state
reforms we focus on include rate regulation of medical malpractice insurance, caps
on non-economic damages, the presence of a state operated patients’ compensation
fund and the presence of a state operated medical malpractice joint underwriting
association. As suggested by the research referenced above, we control for
economic and industry specific factors that may influence firms’ decisions to
participate in the market.
An important characteristic of the medical malpractice insurance market is that
relatively few insurers provide coverage. Further, companies that do write policies
typically do so in only a small number of states rather than broadly across the
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country.7 The business is predominantly local or regional rather than national in
scope. This, along with the fact that many of the state reforms we examine were
enacted at the state level, suggests that state-level empirical analyses are appropriate.
Table 1 reports state-level summary statistics on the number of insurers per
state per year from 1994 through 2006.8
7. According to our analysis of the NAIC database for each of the years studied (except
2001 and 2002), more than half of the medical malpractice insurers operated in only one state.
8. Two premium measures can be used as possible criteria to define medical malpractice
insurers. The first one is direct premiums written (DPW) in medical malpractice, and the second
one is net premiums written (NPW) in medical malpractice, which is direct premiums written
plus premiums from reinsurance assumed minus premiums from reinsurance ceded. In this study,
we use DPW for the following two reasons. First, DPW better measures insurers’ willingness to
write business, whereas NPW does not tell us whether an insurer is growing in the direct business
market. Second, the regression analysis discussed later in this paper is done at the state-level.
Data on NPW is not available at the state level.
Many studies of the medical malpractice insurance market define insurers as market
participants if the amount of coverage that they wrote in a particular state in a particular year
exceeds a specified percentage of the market total. Nordman, Cermak and McDaniel (2004)
report that the NAIC database “contains insurers that may have withdrawn from the market or
suspended writing new business, but continue to report losses. These insurers continue to provide
financial data to the NAIC, but do not indicate whether they are active in the market. This poses
an additional problem for market analyses. These insurers usually report a very small level of
premium, which may create the appearance that there are many insurers in the market when in
fact there may be very few actively writing business.”
To address this problem, we follow Nordman, Cermak and McDaniel (2004), who use the
following rule to classify insurers. A medical malpractice insurer is considered to have been
active in a given state in a given year if it wrote at least 2 percent of that state’s DPW for medical
malpractice insurance in that year. An insurer that satisfies this criterion is also considered to be
participating in the national market. Note that this does not mean the insurer is writing in every
state. The company may, in fact, be writing in only one state.
We define an insurer as entering the market in a state in a given year if its DPW for medical
malpractice insurance in that state exceeded the 2 percent threshold for the first time in that year.
Similarly, we follow prior research in defining a firm as exiting a state in a particular year if it
wrote malpractice coverage in a particular state in a particular year, but in no subsequent years
wrote 2 percent or more of the direct premiums in that state.
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Journal of Insurance Regulation
Table 1: Summary Statistics of the Number of Malpractice Insurers
at the State Level
Year
Min
Max
Mean
Std
1994
4
11
6.765
1.829
1995
3
11
7.392
2.089
1996
3
13
7.725
2.136
1997
3
12
7.824
2.047
1998
4
12
8.059
1.902
1999
5
13
8.020
1.913
2000
4
15
7.784
2.411
2001
4
14
8.392
2.450
2002
4
15
8.569
2.524
2003
5
18
8.176
2.520
2004
3
14
7.706
2.166
2005
3
14
7.961
2.218
2006
3
12
7.706
2.175
Source: Authors’ analysis of NAIC data
The mean number of insurers per state ranges from 6.765 to 8.569 over the
period of our analysis. The maximum number in any state-year is eighteen in 2003
(in Mississippi), and the minimum is three in 1995 (in Massachusetts and New
Jersey), 1996 (in Massachusetts), 1997 (in Massachusetts), 2004 and 2005 (in
Maine) and 2006 (in Maine and South Dakota). Unlike some other lines of
insurance, there are relatively few insurers writing coverage in any state.
One thing worth noting is that some carriers only cover certain types of health
care providers.9 The NAIC database distinguishes five types of providers:
physicians (PH); other health care professionals (OP); hospitals (HS); other health
care facilities (OF); and medical malpractice policies (MM) that cover providers
not included in the first four categories.10 Table 2 reports percentages of insurers
that provide coverage to only one of the specific categories of providers. The
percentages reported are the averages of the corresponding percents in each of the
states.
