He Sets Your Doctor's Bill

By Jyoti Thottam

You don't have to feel sorry for the insurance industry to appreciate Donald Zuk's predicament. The CEO of SCPIE Holdings, California's second largest malpractice insurer, Zuk launched an ambitious plan in 1996 to expand into new states like Texas and Georgia and into new lines of business, such as insuring dentists and higher-risk doctors. It was a disaster.

Zuk, 66, a burly former football player, found himself fighting a multistate price war, cutting premiums to grab market share and badly underestimating how much his firm would pay out for claims against doctors. "The loss ratios were going through the roof," Zuk says. SCPIE raised premiums for policies outside California about 40% in 2001 and 30% in 2002. Yes, Zuk is one of the people responsible for the malpractice-insurance crisis that is disrupting the lives of so many doctors and patients. But he's not exactly profiteering. His firm has posted $96 million in losses over the past two years.

The Los Angeles--based company has retreated to California, pulling out of the malpractice business in other states. Says Zuk: "We knew that there was a risk when you go into a state without tort reform"--limits placed on personal-injury lawsuits and damages. "We thought the rates were sufficient, so we went with it. Today I know what's going on around the country. I won't go into Texas, Florida or any of the states I pulled back from until there's some semblance of tort reform."

Zuk has plenty of company in his malpractice losses and in his zeal for reform. In 2001 medical-malpractice insurers paid out $1.53 in claims and expenses for each $1 in premiums they collected. The industry has lost a combined $8 billion since 1995, and its reserves for estimated future claims are underfunded by about $4.6 billion. So if insurers aren't profiting from higher premiums, who is? Zuk and his peers point to trial lawyers and frivolous claimants. Insurers are lobbying alongside doctors for caps on noneconomic damages (for pain and suffering), like the ones in California and 18 other states. Rising awards, Zuk says, are bleeding money out of the system and forcing insurers to raise premiums. Cap the damages, and premiums will fall in line, he says.

Not everyone accepts that link. "In theory, tort reform would have an impact on premiums. In reality, that has not been the case," says Martin Weiss, chairman of Weiss Ratings, an independent insurance-rating agency in Palm Beach Gardens, Fla. In a study published this week, Weiss Ratings found that in states without caps on noneconomic damages, median annual premiums for standard medical-malpractice coverage rose 36% between 1991 and 2002. But in states with caps, premiums rose even more--48%. In the two groups of states, median 2002 premiums were about the same. Weiss found nine states with flat or declining premiums; two of them had caps, seven didn't. Weiss speculates that regulation of premium increases made the difference. In California, consumer groups argue that the state's tough oversight of the insurance industry, not its caps on damages, explains why rates have grown more slowly.

Caps on noneconomic damages may not hold down doctors' insurance costs, but they have boosted insurers' profits. In states with caps, the Weiss study found, claims payments grew only 38%, compared with 71% in states without them. By raising premiums, insurers have improved their ratio of claims to premiums, a key measure of profitability, from 110% in 2000 to 89% in 2002. "The caps are great for insurers," Weiss says. "Their payouts will be lower. In a perfect world, they would pass that savings on." But the industry's losses have been so large that lower claims will not reverse them; insurers are likely to keep raising premiums.

Raising rates is exactly what malpractice insurers failed to do in the 1990s, even as claims were rising. Zuk concedes that the industry has to accept some blame. "No one wanted to be the first guy to say, 'We've got to start charging the right premium,'" he says. The insurers feared losing market share, and as long as investment income held up, they could ignore rising claims.

The malpractice-insurance industry went through similar cycles of low rates, squeezed profits and price hikes in the mid-1970s and again in the mid-'80s. Zuk, who enrolled in law school in the '70s just to learn torts, says ballooning malpractice claims make the current crisis worse than previous ones. From 1997 to 2001, the median malpractice jury award doubled, to $1 million, but that counts results only in the 1% of lawsuits that are won by plaintiffs. The number of malpractice suits has remained stable, and although some states have seen sharp jumps, the average claim payment has grown about 8% a year, close to the rate of medical inflation.

Industry analysts say insurers' investment losses, not just jury awards, are behind the crisis. In bull markets, insurers count on investment income to offset underwriting losses; that ended when the 1990s' stock bubble burst. Although malpractice insurers make only about 20% of their investment income from stocks, the losses were steep and came in tandem with low bond yields.

Insurance firms, Zuk says, must stabilize the disruptive cycle of cutting rates and then raising them when losses grow too big. Regulators could stop an insurer from underpricing premiums and "protect it from its own stupidity," as Zuk puts it. "The industry has to say, 'Forget investment income. Let's just write to an underwriting profit.'"

Some industry experts suggest national standards for acceptable outcomes in medical procedures. Zuk says a separate malpractice torts system would be a better solution. New standards, he argues, would only put doctors on the defensive. He recalls his own knee replacement in 2001. His doctors, he says, focused on treating him, not providing disclaimers or ordering tests. Zuk is convinced he knows why: "They don't have to worry about me suing them." --By Jyoti Thottam