Underwriting Strategy and Underwriting Cycle in the Medical Malpractice

Insurance Industry

Yu Lei
Barney School of Business
University of Hartford
200 Bloomfield Ave.
West Hartford, CT
Phone: 860-768-4682
Email: lei@hartford.edu

Mark J. Browne
975 University Avenue
Madison, WI 53706-1323
Phone: (608) 263-3030
Fax: (608) 265-4195
Email: mbrowne@bus.wisc.edu

July 2012
To be Presented at the 2012 American Risk and Insurance Association Meeting
Preliminary draft. Please do not quote without permission.

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 Underwriting Strategy and Underwriting Cycle in the Medical Malpractice Insurance Industry

ABSTRACT
Even though underwriting cycles have been extensively studied, one area seems to receive little
attention. This article fills the gap by examining whether medical malpractice insurers’ underwriting strategy
exhibits any cyclical behavior. Our analysis of the NAIC data indicates that some aspects of malpractice
carriers’ underwriting strategy do show certain degrees of cyclical nature and they display trend that seem to be
opposite that of the combined loss ratio in medical malpractice insurance, which we use in this study as a
measure of the underwriting cycle. We find that when insurers’ underwriting performance worsens, there are
fewer insurers offering medical malpractice, there are more exits than entries, insurers are less geographically
concentrated in selling malpractice, and the significance of malpractice in terms of this line’s premium share
declines. Moreover, when we look at which states in which malpractice carriers do business, we see that the
percentage of safer states (states that have caps on general damages or patient compensation funds) in which
insurers write malpractice and the percentage of insurers that choose to do business only in safer states are both
negatively associated with the combined loss ratio of the medical malpractice insurance industry. Taken all
together, it seems that at the industry level, insurers’ underwriting performance has a negative association with
their risk taking behavior in terms of how much to focus on malpractice line of business and where to write such
business. Less focus on malpractice and wider distribution of malpractice products are seen to accompany
worsened underwriting performance.
We also test whether the capacity constraint theory can help explain the cyclical nature of medical
malpractice insurers’ underwriting strategy. We find that when the total surplus of all single-line insurers (those
only selling medical malpractice) shrinks, insurers are less likely to go single-line. We observe the same trend
when we examine single-state insurers (those selling medical malpractice in just one state) and ONLY-CAP-
State insurers (those selling medical malpractice only in states with caps on general damages). In other words,
our results provide some support for the capacity constraint theory which predicts an inadequate capacity will
shrink insurance supply.

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INTRODUCTION
It is well recognized that many property/liability insurance markets exhibit cyclical nature. Soft market
periods, where prices are low and coverage is abundant, are followed by hard markets, where prices are high
and coverage is scarce. Medical malpractice insurance, which provides coverage against professional liability
for health-care providers, is a great example of the recurring soft and hard markets. Over the past several
decades medical malpractice insurance has experienced periodic performance “crises” evidenced by rising
premiums and decreasing supply of malpractice carriers.
Even though underwriting cycles have been extensively studied, previous literature usually focuses on
the cyclical behavior of prices, premium growth, underwriting performance (loss ratios or combined loss ratios)
or insurance availability. On the other hand, most research on medical malpractice insurance crisis concentrates
on the causes of price volatility during hard markets.
This paper intends to examine one little-studied area of the medical malpractice insurance market. We
will examine malpractice insurers’ underwriting strategy during the underwriting cycle and see if it exhibits any
cyclical behavior. If so, we want to see whether the capacity constraint theory can help explain such
phenomenon.
This paper makes contribution to both the underwriting cycle study and the medical malpractice
insurance literature by focusing on various aspects of insurers’ underwriting strategy. When the insurance
industry swings from soft (or hard) to hard (or soft) markets, it is natural for insurers to re-evaluate and adjust
their underwriting strategy to gain a competitive hold. It is likely the underwriting cycle causes changes in
underwriting strategy, but it is also plausible for the modified underwriting strategy to have an impact on the
depth and length of the underwriting cycle. It is not this paper’s intention to discuss how the two-way feedback
works. We’ll instead try to identify if there is any cyclical pattern in insurers’ underwriting strategy during the
medical malpractice insurance cycle, which we will measure using the malpractice industry’s combined loss
ratios.
Insurers’ underwriting strategy could encompass many aspects. For instance, in response to medical
malpractice crises, do insurers establish tighter claims frequency and severity standards for potential insured
health care providers? Do they increase deductible amount and/or decrease the policy limit they’re willing to
insure? Do they choose to exclude certain high-risk specialties to cover? Ideally, we’d like to explore how
insurers adjust their underwriting strategy in reality. Unfortunately, we do not have such information available.

