By Barbara Smith
While Pennsylvania physicians push their legislators to take steps to more effectively control the escalating cost of malpractice insurance through permanent reforms, the insurance industry has remained skeptical that any significant reform will occur. The lack of any meaningful reform, coupled with a skittish reinsurance market, has created an environment in which a “readjustment” in the insurance marketplace will continue. In order to protect their own interests, the insurance carriers will respond by either significantly limiting the number of Occurrence policies that they are offering to physicians that are totally claims free, or by converting all of the policies from Occurrence to Claims Made. Although there are carriers that will continue to offer Occurrence coverage, carriers in general have found that this move from Occurrence to Claims Made enables them to better predict their costs and be more proactive in the event that the experience indicates that loss ratios are deteriorating quickly on a book of business.
This shift from Occurrence to Claims Made allows the carrier to switch the financial burden from the insurer to the policyholder and becomes an issue when losses are incurred, but not reported, during the policy period. With an Occurrence policy, the carrier is responsible for the payment of a claim in which an incident occurred within the policy period regardless of when the claim was brought against the physician. The Claims Made policy will only respond when the claim is made, as long as the policy continues to be in effect. In the event the policy is terminated, then the physician is responsible for the continued coverage required until the time in which all possible claims can be brought has expired. In many cases, a patient’s right to bring a claim can extend for many years. It is through the obligation of the “tail” coverage that the insurance carrier shifts the ongoing financial obligation to the physician.
By shifting this financial responsibility, physicians are now confronted with the task of establishing a mechanism to pay for the cost of the tail coverage or extended reporting period. The cost for tail coverage can be up to 250 percent of the expiring mature Claims Made premium.
Consider an example of the potential financial impacts to an internist whose standard rate is $500,000/$1,500,000. Note that premium, claims made step increases and tail factors can and do change on an annual basis, and that this example does not reflect the MCARE payments. It is anticipated that the coverage provided by MCARE will continue to be on an Occurrence Form.
A Claims Made premium schedule for that internist might look like this: $6,173 (Year 1), $9,524 (Year 2), $16,579 (Year 3), $17,637 (Year 4 – mature policy), $17,635 (Year 5), for a total cost of $64,550 over those five years.
An Occurrence premium schedule for that internist might cost $17,637 for each of those five years, for a total cost of $88,185 over the five years.
The cost of the Claims Made policy for the first five years actually provides a savings for the physician. If the physician at this point were to retire permanently, the tail coverage would be free. Under this scenario there is a clear financial advantage to selecting a Claims Made policy over an Occurrence policy. However, given the scenario presented above, if the physician were leaving the practice and not eligible for a free tail, the cost of the tail based on the above scenario could be as much as $44,000.
For the physician who is in a stable environment and will continue to work in the same practice or stay in Pennsylvania for their entire career, the financial issues related to the shift from Occurrence to Claims Made may be minimized. Many carriers have taken the initiative to work with the physician to facilitate a smooth transition. In addition, many carriers offer a free tail in the event of permanent retirement, death or disability.
However, with this shift in cost to the physician, physicians need to understand the issues and establish some guidelines under which their practices will operate. In making the shift to Claims Made, the first question should address who contractually will be responsible for the cost of the tail. Contractually, is the individual physician or the practice responsible for the cost of malpractice insurance? For a practice in which there is a high turnover of the physician staff, the financial impact of the practice assuming this responsibility can be tremendous. In setting up a policy for handling the cost of tail coverage, the responsibility for the cost may differ based on several variables:
Status of the physician within the group. Is the physician a shareholder or partner? Is the obligation for the cost of the “tail” coverage different for the physician that is an employee of the practice?
Tenure with the group. Does the amount of time the physician has been with the group impact the individual physician’s responsibility to pay for the tail?
Purpose for leaving the practice. How the cost of the tail coverage is handled may differ based on the circumstances in which a physician will leave a group. A physician who is retiring, but who has not been insured with the same carrier continuously for five years, may be handled differently than a physician who is leaving after a shorter period of time to join a competing practice.
In addition to recognizing the liability for the individual physician, it is important to understand the corporate exposure that will continue to exist once the physician resigns. If the responsibility for purchasing the tail rests with the physician, the issue is how the corporate exposure or how the tail coverage for the corporation will be paid. If the responsibility of purchasing the tail rests with the individual physicians, and they choose not to purchase the coverage, then it is likely that there is a corporate exposure that will not be covered going forward. Consequently, in the event that both the physician and the corporation are named in a lawsuit, and the tail coverage is not purchased, then there is no coverage for the corporate liability. This consequence may expose the assets of the corporation.
Within a physician’s practice, addressing who is responsible for the cost of the tail for the individual physician as well as how the cost of the tail for the corporation will be paid should be outlined in each physician’s contract. With the shift of the market to the Claims Made form, it would be beneficial to address these issues before the practice actually makes the change to Claims Made. By addressing this issue proactively, the discussion may be a more meaningful business decision as opposed to having to try to address the issue when someone is leaving the practice
Finally, the issue of the tail coverage needs to be addressed in the event of a sale or dissolution of a practice. Many carriers provide for “free tail coverage” if the physician retires and does not practice medicine at all. However, if a physician’s practice is being sold and the “free tail coverage” does not apply, it is likely that the entity buying the physician’s practice will not assume the financial responsibility for the tail coverage. With this change in coverage form, it is probably a good time for physicians who have been in practice for some period of time to review their Buy/Sell Agreements. If the responsibility of the cost of the tail has not been addressed previously, addressing this issue at the time of the transaction will likely delay the transaction, as well as increase the costs related to the transfer.
As complicated as the switch from Occurrence to Claims Made may seem, with the proper planning the process can be made simpler. By planning ahead, the physician will be better served by making this decision on their own, rather than being forced into it by the changing market place. The physician may want to take the initiative now to begin to evaluate the impact that this change in policy form will have on their practice. To facilitate the review, it will be helpful for physicians to think about the impact of this change, not just in terms of the cost of the different policies, but in relationship to the impact on their employment contracts, shareholder agreements and buy/sell arrangements.
Barbara Smith is Senior Vice President/HealthCare Unit Manager, Commerce Insurance Services, Cherry Hill, N.J.