Philadelphia Reflections

Malpractice: Insurance War Stories

ROBERTS

The 1937 Supreme Court (Owen Roberts, for the majority) allowed Franklin Roosevelt's New Deal to place the federal government in charge of all American commerce, not merely interstate commerce as the "commerce" clause of the Constitution provides. Congress, however, soon exempted the insurance industry from that federal control by passing the McCarran Ferguson Act. States were thus put back in charge of insurance, and it's about the only commerce they are in charge of. Out of this peculiar political anomaly, grows the present uncomfortably deep penetration of the local insurance industry into state politics. And over time, the unanticipated deep penetration of state politics into insurance.

In return, state governments have conferred at least one favor on insurance lobbyists unwisely. If an insurance company fails, subscribers angrily find themselves stranded. The patchwork solution arises, of assigning the obligations of a failed company to its surviving competitors. With no immediately visible cost to the taxpayers, that seems to rescue the subscribers. But it removes any point to competition, eventually raises premium prices, and overall, broadcasts moral hazard. That is, it doesn't matter how badly they behave, their competitors will have to pay for their mistakes. Moral hazard is the most insidious form of political corruption because it is so seldom punished.

Politically inclined state insurance commissioners have other favors to extend. Malpractice companies work in an environment with a peculiarly long tail. (Translation: It's at least six years before the average case is finally settled and paid.) A brand new insurance company collects premiums for six years before paying out much for claims. True, with unrealistically low premiums they are destined to go bust in six years, but there's a free ride in the meantime, including an available punt in the stock market with unspent cash. Investment income during those six years is chancy, making survival a gamble after six years. Lately, the true finances can be obscured by "finite reinsurance", which guarantees to absorb heavy losses, but often neglects to announce how briefly it will do so. It's the job of the Insurance Commissioner to decide whether premiums are realistic, the job of the auditors to assure that the complexities are transparent, the job of the competitors to complain if premiums are too low, and the moral hazard for the Insurance Commissioner arises -- from knowing in the worst case it won't matter to the subscribers, the competitors will bear the cost. Since Insurance Commissioners are usually politically appointed young lawyers, competing insurance companies are actually in political competition, not economic competition. As we say in Pennsylvania, you must Pay To Play.

These seamy realities can unexpectedly exploit premium differentials between medical specialties. There are a lot of lawsuits against obstetricians, neurosurgeons, and orthopedists; consequently, the premiums for these specialties are quite high. Pediatricians and general practitioners have low premiums reflecting infrequent lawsuits. Now, it might be supposed a company seeking long-term profitability would prefer to ensure clients who don't get sued. But here and there you can be surprised to see a new company with great eagerness for high-risk clients, people who get sued a lot. This paradox rests on the quick accumulation of big-ticket premiums from a mere handful of clients. Competitors are prompted to suspect companies with that behavior are looking to accumulate as much premium revenue as possible during a six-year free ride, even lowering premiums somewhat to generate business. But if they misjudge the stock market during those six years, all the other competing companies will likely be forced to pay for the gamble.

Once in a while, the totally unexpected happens. For example, some years ago thirteen judges in one city went to jail for accepting bribes. The Republicans wouldn't appoint Democrat judges, and the Democrats wouldn't confirm Republican appointees to fill the vacancies. During this impasse, Congress happened to pass a law leap-frogging drug offender cases ahead of everything else on court dockets; the unanticipated consequence was an eight-year period without malpractice trials. It became a sort of judicial coiled spring. Insurance companies accumulated huge reserves, the politicians squeezed down the excessive premiums as "windfall profits", money was made and lost in the stock market, and when finally the judicial logjam was broken, the cases had to be paid. Guess what. There wasn't enough money to pay the claims, and premiums took a big jump. Doctors and lawyers bellowed at each other that it was the other profession's fault. In a sense, that wasn't fair either way, although come to think of it, most judges are lawyers. As are most legislators. And Insurance Commissioners. These particular lawyers may not have participated in the problem, but only they are in a position to fix it.

Originally published: Tuesday, June 20, 2006; most-recently modified: Sunday, July 21, 2019