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Instead, we’ll utilize the National Association of Insurance Commissioners (NAIC) database and focus on the
following things which we call underwriting strategy in our paper.
First, do insurers choose to enter or exit the medical malpractice market? Lei and Browne (2008) study
malpractice insurers’ entry and exit during the period of 1994-2006 and find that exits are less frequent in states
where there are caps on general (noneconomic) damages. We extend their study by looking at how insurers
move in and out of the market in accordance with the underwriting cycle.
Second, when insurers do choose to enter the malpractice market, how much do they want to focus on
the malpractice line of business? Do they want to devote the entire business to malpractice or do they also write
other lines of business? In other words, we want to examine how the significance of medical malpractice (which
will be measured by malpractice line’s premium share) changes in accordance with the underwriting cycle.
Third, where do insurers sell medical malpractice? Do they write malpractice in just one state or
multiple states? When they go multi-state, how do they allocate malpractice premiums across states?
Fourth, do insurers choose to sell malpractice in safer states? In response to malpractice crises, many
states enacted tort reforms (such as caps on awards for non-economic damages) and/or created alternative
mechanisms (such as joint underwriting associations and patients’ compensation funds that provide coverage
for substandard risks or limit an insurer’s loss exposure on catastrophic claims). These efforts are intended to
reduce the claims cost as well as the uncertainty associated with them. In this paper, we call states with either
caps on general damages or patient compensation funds “safer states.” Viscusi and Born (2005) find that many
tort reforms help reduce losses, lower premiums, and enhance insurer profitability, with limits on noneconomic
damages being the most influential in affecting insurance market outcomes.
Lastly, do insurers choose to insure more physicians or hospitals? Or do they choose to specialize in
covering just one type of health care providers since different policyholders have different risk implications?
It is not hard to imagine that these various aspects of insurers’ underwriting strategy, namely, entry and
exit, geographic concentration of malpractice business, significance of malpractice line of business, distribution
of malpractice business between safer states and less safe states (those without tort reform measures in place),
and choice of prospective policyholders to cover, will have different implications on firms’ performance.
Different strategies may have their own comparative advantages and will likely affect insurers differently. 1 We

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There is not much study on the underwriting strategy mentioned here yet. The few available studies on geographic diversification
and product diversification produce mixed results. Liebenberg and Sommer (2008) find that single-line property-liability insurers
consistently outperform multiline insurers. Elango et al. (2008) discover that performance advantages associated with product
diversification are contingent upon an insurer’s degree of geographic diversification. Their results indicate that a highly diversified
product profile with low geographic diversification is associated with the highest performance. Insurers that have relatively low
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do not intend to evaluate the effectiveness of insurers’ underwriting strategy in this paper, but rather we will
show how they change in the underwriting cycle.
In the next section, we discuss our data and definitions of medical malpractice insurers. We generate two
samples for our empirical study and we offer a brief overview of the samples in the same section. In the next
five sections that follow, we show how the above-mentioned five aspects of insurers’ underwriting strategy,
namely, entry and exit, geographic concentration, significance of malpractice line of business, distribution of
malpractice business between safer states and less safe states, and choice of prospective policyholders to cover,
evolve as the underwriting cycle unfolds. We then test the capacity constraint theory in the subsequent section.
In the last section, we summarize our findings and conclude the paper.

DATA AND DEFINITION OF MEDICAL MALPRACTICE INSURERS

We utilize the 1992-2010 NAIC property/casualty data to conduct our research. Since our focus is the
underwriting strategy of medical malpractice insurers, we need to define such carriers in the first place. A
natural response is to include all insurers that report positive direct premiums written in medical malpractice.
We call the resulting sample “Large Sample.” This sample includes all possible medical malpractice insurers,
yet some of them report to the NAIC even after they have stopped selling new policies. They continue to report
positive premiums from existing relationships, but are not truly active in the market. To account for this issue,
we also follow Nordman, Cermak and McDaniel (2004) and define a medical malpractice insurer as one that
wrote at least 2 percent of the medical malpractice premium in at least one state in that year. We call the
resulting sample “Small Sample.”
Since we need to examine insurers’ geographic concentration, we make use of the state-level financial
information in the NAIC database. The major financial statement we rely on is “Exhibit of Premiums and
Losses” in different states, which we refer to as the “Stage Page” throughout the paper. The Stage Page provides
information on premiums written/earned, losses incurred/unpaid/paid and loss adjustment and other expenses by
line of business for each firm in all 50 states and Washington D.C. each year. With such information, we can
analyze the underwriting performance of medical malpractice insurers both at the state-level and at the country-
level.