9. We thank an anonymous reviewer for raising this point and generously sharing SAS code
and relevant data for us to produce Table 2.
10. Such information is available beginning in 2001.
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Medical Malpractice Insurance Market Entry and Exit
Table 2: Average Percentage of Insurers Covering Specific Types
of Providers
Year
2001
2002
2003
2004
2005
2006
PH only
8.66%
10.17%
11.52%
13.65%
17.09%
18.82%
OP only
1.73%
3.15%
1.40%
0.89%
0.84%
0.81%
HS only
6.68%
8.47%
8.99%
9.20%
7.00%
6.45%
OF only
0.25%
2.18%
3.37%
0.89%
1.40%
1.08%
MM only
8.66%
8.72%
3.93%
4.15%
3.92%
3.76%
PH = physicians; OP = other health care professionals; HS = hospitals;
OF = other health care facilities; MM = medical malpractice policies that cover
providers not included in the first four categories
For instance, in 2001, on average, 8.66 percent of insurers covered only
physicians, and 6.68 percent of insurers insured only hospitals. Table 2 reports that
the percent specializing in insuring only physicians increased from 8.66 percent in
2001 to 18.82 percent in 2006. About half of the medical malpractice insurance
sold nationally provides coverage for physicians.
Entry and exit at the state level occurs throughout the time period of our
analysis. Table 3 provides summary statistics on entry and exit.
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The state average of entry ranges from a low of 0.882 firms in 2006 to a high
of 2.392 firms in 2002. The maximum number of firms entering a state was eight
in 2003 (in Mississippi). In each year there are states in which no new writers
entered the market. The state average of exit ranges from a low of 0.667 in 1994 to
a high of 2.216 in 2001. The maximum number of firms exiting a state was six in
1999 (in the District of Columbia). In each year there are states which no firms
exited.
Table 3 also reports the total number of entries and exits at the state level. The
sum of state-level entries ranges from 45 to 122, and that of exits from 34 to 113.
It is apparent that firms enter and exit various states quite frequently.
Empirical Analysis
To test what factors are associated with insurers’ decisions to enter or exit
state insurance markets, we estimate two equations of the form:
Entries (Exits) s,t = f(Economic conditionss,t, Industry conditionss,t, Reformss,t)
Where,
Entries (Exits) s,t is the number of firms that were entering state s during year t
in our first equation and is the number of firms that were exiting state s during
year t in our second equation.
Economic conditionss,t is a set of variables representing general economic
conditions in state s during year t which are expected to be associated with
firms entering or exiting a state’s medical malpractice insurance market.
These conditions include:
Invest Yield
Investment earnings are an important income source for writers of
medical malpractice insurance. Other things equal, we expect that greater
investment yields will be associated with fewer firms exiting the
malpractice insurance line and more entering. To measure the average
investment yield medical malpractice insurers earned in each year, we
first calculate the investment yield for each insurer in that year, which is
defined as net investment income divided by the average of total cash and
invested assets in the current year and the prior year. Then we average
across the firms to get the average investment yield for that year.
GSP Growth
This is the growth rate of the gross state product (GSP) in each state each
year. Growth in GSP indicates growth in the state economy. A higher
GSP growth rate is expected to attract more entries and discourage exits.
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Journal of Insurance Regulation
Industry conditionss,t is a vector of variables representing factors specific to
the insurance industry that are expected to be associated with firms’ decisions
on market participation in state s during year t. These include:
Number of Firms (Num Firm)
This is the number of medical malpractice insurers in each state each year
divided by the total direct premiums written in medical malpractice in
that state that year.11 Other things equal, the greater the adjusted number
of insurers writing medical practice in a particular year, the greater the
number of exits we expect the following year. A priori, the effect on entry
decisions of the number of firms writing medical malpractice insurance in
the state is ambiguous. A large number of firms operating in a state may
suggest a highly competitive market with little room for an additional
writer of insurance. Alternatively, it may suggest a favorable environment
in which to write coverage.
Percent Mutual
This variable is the percentage of medical malpractice insurers that are
mutual companies, reciprocals or risk retention groups in each state each
year. If these types of medical malpractice insurers, which are generally
owned by the physicians they insure, have an informational advantage in
this line of insurance due to their organizational structure, a higher
percentage of writers in a state having one of these organizational forms
would be expected to be negatively associated with both entry and exit.
