Professional malpractice liability insurance protection is a major fixed operational expense in any at-risk medical practice. In most practices, liability insurance costs often represent one of the largest single line item expenses, often falling second only to staff payroll expenses. To contain these liability overhead expense costs, the physician-executive should understand the dynamics of the insurance industry selling process, which is generally sold through one of three agency avenues: • direct insurance agents serving as employees of a single insurance company; • captive insurance agents representing only one insurance company; or • independent insurance agents representing multiple insurance companies. The first two agents have little incentive to promote any company other than the one they represent. The latter agent type brings a different set of complexities to the arena. For example, they often receive bonuses, incentives or are held to production quotas as a requirement of employment. Commission structures are the most important incentives at work on the selling side of the process since different companies pay varying percentages of total premium dollars sold. This can work against the doctor because the agent has an incentive to sell the highest priced product in order to earn the greatest commission. Upon request, however, a reputable insurance brokerage house will provide a detailed market comparison in writing that demonstrates the major options available to the practitioner. This is because, in contrast to agents, an insurance broker is an independent contractor who examines the malpractice needs of the client and then shops for coverage to best fill those needs. Moreover, group insurance purchasing usually nets a better deal than a practitioner could negotiate individually. Thus, if capitated medicine, as demonstrated by many managed care organizations (MCOs), continues, the potential for reduced operational costs through lower medical malpractice premiums could be significant. This is the major thrust of the Capitation Liability Theory (CLT). Moreover, it suggests that a fixed rate reimbursement system reduces malpractice incidents due to a reduction in the total number of patient-physician encounters and the acuity of those encounters, particularly for invasive procedures such as surgery and for procedural specialists. Consequently, some providers may be paying too much for professional liability protection while others pay too little. What Goes Into Setting Liability Premiums Most liability insurance companies, their associated underwriters and actuarial advisors tend to focus on economic factors such as income/loss ratios, market forces and trend analysis as a basis for a continuing line of insurance coverage. That said, carriers have considerable latitude in how they function as a business, whom they insure, how they align their members, in what manner they allocate reserves and how they manage cost/income factors and determine market variations for the purpose of setting premium levels. While underwriters and actuaries may strive to make the premium pricing process a scientific discipline, the process is still a decidedly heuristic one. As the liability premium pricing process arrives at the bottom line of corporate fiscal responsibility, the stability of the individual company and national market forces determine premium structure on a comprehensive basis. Managed care entities may be national in scope, but the delivery of healthcare services is a local business. The potential negative effect of national pooling on individual premium pricing is significant. Unfortunately, liability underwriters are reluctant and even secretive about sharing confidential experience data. These professionals are skilled at data collection, information management, manipulation and trend analysis to justify and defend their own charges. Challenging such cost projections and making a case for premium reductions is not easy but can be addressed with adequate knowledge, information and constant persistence. With this in mind, let’s take a closer look at the CLT. A Guide To The Capitation Liability Theory Or Litigation Equation The CLT considers four primary areas of potential significance in malpractice liability management and premium costs. This is known as the litigation equation and includes (1) patient communication factors; (2) provider healthcare delivery systems and reimbursement factors; (3) payer factors; and (4) revised liability legislation and patient encounter data factors. Patient communication factors include reduced economic and financial fear, possible cultural barriers, improved medical awareness through continuing education, concern for geographic access, focused primary and specialty care availability, management information systems, and the frequency and duration of utilization. Provider reimbursement factors and healthcare delivery systems include both soft and hard varieties. Soft provider factors include increased patient availability to services, accessibility to timely appointments, office and quality care satisfaction surveys, communication assessments, known fixed costs and technical information interchanges. Hard factors include managed operational procedures, reduced illness severity, defined treatment options, reduced clinical variations, outcomes measurements and quality monitoring, performance quotas, aligned financial incentives and predictable reimbursements. Payer factors include practitioner screening and shifting, quality assessment, behavioral modification and team care, provider discipline, complaint management, cost and call economic considerations and adequate capitalization rates. Liability factors include allegation frequency and severity, standards of care, defensibility, risk management, premium pricing, loss adjustment, settlement losses and administrative costs. To fully understand the CLT, one must recognize all four parts of the litigation equation. These factors, when integrated with underwriter data and experience, determine the level of liability risk and the ultimate cost of malpractice coverage. If capitated medical care is deemed to involve less risk than the indemnity environment, the cost of liability coverage should gradually decrease as the percentage of capitated managed care increases in a particular office setting. In actual terms, the CLT suggests that capitated insurance and patient care risk are inversely, but not necessarily proportionally related since experiential data will determine the percentages. Understanding The Intersection Of Reimbursement Models And Malpractice Claims Collectively, liability claim managers suggest that financial issues are a secondary, albeit precipitating, factor in 15 to 25 percent of all malpractice allegations. Adjudicators further state that aggressive attempts to collect account balances, deductibles, co-payments and non-covered services are a significant causative factor in litigious individuals. The liability factor is compounded if the medical outcome is less than desirable. With this in mind, let’s consider the following four reimbursement structures and models. The fee-for-service reimbursement model was the bedrock of healthcare financing until the last decade and was the dominant model of paying for medical services. This insurance driven and technology motivated approach was powered by utilization and consumption with limited concern for the total cost of care or economic consequences. While indemnity providers continue to be forgiving in the management of patient indebtedness, the incidence of financial hardship and subsequent litigation is believed to be the most frequent in this system. A review