product and geography diversification have medium level performance. Lei and Schmit (2008) find no significant impact of
geographic diversification on firm performance of malpractice insurers, but show that more product diversification is associated with
stronger firm performance.
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 Using our two definitions of medical malpractice insurers and the Stage Page, we generate our Large
Sample and Small Sample. Table 1 provides a snapshot of the two samples.
Table 1: Comparison of Large Sample and Small Sample
Large Sample Small Sample
State-
Country-
level
level
N of Median Median Median N of Average Median Median Median
Premium
Year MM Loss Expense Combined MM Premium Loss Expense Combined
Share in
Insurers Ratio Ratio Ratio Insurers Share in Ratio Ratio Ratio
Large
Large
Sample
Sample
1992 297 0.73 0.11 0.87 117 0.823 0.852 0.88 0.05 0.95
1993 294 0.74 0.11 0.85 121 0.801 0.834 0.89 0.06 0.94
1994 268 0.70 0.10 0.80 108 0.822 0.851 0.77 0.05 0.83
1995 264 0.77 0.10 0.86 108 0.817 0.846 0.82 0.05 0.89
1996 273 0.72 0.09 0.81 109 0.806 0.836 0.79 0.05 0.85
1997 275 0.72 0.10 0.86 105 0.789 0.827 0.86 0.05 0.92
1998 268 0.71 0.11 0.85 108 0.800 0.831 0.90 0.06 0.97
1999 268 0.82 0.11 0.93 114 0.798 0.831 0.87 0.06 0.93
2000 257 0.81 0.11 0.91 114 0.788 0.816 1.04 0.06 1.07
2001 243 0.96 0.11 1.02 106 0.795 0.825 1.08 0.08 1.12
2002 251 0.82 0.09 0.92 104 0.809 0.829 0.98 0.07 1.02
2003 276 0.73 0.08 0.82 112 0.803 0.824 0.88 0.06 0.94
2004 301 0.65 0.07 0.73 113 0.793 0.816 0.71 0.06 0.78
2005 310 0.63 0.07 0.71 116 0.787 0.817 0.66 0.05 0.73
2006 324 0.55 0.06 0.63 123 0.781 0.811 0.57 0.05 0.62
2007 323 0.50 0.07 0.59 124 0.773 0.800 0.52 0.05 0.58
2008 337 0.49 0.07 0.59 125 0.761 0.789 0.51 0.06 0.62
2009 337 0.51 0.07 0.60 122 0.745 0.782 0.53 0.07 0.61
2010 345 0.49 0.07 0.57 124 0.737 0.775 0.50 0.07 0.59
Source: authors’ analysis of NAIC data.

As we can see from Table 1, from 1992 to 2010, insurers that report positive premiums in medical
malpractice business number from a low 243 in 2001 to an all time high of 345 in 2010. When we require that
insurers must write at least 2% of medical malpractice in at least one state, the sample size drops significantly.
Though the small sample is less than 45% of the large sample in terms of its size, its insurers are very active and
meaningful malpractice writers, as evidenced by the premium shares they have when compared to the large
sample. For instance, in year 2010, the small sample’s total premiums account for 73.7% of the large sample’s
total premiums at the country level. At the state-level, we see that on average in each state, the small sample
writes about 77.5% of the large sample’s premiums. In other words, the small sample is very representative of
the entire medical malpractice industry. For all the analyses we do, we use both samples as a robustness test to
each other and we can also see how the entire industry and the major active writers differ or behave similarly in
various aspects of their underwriting strategy.
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 In this paper we use the medical malpractice insurance industry’s loss ratios as a proxy to the
underwriting cycle. The State Page allows us to calculate three ratios for each malpractice carrier both at the
state-level and at the country-level. Loss ratios are losses and loss adjustment expenses incurred divided by
premiums earned. Expense ratios are commissions, taxes and fees divided by premiums written. Combined ratio
is the sum of loss ratio and expense ratio. Since here we are not doing any other sample selection besides
imposing definitions of medical malpractice insurers, we do have insurers that report negative premiums and
losses. As a result, the mean values of loss ratios are not reliable. Instead, we use median values to show the
trend of the underwriting cycle. Table 1 also shows the ratios for both samples over time. Figure 1 presents the
same information in a more visual form.

Figure 1: Comparison of Large and Small Samples Loss Ratios

As we can see, expense ratios are relatively stable over time for both samples, with the small sample
enjoying lower expense ratios. Volatility in combined ratios is thus largely driven by changes in loss ratios. The
small sample tends to have higher loss ratios and combined loss ratios (except for 2006-2007). Both samples
reached their peak in 2001 with the highest loss ratios during our study period. Overall, the two samples follow
very similar pattern in terms of their loss ratios movement. In the analyses that follow, we use the combined
ratio as a measure of the underwriting cycle. We next show how insurers’ underwriting strategy evolves in the
underwriting cycle.
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NUMBER OF TOTAL INSURERS, ENTRANTS AND EXITERS
The first aspect of the underwriting strategy we study is whether or not an insurer chooses to enter or
exit medical malpractice line of business. For this purpose, we study the movement both at the country-level
and at the state-level. We define an insurer as entering the market in a state in a given year if its direct
premiums written (DPW) for medical malpractice insurance in that state exceeded the 2% threshold for Small
Sample (or 0% threshold for Large Sample) for the first time in that year. Similarly, we define a firm as exiting
a state in a particular year if it wrote malpractice coverage in a particular state in a particular year, but in no
subsequent years wrote 2% or more for Small Sample of the direct premiums in that state (or wrote no positive
premium for Large Sample). Country-level entry and exit are similarly defined, with national entrant of a
certain year being one that had positive premiums in medical malpractice for the first time in that year (for
Large Sample), or that wrote at least 2% of premium in at least one state in that year (for Small Sample). Table
2 reports the total number of medical malpractice insurers, entrants or exiters at the country level. It also shows
the mean values of total number of insurers, entrants and exiters at the state level.