If, however, stock insurers are better suited to write this complex line of
coverage requiring managerial discretion, as organizational theory
suggests, a positive relationship with entry and exit would be expected.
Concentration
This variable measures market concentration in each state each year. We
use the Herfindahl-Hirschman Index (HHI) to measure concentration.
HHI is defined as the sum of the squares of the percentage of market
share of each firm in each state. We define a firm’s percentage of market
share in state s during year t as the ratio of its direct medical malpractice
insurance premiums written to the sum of the direct medical malpractice
insurance premiums written by all insurers in state s during year t. The
effect of concentration on entry and exit is ambiguous. On the one hand, a
large market concentration ratio implies less competition. Therefore,
concentration could serve as a barrier to both entry and exit. The higher
the ratio, the fewer the number of entries and exits we expect. On the
11. We scale the number of firms by total premiums written because “a large state can
support more carriers than a small state,” as noted by our reviewer.
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other hand, concentration could imply more opportunity for competition
by entry, therefore encouraging more entry and exit.
Specialization
This is the weighted average of the specialization rate of medical
malpractice insurers in state s during year t. For each insurer, its
specialization rate in each state is defined as the ratio of its direct
premiums written in medical malpractice insurance to its total direct
premiums written in that state. To compute the average of the
specialization rate, we average across the firms in each state each year,
using direct premiums written as weights. This variable is intended to
proxy both an insurer’s commitment to writing medical malpractice
insurance and its degree of expertise in writing this line of coverage. We
expect higher rates of specialization in a state to be associated with fewer
exits. We hypothesize specialization also serves as a barrier to entry.
Therefore, we expect a negative effect on entry.
Medical Malpractice Insurance Loss Ratio (MM-LR)
This is the weighted average of the medical malpractice insurance loss
ratios of those companies in our data set which wrote this line of
coverage in state s during year t.12 In producing the average, we weight
by direct premiums written. Since increasing loss ratios are associated
with decreasing profitability, other things equal, we anticipate a negative
relationship between the weighted average loss ratio and entry. In
contrast, we anticipate a positive relationship between the weighted
average loss ratio and exit.
Standard Deviation of the Medical Malpractice Insurance Loss Ratio
(MM-LR-STD)
This is the standard deviation of the distribution of medical malpractice
insurance loss ratios in state s during year t. This measures the variation
in the profitability of underwriting this coverage across insurers.
Variability may be due to differences in business practices across insurers
or due to inherent randomness in writing a risky line of coverage. We
anticipate that greater variability is associated with fewer entries and
more exits.
12. The loss ratio for each insurer is defined as the losses incurred in medical malpractice
line divided by premiums earned in medical malpractice line.
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Journal of Insurance Regulation
Loss Change
This variable is the average percentage change in medical malpractice
insurance losses paid in each state each year. For a given insurer this is
defined as:
Loss Changes,t = [(Direct Losses Paid)s,t - (Direct Losses Paid)s, t-1 ] /
(Direct Losses Paid)s,t
We average across insurers to produce the state average for this variable.
We use this variable to proxy the loss experience of the medical
malpractice insurance industry. Positive values of this variable indicate
worsening loss experience. Therefore, we anticipate that this variable is
positively associated with exits and negatively associated with entries.
Combined Loss Ratio for the Medical Malpractice Industry (CLR)
This is the average all lines combined loss ratio (CLR) of those insurers
who wrote medical malpractice insurance in each year. Some insurers in
our sample wrote only medical malpractice insurance, others wrote
additional lines as well. To calculate this variable, we first calculate the
combined loss ratio for each medical malpractice insurer in each year.
This is given by the following equation:
CLR = (Losses Incurred + Loss Adjustment Expenses Incurred) /
(Premiums Earned)
+ (Other Underwriting Expenses / Premiums Written)
We then average across firms to produce the average medical malpractice
industry loss ratio. Since underwriting profits are inversely related to this
variable, we expect it to be positively related to exits and negatively
related to market entries.