of provider owned insurance carriers generally supports this conclusion. Conversely, a capitated model reimbursement system views patients and the services they require as a cost driver to be debited against a fixed rate or constant reimbursement scheme. This system controls utilization, manages referrals and limits technology but also creates a new set of behavioral problems, stress, frustration and liability. However, patient indebtedness and personal financial hardship are substantially reduced and so is a precipitating liability factor. The quasi socialistic model is powered by entrepreneurs who believe that health care is immune to market forces such as competition or accountability. Reformer-change agents suggest consumer needs and social welfare in general will prosper through structured business systems with quantifiable and measurable processes. This top-down management structure embraces the general public opinion that affordable healthcare is a right and that managed markets are the best model for this philosophy. Although results remain uncertain, the market trend is irreversible. A mixed model or transitional reimbursement system represents the best or perhaps the worst of both payment options and is a major administrative challenge for the healthcare provider. Services may be classified as a profit or debit depending on the payer arrangement and all care must be performed with equal concern for quality, medical necessity and appropriateness. Gatekeepers manage the capitated care, control referrals and provide care for at-risk patients for reimbursement with the ultimate payer intent of a 50/50 provider mix of primary care and specialists. A preliminary evaluation of these four reimbursement methodologies suggests the level of malpractice risk and associated litigation is decreasing as the volume of capitated managed care increases. What You Should Know About RRGs And PGs The introduction of the Liability Risk Retention Act (LRRA) in 1986 turned a hard market for malpractice insurance soft as the Act expanded the definition of liability and preempted state regulations that restricted small groups from underwriting for commercial insurance buyers engaged in similar or related business activities. The LRRA permitted the formation of Risk Retention Groups (RRGs) and Purchasing Groups (PGs) to qualify as insurance companies and retain certain layers of risk while transferring higher layers to reinsurers. In essence, the LRRA flipped the insurance industry upside down and returned the decision-making process and control back to the consumer. The fundamental difference between RRGs and PGs is that RRGs retain risks and PGs do not. In enacting the LRRA, Congress provided two ways for insurance buyers to obtain liability coverage. These included becoming owners of their own liability insurance company (RRG) or becoming members of a PG that purchased insurance from a commercial carrier, usually at a substantial discount. There are no group size requirements for either RRGs or PGs. PGs can evolve into RRGs if growth, profitability and actuarial data are favorable. The advantages include: • tailor made coverage; • favorite premium rates; • better policy terms; • ownership of the loss experience; • segregation of loss data; • reward for good experiences; • risk management and loss prevention programs; and • long term commitments from insurers. Addressing Increasing Mergers And Acquisitions As the healthcare delivery system is transformed by consolidations, mergers and acquisitions, so goes the liability need of the individual, group or institutional provider. Traditional insurance solutions are no longer suitable as hospitals are combined into larger systems and large systems are merged into even larger organizations with ownership of, or in partnership with, physician practices and alternative treatment centers. Risk factors and pricing models of the past become inappropriate for contemporary providers who function within a more corporate structure. As these larger organizations develop, their malpractice insurance needs change and so must the companies that supply those needs. Larger groups can afford to take on attrition or frequency risks internal to their own capital base and organization structure. As systems grow, groups become increasingly interested in risk layering, reinsurance and loss sensitive pricing options. Larger systems can institute and provide their own internal risk prevention, quality monitoring and incident management processes. Medical malpractice premium pricing ceases to be a one-dimensional market, even in the same geographic community or specialty provider class. Regulatory management and capitated reimbursement price controls are thus redefining the industry at all levels. Liability pricing and pricing flexibility are no exception. In fact, according to a 2001 Physicians & Surgeons Update, “claims trends in the medical liability market have remained essentially unchanged” for five years running and no rate change is anticipated for the coming year with all physician and surgeon liability policies extended to 12-month terms. Moreover, frequency, severity and average indemnity payments are not necessarily reflective of the entire medical liability industry or specialty underwriters. The significance of risk-based, capitated reimbursement systems in the stability of the current professional liability market is not identifiable from current data, but believed to be a factor. Additionally, liability data from the several closed panel capitated reimbursement systems suggests support for the stability trend. As interesting as this may be, staff model HMOs, which are a shrinking type of delivery option, are not necessarily reflective of other vertically integrated and at-risk delivery systems more prevalent in the emerging healthcare marketplace. Final Thoughts In conclusion, one can emphasize the following points to support reduced professional liability costs in an ever-evolving reimbursement system. • Understand the local medical malpractice market environment and your position in that environment. • Ensure clarity on how the medical service payment is being provided and who is providing it. Also stay on top of the payment mix, percentages and trends. • Don’t accept quoted liability rates as the only possible option since further comparisons, evaluations and alternatives may be available. • Implement a data tracking system with risk management and risk education. This should feature specific data for each medical speciality. • Be familiar with the concept of clash coverage or multiple coverage for a given exposure incident. A single policy covering all entities is always less expensive than multiple policies covering multiple entities. • Note the dissemination of risk and the transfer of professional liability to corporate medicine (i.e., PPMCs, IPAs) enterprise systems and managed care structures, thereby layering risk and coverage. Indeed, doing nothing to reduce professional liability costs in an increasingly integrated delivery system environment with capitated reimbursement is a guaranteed financial drain on your net income. Dr. Marcinko is a board-certified financial planner who has written a dozen management and finance textbooks for physicians. He is the CEO of www.MedicalBusinessAdvisors.com , a practice management resource center. Dr. Marcinko can be reached at (770) 448-0769 or via e-mail at firstname.lastname@example.org . Editor’s Note: This article was adapted with permission from the third edition of Dr. Marcinko’s book, Financial Planning For Physicians And Healthcare Professionals. The second part of this article will appear in the February 2004 issue of Podiatry Today.