Table 2: Total Number of Medical Malpractice Insurers, Entrants and Exiters

Country-level Mean Values at State-level
Year Large Sample Small Sample Large Sample Small Sample
Total Entry Exit Total Entry Exit Total Entry Exit Total Entry Exit
1992 297 - 32 117 - 8 65.53 - 6.43 7.82 0.88
1993 294 29 55 121 12 26 70.37 11.27 22.53 7.86 0.92 3.06
1994 268 29 22 108 13 10 55.29 7.45 4.88 6.75 1.94 0.67
1995 264 18 10 108 10 10 60.80 10.39 8.69 7.37 1.29 0.94
1996 273 19 21 109 11 13 59.69 7.57 5.94 7.67 1.24 1.22
1997 275 23 26 105 9 8 64.12 10.37 6.90 7.82 1.37 1.14
1998 268 19 23 108 11 9 66.94 9.73 7.61 8.06 1.37 1.43
1999 268 23 31 114 15 11 69.61 10.27 12.47 8.02 1.39 1.69
2000 257 20 35 114 11 17 65.61 8.47 10.35 7.78 1.45 1.76
2001 243 21 27 106 9 17 64.71 9.45 12.53 8.39 2.37 2.22
2002 251 35 29 104 15 11 62.14 9.96 9.92 8.57 2.39 1.96
2003 276 54 39 112 19 17 62.63 10.41 10.24 8.18 1.57 1.71
2004 301 64 20 113 18 7 64.63 12.24 8.69 7.71 1.24 0.88
2005 310 29 21 116 10 10 63.12 7.18 7.02 7.96 1.14 1.14
2006 324 35 23 123 17 11 62.33 6.24 5.16 7.71 0.88 1.12
2007 323 22 16 124 12 8 63.33 6.16 3.75 7.45 0.86 0.65
2008 337 30 19 125 9 12 68.02 8.43 4.84 7.55 0.75 0.82
2009 337 19 17 122 9 3 71.16 7.98 3.67 7.61 0.88 0.61
2010 345 25 - 124 5 - 76.51 9.02 - 7.94 0.94 -
Source: authors’ analysis of NAIC data.

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 Figures 2 and 3 provide a visual description of how the total number of insurers, entrants and exiters
correspond to the combined loss ratios in the medical malpractice industry. State-level average values, though
not graphed, show similar patterns.

Figure 2: Large Sample: Total N. of Firms, Entrants and Exiters

As we can see the combined ratio seems to be moving in opposite direction of the total number of
insurers. Around the year of 2001 when the combined ratios worsened for both small and large samples, we see
a dip in the total number of insurers. When loss ratios improved in recent years, we see gradual increase in the
total number of malpractice insurers.
During our study period, year 1993 saw the most exits in both large sample and small sample. In Large
Sample, we notice more exits than entries leading up to the 2001 crisis period. In Small Sample, such
phenomenon coincides with the worsened 2001 combined ratio. In general, we notice that when loss ratios are
high, there tend to be more exits than entries (though there may be a time lag). When loss ratios improve, we
see more entries than exits in both samples, contributing to the increased size of the malpractice market.

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Figure 3: Small Sample: Total N. of Firms, Entrants and Exiters

GEOGRAPHIC CONCENTRATION OF MALPRACTICE BUSINESS

The second aspect of the underwriting strategy we examine is how insurers spread out their malpractice
business across states. We first look at the number of states in which insurers sell medical malpractice. Table 3
reports the median values of this information for both samples over time. Though the number of states in which
insurers write malpractice ranges from 1 to 51, the median values are pretty low in both samples. In Large
Sample, half of the insurers write malpractice in less than 4 states. The small sample insurers write in even
fewer states, with 1 or 2 being the median values. In order to see how insurers allocate their malpractice
premiums across states, we also calculate a geographic Herfindahl-Hirschman Index (HHI) for each firm, which
is defined as the sum of the squares of its premium share in each state 2 . A higher HHI indicates more
geographic concentration. Table 3 also reports the median values of geographic HHI over time for both samples.
As we can see more clearly from Figure 4, the geographic HHI shows an opposite trend to that of the combined
loss ratios. In other words, higher loss ratios are shown to be associated with lower geographic HHI. When loss
ratios improve, we see higher geographic HHI. In other words, a worsening (improving) underwriting
performance seems to be linked with less (more) geographic concentration of malpractice business.