Standard Deviation of the Combined Loss Ratio for the Medical
Malpractice Industry (CLR-STD)
This is the standard deviation of the distribution of combined loss ratios
of writers of medical malpractice insurance. This measures the riskiness
of writing insurance. We expect that greater riskiness, other things equal,
discourages firms from writing insurance. We hypothesize that this
variable will be negatively related to entries and positively related to
exits.
Reformss,t represents the reforms adopted in different states to address the
perceived failure in the market for medical malpractice insurance. Reforms
were adopted by states to expand the availability of medical malpractice
insurance. Assessing the association between these reforms and the market
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participation decisions of insurers is a primary goal of our analysis. The
reforms that we consider include:
Damage Cap
This categorical variable equals one if the state has a cap on general
damages for medical malpractice injuries, and equals zero otherwise.
Since a cap on general damages limits the amount that an insurer would
need to pay for any one claim, the potential loss exposure faced by the
insurer is less than it otherwise would be for policies with high limits. We
anticipate that in states with a cap on general damages, there will be a
reduced likelihood of insurer exit and a greater likelihood of insurer
entry.
Alternative Mechanism
This is a dummy variable that equals one if the state has an alternative
market mechanism such as a joint underwriting association, a state fund
or a patients’ compensation fund. These measures are intended in part to
reduce risk faced by writers of medical malpractice insurance by either
providing coverage for substandard risks or limiting an insurer’s loss
exposure on catastrophic claims. We expect alternative market
mechanisms to be associated with an increased likelihood of entry and a
decreased likelihood of exit.
Prior Approval
This is a dummy variable that equals one if the state requires prior
approval for medical malpractice insurance rates. Prior approval may
serve as a barrier to entry because it restricts the ability of firms to change
rates quickly in response to deteriorating loss experience. Therefore, we
expect that states that require prior approval will attract fewer entries.
Since prior approval of rates restricts insurers in their pricing practices,
we expect that it will be associated with a greater rate of exits from its
market, other things equal.
Table 4 summarizes the variables discussed above.
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Table 4: List of Variables
Variable Name
Definition
Dependent Variables
Entry (s, t)
Exit (s, t)
Number of entering firms in state s, year t
Number of exiting firms in state s, year t
Independent Variables Representing Economic Conditions
Invest Yield (t)
GSP Growth (s, t)
Average investment yield in year t
GSP growth rate for state s in year t
Independent Variables Representing Market (Industry) Conditions
Number of medical malpractice insurers
Num Firm (s, t)
adjusted by total premiums written in medical
malpractice in state s, year t
Percentage of medical malpractice insurers
Percent Mutual (s, t)
that are mutual companies, reciprocals or risk
retention groups in state s, year t
Average market concentration (HHI index) in
Concentration (s, t)
state s, year t
Weighted average specialization in medical
Specialization (s, t)
malpractice in state s, year t
Weighted average pure loss ratio in medical
MM-LR (s, t)
malpractice in state s, year t
MM-LR-STD (s, t)
Standard deviation of MM-LR in state s, year t
[direct losses paid in medical malpractice in
state s, year t - direct losses paid in medical
LossChange (s, t)
malpractice in state s, year t-1]/ direct losses
paid in medical malpractice in state s, year t
Average combined loss ratio for all lines in
CLR (t)
year t
CLR-STD (t)
Standard deviation of CLR in year t
Independent Variables Representing Reform
Dummy variable equal to 1 if state s has a cap
Damage Cap (s, t)
on general damages in medical malpractice in
year t
Dummy variable equal to 1 if state s has an
Alternative Mechanism (s, t)
alternative mechanism in year t
Dummy variable equal to 1 if state s requires
Prior Approval (s, t)
prior approval for medical malpractice
insurance rates in year t
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Data
We use the NAIC data to estimate our models. In addition, we incorporate
data on GSP growth rates from the U.S. Bureau of Economic Analysis.
Information on caps on general damages was obtained from the law firm of
McCullough, Campbell and Lane (MCANDL, 2009) and information on medical
malpractice insurance rate regulation was obtained from the Insurance Information
Institute (III, 2008). Our study period is from 1994 to 2006.
Prior research (e.g., Danzon et al., 2004; Nordman, Cermak and McDaniel,
2004) acknowledges that the NAIC database is not without limitation when used
to study malpractice market. An important limitation of the NAIC data is that not
all medical malpractice insurers are included. Many risk pooling arrangements,
such as self-insurance plans administered by hospitals and health maintenance
organizations, are not subject to state regulation and do not appear in the data set.
