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Commentary: A Look at the Perplexing Process of Determining Rates
By Terrance J. Sheehan, MD
President & CEO
In various Medical Mutual publications and
correspondence to member-policyholders,
I’ve mentioned the recent trend of moderated
claims and the fact that it bodes well for
premium relief because claims are such a
significant factor in setting premium rates.
Well, we are fortunate to be reporting in
this issue of The Advocate on recentlyannounced
rate changes that will produce renewal premium
reductions for almost all insured physicians in both Maine and
New Hampshire for the coming year. At press time, rates for
Vermont were still in the midst of an actuarial analysis.
Yet while I’m sure everyone will agree that it makes complete
sense for rates to reflect claims activity, I’m just as certain that
most would say there is a significant element of perplexity surrounding
how rates are actually determined. Which is why I’d
like to take this opportunity to shed some light on the process.
It’s All About Future Expectations
In setting rates, any medical professional liability insurance company
must cover the cost of claims and claims related expenses, as
well as the operating expenses related to the company’s everyday
work. Unlike Medical Mutual, large stock commercial carriers must
also factor in the need to show adequate profit for its investors.
Given these needs, what is a fair price for a physician to pay
Medical Mutual today to protect against the financial impact of
potential claims he or she may face due to his or her delivery of
patient care in the coming year? The implication of this question
is that we must determine the risks — and the costs associated
with them — for potential future events. It goes without saying,
then, that the process for doing so is inherently inexact.
Particularly since the accounting for potential costs can stretch
out years into the future. And the claim itself may not be filed
until years after the incident.
We can and must look to the past for insight on the question,
but it’s important to note that we cannot and do not use the
process to recoup costs for past claims and losses. Again, rates for
coverage must only reflect estimated future costs. That said, our
actuaries fortunately have access to lots of data they can analyze
to guide them in their work.
Of Sample Size, Frequency and Severity
For any kind of insurance, the process of determining rates begins
with an analysis of losses aggregated over defined periods of time in a
specified market. This includes looking at loss frequency—the variation
in the raw number of claims in the market over a specific time
period. Claims severity, the measure of the magnitude of financial
losses associated with claims, is the other major factor to analyze.
In, say, the automobile insurance market, for instance, future
losses are relatively predictable because the frequency is high and
the severity is low. In medical professional liability insurance, one
has a small number of claims that have a much higher average
value and a significantly wider range of possible outcomes.
In smaller markets like Maine, New Hampshire and Vermont,
this combination presents a challenge for determining rates.
Modest spikes in frequency or a few claims of disproportionately
high severity can significantly skew the picture of the local market’s
claims experience.
Base Rates and Relativities — The Specialty Factor
This sample size-variability factor is further compounded when
you break the physician market down into even smaller specialty
groups, which is essential given the varying degrees of risk
involved among different medical specialties.
To moderate the potentially drastic peaks and valleys in claims
experience to which Medical Mutual’s small service markets can be
prone, we also look at national loss data by specialty. Beginning with
Family Practice, our actuaries determine the projected losses tied to
the ensuing year’s coverage and recommend a premium rate to cover
claims and expenses. The actuaries then examine the loss experience
of all other specialties, compare them to the base rate established for
Family Practice and adjust the specialty rates relative to the variance
from the Family Practice base. Hence the term “relativity factor.”
Investments as a Mitigating Influence
Medical Mutual, like all insurance companies, uses its investment
income to offset any underwriting losses. This investment activity
is regulated by State laws. Accordingly, and in line with our conservative
investment philosophy, the vast majority of Medical Mutual’s
invested assets are in fixed-income instruments. So the higher the
prevailing interest rates, the more Medical Mutual’s investment
income can serve as a mitigating factor in the ratemaking process.
It’s important to note that, as with past claims losses, we cannot use future premium rates to recoup investment losses, rare as they are.
The Unique Bonus of Dividends
Similarly, Medical Mutual, by virtue of its mutual structure whereby
member-policyholders actually own the company, has the ability to
declare a dividend when premiums collected exceed the costs of
claims, everyday operations and assuring a financially strong company.
At Medical Mutual, such dividends, like the one recently declared
which aggregates nearly four million dollars, are payable as credits
against renewal premiums, thus effectively reducing rates for the year.
Ratemaking and The Medical Mutual Record
So with the inexact nature and complexity of ratemaking, how
has Medical Mutual’s process fared? We’re not always the lowest
in the market. Like everyone, we’d prefer to be able to offer lower
rates when possible (this year’s rate reductions are clearly welcome).
But when it comes to proper rate-setting, perhaps the best measure
is that as of September 1 of this year, Medical Mutual has been
here to protect the assets and reputations of our insureds for 30
uninterrupted years. All with premium rates that in New
Hampshire are below national averages (third quartile), while
Maine and Vermont are in the lowest quartile nationally.
By contrast, during that same 30-year span, many carriers who
did offer lower rates—and some who didn’t—have either become
insolvent or left the market voluntarily to pursue more lucrative
lines of business or to serve geographic markets that promised better
financial returns for medical professional liability coverage.
The ratemaking process may indeed have an element of mystery. But as history has shown, whatever premium rate you pay to Medical Mutual, it’s your assurance that we are here for you when you need us most.