2
Premium share is the firm’s malpractice premium in each state divided by its country-level total malpractice premiums.
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Table 3: Analysis of Geographic Concentration of Medical Malpractice Insurers
Large Sample Small Sample Small Sample Large Sample
N of N of
Year Geographic States States
Geographic N of SS % of SS % of SS N of SS % of SS % of SS
Insurers Insurers
HHI HHI Insurers Insurers Premium Insurers Insurers Premium
Sell Sell
MM MM
1992 0.893 3 0.943 1 74 0.633 0.409 116 0.391 0.278
1993 0.777 3 0.888 1 80 0.661 0.410 105 0.357 0.258
1994 0.871 2 0.962 1 71 0.657 0.456 99 0.369 0.312
1995 0.816 3 0.951 1 65 0.602 0.418 84 0.318 0.287
1996 0.841 3 0.886 1 62 0.569 0.405 95 0.348 0.259
1997 0.828 3 0.744 1 55 0.524 0.389 90 0.327 0.249
1998 0.769 4 0.661 1 57 0.528 0.341 87 0.325 0.223
1999 0.706 4 0.650 1 61 0.535 0.334 80 0.299 0.231
2000 0.696 4 0.602 1 62 0.544 0.347 70 0.272 0.206
2001 0.614 4 0.496 2 46 0.434 0.226 71 0.292 0.147
2002 0.691 4 0.610 2 48 0.462 0.198 80 0.319 0.133
2003 0.855 3 0.591 1 59 0.527 0.245 103 0.373 0.149
2004 0.917 2 0.778 1 62 0.549 0.243 121 0.402 0.146
2005 0.964 2 0.848 1 68 0.586 0.329 132 0.426 0.177
2006 0.970 2 0.893 1 78 0.634 0.384 144 0.444 0.224
2007 0.961 2 0.922 1 80 0.645 0.422 139 0.430 0.232
2008 0.919 2 0.849 1 78 0.624 0.400 143 0.424 0.243
2009 0.919 2 0.799 1 73 0.598 0.384 138 0.410 0.239
2010 0.931 2 0.774 1 70 0.565 0.385 146 0.423 0.244
Source: authors’ analysis of NAIC data.

Figure 4: Dynamics of Geographic Concentration

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 We next look at an extreme case of geographic concentration, given that many medical malpractice
insurers operate in just one state. Table 3 also shows how many (and what percentage of) insurers sell medical
malpractice in just one state, and the premium share these single-state insurers have when compared to the
entire malpractice industry. Figure 5 graphs the same information. Again, we notice similar pattern. When
insurers’ underwriting performance worsens, we see fewer insurers that sell malpractice in just one state.
Improved loss ratios are shown to be associated with more insurers selling malpractice in just one state.
Figure 5: Analysis of Single-state MM Insurers

Single-state (SS) and multi-state (MS) insurers each have their own competitive advantage. Operating
in just one state may gain insurers superior knowledge in dealing with state legal and regulatory environments
and thus enable them to have better loss control. On the other hand, multi-state insurers may enjoy the benefits
of diversification should a certain state suddenly changes its legal or regulatory environments in a way that’s
detrimental to the firms. Table 4 shows that usually multi-state insurers have higher expense ratios than single-
state insurers (except in year 2001 when in large sample, MS insurers have a higher median value of expense
ratio than SS insurers). Figure 6 presents the same information in a more straightforward way.
We also notice that single-state insurers have lower combined ratio than multi-state insurers from 1995
to 2004, but in other times they underperform. We suspect it is the comparative advantage of different
underwriting strategies that are at play. Figures 7-8 provide a better presentation of the loss ratio information.

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Table 4: Median Loss Ratios of Single-state vs Multi-state Insurers
Small Sample MS Insurers Small Sample SS Insurers Large Sample MS Insurers Large Sample SSInsurers
year Exp Loss Comb Exp Loss Comb Exp Loss Comb Exp Loss
Comb Ratio
Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio
1992 0.102 0.888 0.987 0.035 0.873 0.907 0.138 0.718 0.883 0.057 0.735 0.833
1993 0.095 0.812 0.931 0.042 0.901 0.942 0.131 0.733 0.867 0.075 0.754 0.798
1994 0.069 0.754 0.815 0.038 0.789 0.841 0.122 0.702 0.814 0.060 0.676 0.750
1995 0.074 0.849 0.933 0.046 0.808 0.850 0.117 0.789 0.902 0.055 0.687 0.769
1996 0.070 0.861 0.912 0.039 0.746 0.776 0.103 0.732 0.848 0.048 0.675 0.752
1997 0.066 0.868 0.955 0.038 0.795 0.874 0.110 0.750 0.873 0.069 0.638 0.687
1998 0.064 0.910 0.991 0.053 0.898 0.915 0.122 0.770 0.942 0.085 0.506 0.638
1999 0.074 0.936 0.998 0.059 0.802 0.870 0.110 0.821 0.927 0.089 0.851 0.932
2000 0.066 1.069 1.132 0.053 1.010 1.030 0.108 0.833 0.962 0.135 0.670 0.826
2001 0.079 1.131 1.189 0.056 0.908 0.916 0.117 0.993 1.106 0.089 0.834 0.916
2002 0.075 1.047 1.101 0.050 0.866 0.910 0.101 0.962 1.010 0.067 0.674 0.775
2003 0.071 0.903 0.986 0.041 0.807 0.887 0.084 0.745 0.826 0.064 0.710 0.750
2004 0.062 0.758 0.833 0.049 0.651 0.733 0.077 0.665 0.751 0.044 0.612 0.693
2005 0.068 0.666 0.716 0.041 0.659 0.731 0.080 0.627 0.718 0.045 0.643 0.696
2006 0.065 0.575 0.620 0.046 0.545 0.625 0.082 0.553 0.636 0.046 0.530 0.617
2007 0.070 0.453 0.553 0.046 0.556 0.624 0.084 0.475 0.582 0.044 0.528 0.603
2008 0.071 0.445 0.523 0.045 0.587 0.651 0.095 0.473 0.591 0.041 0.513 0.593
2009 0.076 0.515 0.605 0.043 0.545 0.632 0.094 0.495 0.613 0.047 0.518 0.567
2010 0.078 0.530 0.592 0.045 0.487 0.574 0.100 0.479 0.574 0.041 0.496 0.559
Source: authors’ analysis of NAIC data.