Further, state pools—such as joint underwriting associations and patients’
compensation funds—do not file financial data with the NAIC.
Even though the NAIC data represents only a segment of the market, it is the
most extensive national insurer financial database available. Therefore, albeit
subject to limitations, the data are a valuable source of information for studying
insurer operations and market dynamics.
The analysis is done at the state-year level. For the entry equation, the data used
are from 1995-2006 and for the exit equation, the data used are from 1994-2005. We
are not able to use all years in our regression because we are looking at yearly
changes. Altogether, we have 663 state-year observations in our final sample.
All the independent variables are average values. For variables that vary with
both state and year, we average values across firms for each state and year; for
variables that vary with year only, we average values across firms in each year.
The by-year mean values of the independent variables used in the study are shown
in Table 5.
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Medical Malpractice Insurance Market Entry and Exit
From Table 5, we can see that from 1994 to 2001, the adjusted number of
medical malpractice insurers in each state remained relatively stable. However, we
see some decline from 2002 to 2006. The percentage of medical malpractice
insurers that are mutuals, reciprocals or risk retention groups was smallest in 1997
at 21.5 percent and greatest in 2006 at 31.1 percent. Medical malpractice insurers
tend to be geographically concentrated. The concentration ratio decreased from
1994 to 1998, after which the ratio has remained relatively stable at around 20
percent until 2004 when the ratio began to increase, reaching its peak of 21.4
percent in 2006. Medical malpractice insurers tend to be highly specialized. The
specialization ratio is generally around 67 percent throughout the study period.
Table 5 also shows that more states have adopted alternative mechanisms in recent
years, reflecting the perceived need to alleviate problems in the medical
malpractice insurance market. On average, about 43.1 percent of states require
prior approval of medical malpractice insurance rates and 64.7 percent of states
have imposed caps on general damages. From Table 5 we can also tell that
investment experience worsened over the period of our analysis. The all line
combined loss ratio was highest in 2001, after which it kept decreasing until 2006
when it began to go up again.13
Empirical Results
The two dependent variables used in our study are the number of firms
entering and exiting each state every year. Since both variables are count data, we
use Poisson regression in our analysis.14 One characteristic of Poisson regression is
that the mean and the variance are equal to each other. When the data have
differing mean and variance, we encounter the problem of over-dispersion. For
both dependent variables, the mean and the variance are different.15 In order to
address the over-dispersion problem in our data, we allow the variance function of
the Poisson distribution to have a multiplicative over-dispersion factor in the
regression. The results reported in this section have been corrected for overdispersion.
13. Notice the peak of loss ratio in 2001 coincided with the withdrawal of certain insurers,
including St. Paul Travelers.
14. A Poisson regression has a probability density function of Pr( y = n) = e
n=0, 1, 2,…, where
−λ
λn
n!
,
λ > 0 represent the parameter for the Poisson regression from which y is
λ is the log-linear model, ln λ = β ' x . It can be
drawn. The most common formulation for
shown that ∂E[ y x]
∂x
= λβ , which means that the sign of the coefficient is also the same as the
sign of the true slope, and that the magnitude of the true slope depends on the value of x. For
more discussion of the Poisson regression, see Greene (1997).
15. For variable Entry, the mean and the variance are 1.4804 and 1.3324, respectively. For
variable Exit, the mean and the variance are 1.4020 and 1.2318, respectively.
© 2009 National Association of Insurance Commissioners
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Journal of Insurance Regulation
For both the entry and exit equations, we report regression results of two
models. Model 1 utilizes all the variables described earlier. Model 2 includes two
additional variables: lagged entry and lagged exit. As Ilmakunnas and Topi (1999)
point out, “entry and exit are likely to be interrelated, possibly with a time lag.”
Past entry can influence future entry and exit, and vice versa. It is also possible
that the entry-exit interaction is simultaneous. Ilmakunnas and Topi (1999)
acknowledge the difficulty in modeling the complex relationship between entry
and exit using panel data. Here in our study, we let past entry and exit affect both
future entry and exit.
