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The same long payment horizons make it difficult to estimate the ultimate value of the claims to be paid. When coupled with the uncertainty in investment yields, and other assumptions such as inflation rates, there can be large differences between the expected costs of writing medical professional liability insurance policies and the actual costs, which are not known until many years after the policy expires.

During the late 1980s and early 1990s, these uncertainties worked to the advantage of insurance companies. The pricing assumptions proved to be conservative (i.e., rates were set too high) and profits were realized. These profits brought competition from other insurers, resulting in several rounds of rate cutting. These same competitive forces, aided by low inflation and high investment returns, kept rates stable through the 1990s. By the end of that decade, however, the underwriting cycle had reversed itself as the average size of medical malpractice claims increased dramatically and investment yields fell. Profits had dried up and losses were the norm as the insurance industry paid the price for many years of flat rate levels.

Today, healthcare providers are faced with, at best, large rate increases and, at worst, lack of adequate insurance protection. Double-digit and often triple-digit rate increases are the rule more often than the exception.

  The Captive Solution
After considering the underpinnings of the underwriting cycle and the challenges involved in pricing this type of insurance, a reasonable conclusion would be that medical professional liability insurance needs to be written by an insurer with a very long-term view. Competitive pressures make this difficult to accomplish. Further, stock insurance companies face additional pressures to produce consistent profits on a quarterly basis.

The ideal environment in which to insure medical malpractice exposures, therefore, is one where:

• the insureds have a stake in the insurance company,
• pricing is not subject to the ups and downs of the underwriting cycle, and
• short-term adverse results can be tolerated. If structured properly, captives can provide this ideal environment. To be successful, captive owners must be willing to sacrifice certain short-term gains for long-term viability. They must be willing to (a) capitalize the captive, (b) not abandon the captive in “soft” insurance markets when prices are low and (c) pay an adequate, or even conservative, insurance premium in exchange for future dividends (i.e., return of expected profits once they are realized many years later).

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