Figure 6: Expense Ratio: Single-state vs Multi-state Insurers

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Figure 7: Loss Ratio: Single-state vs Multi-state Insurers

Figure 8: Combined Ratio: Single-state vs Multi-state Insurers

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SIGNIFICANCE OF MEDICAL MALPRACTICE IN INSURER’S PORTFOLIO
The third aspect of the underwriting strategy we examine is the significance of malpractice insurance in
insurers’ entire portfolio. We first look at the percentage of insurers’ total premiums written in malpractice line
of business. Table 5 reports both mean and median values of such percentages over time. We observe that since
2003 there’s been increased significance of malpractice business. By 2010, on average medical malpractice
accounts for about 68.7% of total property/liability insurance premiums in Large Sample, and 84.9% in Small
Sample. When we turn to median values of such premium percentages, we notice that half of malpractice
insurers write more than 98% of premiums in this particular line. When we graph such information in Figures 9
and 10, we see that overall the percentage of malpractice premiums shares a negative association with the
combined loss ratios. When insurers’ underwriting performance worsens, there is less significance of
malpractice insurance (meaning insurers are writing less malpractice). When performance improves, we see
insurers focus more on malpractice. This makes intuitive sense since it’s natural for profit-driven firms to move
away from less profitable business.
Table 5: Analysis of Significance of Medical Malpractice Business
Large Sample Small Sample
Year N % of MM % of MM N % of MM % of MM
% of % of SL % of % of SL
of Premiums Premiums of Premiums Premiums
SL Premiums SL Premiums
SL (Mean) (Median) SL (Mean) (Median)
1992 62 0.209 0.206 0.444 0.150 41 0.350 0.218 0.778 0.995
1993 62 0.211 0.196 0.447 0.187 36 0.298 0.210 0.741 0.979
1994 56 0.209 0.230 0.464 0.256 34 0.315 0.238 0.812 0.992
1995 57 0.216 0.194 0.493 0.381 26 0.241 0.194 0.786 0.983
1996 55 0.202 0.094 0.482 0.341 21 0.193 0.078 0.793 0.980
1997 46 0.167 0.069 0.465 0.243 17 0.162 0.060 0.795 0.967
1998 37 0.138 0.106 0.443 0.198 15 0.139 0.096 0.776 0.920
1999 35 0.131 0.108 0.440 0.157 14 0.123 0.099 0.736 0.909
2000 29 0.113 0.111 0.416 0.145 14 0.123 0.109 0.723 0.915
2001 30 0.124 0.110 0.427 0.167 14 0.132 0.115 0.737 0.950
2002 38 0.151 0.066 0.489 0.461 13 0.125 0.065 0.781 0.961
2003 60 0.217 0.081 0.527 0.626 18 0.161 0.072 0.798 0.965
2004 103 0.342 0.113 0.641 0.969 25 0.221 0.100 0.828 0.977
2005 110 0.355 0.150 0.659 0.973 32 0.276 0.134 0.849 0.983
2006 133 0.411 0.198 0.692 0.981 38 0.309 0.180 0.846 0.981
2007 139 0.430 0.212 0.704 0.989 42 0.339 0.188 0.839 0.985
2008 143 0.424 0.228 0.696 0.983 43 0.344 0.202 0.854 0.985
2009 138 0.410 0.222 0.682 0.975 41 0.336 0.198 0.850 0.981
2010 139 0.403 0.223 0.687 0.976 42 0.339 0.199 0.849 0.983
Source: authors’ analysis of NAIC data.

14
Figure 9: Significance of MM in Large Sample

Figure 10: Significance of MM in Small Sample

15
 We also examine an extreme case where insurers devote its entire business to medical malpractice.
Table 5 also shows that the total number and percentage of single-line (SL) insurers that only sell medical
malpractice, as well as the premium share these single-line insurers have among all medical malpractice
insurers. From 1996 to 2002, we see fewer single-line insurers only selling medical malpractice. The number
and percentage picked up since 2002. In Large Sample, 40.3% of insurers are single-line insurers in 2010,
contributing 22.3% to total medical malpractice premiums. In Small Sample, we see a slightly lower percentage
of single-line insurers representing 19.9% of the medical malpractice market.
Figure 11 shows that for the most part the percentage of the number and premium share of single-line
insurers move in opposite direction to that of the combined loss ratios. When loss ratios improve, we see more
single-line insurers focusing on malpractice.

Figure 11: Analysis of Single-line (SL) Insurers

Table 6 shows how single-line (SL) insurers fare as opposed to multi-line (ML) insurers. Figure 12
indicates that SL insurers usually have lower expense ratios. The only exception is in year 2005 when ML
insurers have lower expense ratios in Small Sample.