Table 6 reports the estimation results for the entry equation. When we exclude
previous entries and exits in the regression equation, we find that states with prior
approval rate regulation experienced fewer entries, a result consistent with our
expectation. This suggests that such regulation serves as an entry barrier. For
states that intend to encourage entries, relaxation of such regulation may be
warranted. However, if we also include previous entries and exits in the regression
equation, the marginal significance of rate regulation disappears. But at the same
time, we notice that past exits do have a significant positive impact on current
entries. This indicates the displacement of some of the older firms by new firms.
© 2009 National Association of Insurance Commissioners
65
Medical Malpractice Insurance Market Entry and Exit
Table 6: Poisson Regression Results of Entry Equation
Dependent Variable = Entry (Number of Firms Entering
State s in Year t)
Model
Model 1
Standard
Estimate
Error
-0.3024
0.5297
Model 2
Standard
Estimate
Error
-0.3082
0.5383
-0.0365
0.0293
0.1716 0.0315***
10.8639
4.259**
10.6899
4.6329**
-0.7199
1.5085
-0.9102
1.5243
Num Firm (s, t-1) (x10 )
-0.0476
0.0194**
-0.0495
0.0197**
Percent Mutual(s, t-1)
-0.0402
0.2516
-0.0172
0.2604
Concentration(s, t-1)
-0.3778
0.437
-0.5037
0.4464
Specialization(s, t-1)
-1.5265
0.4056***
-1.3062
0.4232***
MM-LR(s, t-1)
0.0776
0.1413
0.0159
0.1444
MM-LR-STD(s, t-1)
-0.0782
0.09
-0.0738
0.0959
Loss Change(s, t)
-0.2386
0.0669***
-0.2147
0.0693***
CLR(t-1)
1.2834
0.2949***
1.0115
0.3363***
CLR-STD(t-1)
-0.1652
0.0545***
-0.1368
0.0561**
Damage Cap (s, t)
-0.0563
0.078
-0.0391
0.0791
Alternative Mechanism (s, t)
0.0987
0.0784
0.0475
0.0797
Parameter
Intercept
Entry (s, t-1)
Exit (s, t-1)
Invest Yield (t-1)
GSP Growth(s, t)
-7
-0.1382
0.0768*
-0.0714
0.0780
Prior Approval (s, t)
1.0974
1.0701
Scale
612
561
N
-416.7125
-382.6023
Log Likelihood
***, **, * indicate statistical significance at the 1%, 5% and 10% levels,
respectively.
Source: Authors’ analysis of NAIC data
Except for the above mentioned differences, the two models generate very
consistent results. Among the economic conditions variables, the investment yield
is positively associated with entries as expected. However, there is no evidence
indicating that the potential economic opportunity represented by the GSP growth
rate has a significant effect on a firm’s decision to enter the medical malpractice
market.
© 2009 National Association of Insurance Commissioners
66
Journal of Insurance Regulation
The adjusted total number of medical malpractice insurers in states is
negatively linked to the number of entries. This suggests that a larger industry size
as measured by the number of players discourages entries. A possible explanation
for this is that prospective firms may view the existence of many incumbents as a
sign of increased competition, hence attract fewer entries.
Increases in the specialization ratio are associated with fewer entries. This
provides support for the hypothesis that states in which there is greater
specialization are more difficult markets in which to compete and therefore are
less likely to be entered.
The percentage change in losses paid is negatively related to entry, as
hypothesized. This suggests that deteriorating loss experience, other things equal,
discourages market entry.
The all lines combined ratio and the standard deviation of the distribution of
the all lines combined ratio are both significant. The loss ratio has a significantly
positive association with entries, which is contrary to our expectation. A possible
explanation is that since combined ratios are a function of investment returns, the
model estimation is driven by an underlying dynamic of insurers seeking to write
long-tail lines, such as medical malpractice, during periods offering higher
investment returns in order to access capital to invest. The standard deviation of
the combined loss ratio distribution is negative, as hypothesized. This suggests that
greater variation in underwriting results for malpractice insurers discourages firms
from entering new markets to write medical malpractice insurance.
Table 7 reports the estimation of the exit equation. When we consider the
impact of past entry and exit, we find that more past entries tend to lead to more
current exits. This result is consistent with the firm-level analysis by Danzon et al.
(2004), who find that recent entrants in medical malpractice insurance had much
higher estimated exit probabilities.