16
Table 6: Median Loss Ratios of Single-line vs Multi-line Insurers
Large Sample SL Insurers Large Sample ML Insurers Small Sample SL Insurers Small Sample ML Insurers
Year Exp Loss Comb Exp Loss Comb Exp Loss Comb Loss Comb
Exp Ratio
Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio
1992 0.024 0.800 0.823 0.151 0.717 0.882 0.028 0.891 0.914 0.080 0.870 0.974
1993 0.032 0.851 0.913 0.144 0.683 0.827 0.033 0.942 0.960 0.075 0.827 0.930
1994 0.031 0.709 0.743 0.141 0.701 0.813 0.024 0.723 0.749 0.061 0.803 0.857
1995 0.030 0.724 0.817 0.125 0.795 0.904 0.026 0.750 0.831 0.064 0.875 0.931
1996 0.034 0.756 0.862 0.103 0.694 0.799 0.024 0.812 0.831 0.061 0.784 0.852
1997 0.029 0.652 0.709 0.112 0.734 0.869 0.026 0.718 0.735 0.067 0.872 0.928
1998 0.036 0.692 0.788 0.122 0.715 0.872 0.031 0.900 0.926 0.065 0.904 0.977
1999 0.030 0.759 0.867 0.119 0.859 0.947 0.030 0.842 0.900 0.074 0.868 0.938
2000 0.025 0.766 0.812 0.121 0.816 0.918 0.021 1.121 1.145 0.071 1.034 1.059
2001 0.026 0.975 1.002 0.125 0.960 1.026 0.024 1.005 1.015 0.085 1.081 1.133
2002 0.032 0.718 0.785 0.105 0.860 0.987 0.029 1.001 1.021 0.069 0.976 1.028
2003 0.045 0.648 0.710 0.086 0.798 0.887 0.055 0.719 0.825 0.064 0.899 0.986
2004 0.038 0.613 0.688 0.077 0.658 0.753 0.055 0.754 0.856 0.060 0.704 0.773
2005 0.042 0.645 0.716 0.077 0.630 0.703 0.058 0.682 0.756 0.048 0.644 0.691
2006 0.044 0.552 0.620 0.085 0.540 0.643 0.049 0.522 0.615 0.058 0.595 0.632
2007 0.046 0.526 0.584 0.089 0.473 0.585 0.051 0.438 0.493 0.058 0.563 0.649
2008 0.047 0.515 0.603 0.093 0.454 0.567 0.056 0.501 0.622 0.065 0.514 0.614
2009 0.051 0.505 0.605 0.092 0.505 0.593 0.055 0.542 0.613 0.069 0.524 0.605
2010 0.048 0.512 0.555 0.093 0.481 0.578 0.051 0.542 0.593 0.071 0.487 0.579
Source: authors’ analysis of NAIC data.

Figure 12: Expense Ratio: Single-line (SL) vs Multi-line (ML) Insurers

17
Figure 13: Loss Ratio: Single-line (SL) vs Multi-line (ML) Insurers

Figure 14: Combined Ratio: Single-line (SL) vs Multi-line (ML) Insurers

18
 Figures 13-14 show that in terms of loss ratios and combined ratios, SL and ML insurers have their
comparative advantage at different times of the underwriting cycle. From 1997 to 2004, single-line insurers
perform better. Multi-line insurers have better results at other times.

DISTRIBUTION OF MALPRACTICE INSURANCE BETWEEN SAFER AND LESS SAFE STATES

The fourth aspect of the underwriting strategy we study is how insurers allocate their malpractice
business between safer states (those that have caps on general damages and/or patient compensation funds) and
less safe states (states that do not have tort reform measures in place). Table 7 counts how many firms sell
malpractice in CAP- or PCF- states (those that have caps on general damages and/or patient compensation
funds), and how many in less safe states. Since a firm may sell in both safer and less safe states, the number of
firms selling in CAP states and the number of firms selling in NO-CAP states do not add up to the total number
of firms. We see some sharp increase in the number of firms operating in PCF states in recent years.

Table 7: Analysis of Number of Firms in States of Different Regulatory Environments

Large Sample Small Sample
Year N of N of N of N of N of
N of Firms N of Firms N of Firms
N of Firms in Firms in Firms in Firms in N of Firms in
in PCF in CAP in No-CAP
Firms PCF CAP No-PCF No-CAP Firms No-PCF
States states States
States states States States States
1992 297 149 195 280 260 117 39 63 102 89
1993 294 146 198 280 256 121 36 66 107 89
1994 268 129 183 251 228 108 36 52 94 82
1995 264 134 189 249 226 108 39 62 93 80
1996 273 140 199 260 229 109 37 62 99 82
1997 275 144 205 265 236 105 37 65 96 78
1998 268 146 210 257 222 108 33 68 101 78
1999 268 148 207 258 232 114 37 70 106 87
2000 257 140 196 245 225 114 41 73 105 84
2001 243 131 187 238 211 106 44 72 97 80
2002 251 148 184 233 220 104 44 68 92 80
2003 276 170 199 243 227 112 53 73 94 85
2004 301 185 219 257 242 113 48 74 97 81
2005 310 186 232 268 236 116 49 74 97 78
2006 324 193 242 270 239 123 46 78 104 79
2007 323 191 234 279 248 124 48 78 106 78
2008 337 196 242 292 260 125 47 78 109 84
2009 337 197 241 292 266 122 49 75 106 83
2010 345 208 253 296 266 124 55 82 105 81
Source: authors’ analysis of NAIC data.