© 2009 National Association of Insurance Commissioners
Medical Malpractice Insurance Market Entry and Exit
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Table 7: Poisson Regression Results of Exit Equation
Dependent Variable = Exit (Number of Firms Exiting
State s in Year t)
Model 2
Standard
Estimate
Error
Parameter
-0.7147
0.4852
Intercept
0.0696
0.0278**
Entry (s, t-1)
0.0354
0.0314
Exit (s, t-1)
-6.2045
4.3863
-1.1037
5.0008
Invest Yield(t)
1.0184
1.3997
0.7305
1.4473
GSP Growth(s, t)
-7
0.0165
0.0162
0.0154
0.0167
Num Firm/P (s, t) (x10 )
-0.7368 0.2494*** -0.7171 0.2561***
Percent Mutual(s, t)
-3.2376 0.5039*** -2.6041 0.5377***
Concentration(s, t)
0.5146
0.4362
0.5043
0.4516
Specialization(s, t)
0.1864
0.1425
0.1438
0.14328
MM-LR(s, t)
-0.0631
0.0793
-0.0453
0.0757
MM-LR-STD(s, t)
0.0112
0.0727
0.0099
0.07222
Loss Change(s, t)
1.3761 0.2913*** 1.1172 0.3265***
CLR(t)
-0.1033
0.0466**
-0.0839
0.0472*
CLR-STD(t)
-0.1585
0.0757**
-0.1338
0.0776*
Damage Cap(s)
0.0863
0.0764
0.0952
0.0782
Alternative Mechanism (s, t)
-0.1504
0.0727**
-0.1361
0.0749*
Prior Approval(s, t)
1.0041
0.9919
Scale
561
510
N
-448.0244
-404.2143
Log Likelihood
***, **, * indicate statistical significance at the 1%, 5% and 10% levels,
respectively.
Model
Model 1
Standard
Estimate
Error
-0.4915
0.4693
Source: Authors’ analysis of NAIC data
Regarding other variables, the two models generate very consistent results.
Among the market condition variables, the percentage of insurers organized as
mutuals, reciprocals or risk retention groups is negatively associated with exit. In
other words, a stronger presence of such physician-owned firms is associated with
fewer exits. This is likely due to the capital contribution by the physicians bonding
them to stay with the same insurer, and bonding the insurer to stay in the market,
in spite volatility in the market over time. Our result provides some evidence,
albeit limited, that firms of this type may be more stable market participants than
© 2009 National Association of Insurance Commissioners
68
Journal of Insurance Regulation
firms organized as stock companies. Moreover, our result also lends support to the
hypothesis by Lei and Schmit (2008) that physician-owned insurers may have an
informational advantage in terms of underwriting, pricing and claims adjustments,
and that they may be better at managing risks internally. Their empirical results
show that such insurers demand less reinsurance as a risk management method.
Our results show that states with more geographically concentrated firms see
less frequent exits of insurers. The reason could be that less competition associated
with higher concentration ratio implies superior incumbent advantages, thus
discouraging exit.
As in the entry equation, the all lines combined loss ratio and its standard
deviation have statistically significant relationship with market exit. Higher loss
ratios are positively associated with exits, which is consistent with our hypothesis.
Contrary to our expectation, the standard deviation has a negative relationship
with exits. One potential explanation could be that a higher standard deviation
implies more volatility in underwriting profitability and incumbent insurers may
see greater opportunity in increasing future profits. Therefore, they are less likely
to withdraw from the malpractice market.
In both models, we find that two of the reform variables, damage cap and
prior approval, serve as exit barriers. As hypothesized, states that have caps on
non-economic damages experience fewer exits, which suggests that this reform
does help stabilize the medical malpractice market in a state. Contrary to our
expectation, our results show that states that require prior rate approval for medical
malpractice line of business see less frequent exits of insurers. One possible reason
could be that prior rate approval restricts market entry, hence reducing competition
from newer firms.
Robustness Tests
We performed two robustness tests. The first one was to lag the Loss Change
variable by three years to adjust for the average claim tail. As a result, the number
of observations was reduced to 459 for the entry equation, and 408 for the exit
equation. We find that our main results still hold. Past exit, number of firms,
specialization ratio, combined loss ratio and its standard deviation remain
associated with market entry. However, the investment yield and the Loss Change
variable itself do not remain significant. The marginal significance of Prior
Approval also disappears. As for the exit equation, our results show that past
entry, percent mutual, concentration ratio, combined loss ratio, damage cap and
prior approval remain significant. The only major difference is that the standard
deviation of the combined loss ratio is no longer significant in both models.
The second robustness test we performed was to create a sub-sample that only
included insurers that covered at least some physicians or hospitals. On average,
more than 80 percent of the malpractice premiums in our sample come from
physicians and hospitals. Restricting our sample to just those firms, we were left
with a sub-sample of 255 observations. For the entry equation, we find that past
exit, the investment yield, the specialization ratio, the combined loss ratio and its
© 2009 National Association of Insurance Commissioners
Medical Malpractice Insurance Market Entry and Exit
69
standard deviation remain significant with the same signs as in the full sample.
However, Loss Change and prior approval are no longer significant. As for the exit
equation, past entry, the percent mutual, the concentration ratio, the combined loss
ratio and its standard deviation remain significant. Their coefficients have the
same sign as in the full sample, except for the loss ratio standard deviation. The
major difference is that none of the reform variables turn out to be significant in
this sub-sample. We think the reason is that this sub-sample only covers a short
period, from 2001 to 2006, due to data availability. However, in many states the
reforms were undertaken long before 2001. Therefore, it is difficult to detect the
effects of state reforms in this sub-sample.
Conclusion
The past three decades have seen periodic premium increases and withdrawal
of insurers in the medical malpractice market. In order to alleviate these market
problems and increase the availability of malpractice insurance, some states
enacted tort reforms including caps on non-economic damages. Additionally, some
states instituted Patients’ Compensation Funds and Joint Underwriting
Associations to augment the availability of insurance coverage. At the same time,
the amount of malpractice insurance written in the private market by physicianowned insurers expanded.
The current study examines the effect of these state actions and the growth of
physician-owned insurers on the dynamics of the medical malpractice insurance
market. The NAIC 1994-2006 database is used to conduct the analyses at the state
level.
Our results show that the medical malpractice industry combined loss ratio
and its standard deviation are important determinants of market participation. The
standard deviation of the combined loss ratio appears to serve as a deterrent both
to entry and exit, as higher values of this variable are related both to fewer entries
and exits. This suggests that greater volatility in profitability deters potential
market participants from entering, but at the same time also discourages
incumbents from exiting the market, perhaps because they perceive possible
higher returns associated with higher risk. The combined ratio itself is associated
with more entries and exits. This suggests that lower profitability in the market
may attract new entrant firms who perceive opportunity in the exit of other firms
from the market.
Our results indicate that the investment yield, the specialization ratio and the
yearly percentage change in losses paid are associated with insurer entry decisions.
Higher investment yields attract more entrants. States with higher rates of insurer
specialization and those with deteriorating loss experience have less entry than
other states, other things equal.
We find fewer exits in states with a higher percentage of writers organized as
mutual companies, reciprocals or risk retention groups. States with more
geographically concentrated insurers also saw fewer exits.
© 2009 National Association of Insurance Commissioners
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Journal of Insurance Regulation
Our results suggest that states that have placed caps on non-economic damages
have lower rates of insurer exit, other things equal. In order to discourage exit, state
legislatures may want to consider enacting caps on non-economic damages.
We find that prior approval regulations are associated with both fewer entries
and fewer exits. The model coefficients suggest that exit decisions are more
sensitive to the presence of a prior approval regulation. For instance, in Model 1,
the coefficient for prior approval regulation in the entry equation is -0.1382 and in
the exit equation it is -0.1504. Therefore, the enforcement of such regulation
results in a positive change in number of insurers, specifically, 0.0122.
Future research that examines the extent to which entering firms replace
exiting firms is needed. Our data did not permit us to examine whether entering
firms provide coverage similar to that which had been provided by exiting firms.
For instance, whether entering firms serve physicians in the same medical
specialties as those covered by the exiting firms is warranted. Since some carriers
underwrite only one physician specialty, future research studying entry and exit
decisions by different specialty carriers would be informative.16
16. We thank the reviewer for pointing this out.
© 2009 National Association of Insurance Commissioners
Medical Malpractice Insurance Market Entry and Exit
71
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© 2009 National Association of Insurance Commissioners
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SOURCE: J Insur Regul 27 no1 Fall 2008
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