19
 Next we examine how many CAP- or PCF-states each firm sells malpractice in. Table 8 shows the
average values across insurers. For instance, in 2010, insurers in Large Sample write malpractice in 4.27 PCF
states, which represents 45.4% of the states in which firms sell malpractice. Similarly we find that insurers sell
malpractice in an average number of 8.07 CAP states, which account for 66.8% of total states in which insurers
have malpractice business.
Table 8: Average Number of States of Different Regulatory Environments Insurers Sell Medical Malpractice
Large Sample Small Sample
Year N of PCF % of PCF N of CAP % of CAP N of PCF % of PCF N of CAP % of CAP
States States States States States States States States
1992 3.91 0.321 5.70 0.495 1.897 0.558 2.381 0.692
1993 4.21 0.297 6.02 0.489 1.972 0.575 2.242 0.716
1994 3.77 0.338 5.11 0.510 2.000 0.579 2.173 0.700
1995 4.01 0.315 5.88 0.514 2.051 0.570 2.274 0.687
1996 3.81 0.304 5.76 0.533 2.135 0.483 2.403 0.680
1997 3.97 0.278 6.35 0.522 2.108 0.474 2.492 0.680
1998 4.08 0.278 6.59 0.540 2.485 0.473 2.529 0.688
1999 4.22 0.275 6.93 0.517 2.243 0.492 2.429 0.662
2000 4.14 0.284 6.81 0.504 1.976 0.477 2.370 0.685
2001 4.43 0.254 7.08 0.509 2.068 0.467 2.431 0.634
2002 4.28 0.341 6.80 0.511 2.227 0.513 2.632 0.641
2003 4.29 0.423 7.22 0.598 2.094 0.577 2.575 0.665
2004 4.04 0.451 7.04 0.620 2.042 0.565 2.581 0.706
2005 3.90 0.439 7.54 0.690 2.061 0.593 3.095 0.792
2006 3.85 0.482 6.96 0.696 2.130 0.639 2.782 0.808
2007 3.92 0.452 7.30 0.687 1.958 0.588 2.718 0.823
2008 4.07 0.451 7.49 0.673 1.936 0.586 2.718 0.792
2009 4.17 0.449 7.90 0.666 1.918 0.574 2.813 0.788
2010 4.27 0.454 8.07 0.668 1.855 0.590 2.622 0.778
Source: authors’ analysis of NAIC data.

Figure 15 shows that the average percentage of CAP- or PCF- states in which firms sell medical
malpractice insurance moves in opposite direction to the combined loss ratios. Overall, we notice that higher
loss ratios are associated with fewer CAP- or PCF-states in which insurers write malpractice. In other words,
underwriting performance worsens when insurers write in fewer safer states. It is likely that operating in riskier
states lead to worsened loss ratios in the first place. Since it’s hard to identify cause and effect, we can only
conclude that less business in safer states is associated with higher loss ratios.

20
Figure 15: % of PCF/CAP States Insurers Sell MM In

We now turn to an extreme case where insurers choose to write malpractice only in safer states (CAP- or
PCF- states). For simplicity purpose, we call such firms Only-CAP firms or Only-PCF firms. Table 9 shows the
number, percentage and premium share of Only-CAP and Only-PCF firms. We notice since 2003 there’s been
an increase in the number of insurers that choose to sell malpractice only in PCF-states, or CAP-states. When
we graph such information in Figures 16 and 17, we observe that the percentage of Only-CAP firms and Only-
PCF firms share a negative relationship between the loss ratios. Such firms’ premium shares also seem to move
in opposite direction to the combined ratios, though not as closely as the percentage of the number of firms. In
other words, when loss ratios are high, we have fewer insurers that choose to sell malpractice only in safer
states. When loss ratios improve, we see more firms preferring to write malpractice only in CAP- or PCF- states.
This is consistent with our earlier observation in that fewer firms operating in safer states may have caused the
underwriting performance to decline in the first place.

21
Table 9: Number, Percentage and Premium Share of Insurers that Only Sell MM in Cap-/PCF- States
Large Sample Small Sample
Year Only-CAP Firms Only-PCF Firms Only-CAP Firms Only-PCF Firms
% of % of % of % of % of % of % of % of
N N N N
N Premium N Premium N Premium N Premium
1992 37 0.125 0.073 17 0.057 0.018 28 0.239 0.107 15 0.128 0.035
1993 38 0.129 0.071 14 0.048 0.019 32 0.264 0.107 14 0.116 0.037
1994 40 0.149 0.104 17 0.063 0.025 26 0.241 0.144 14 0.130 0.048
1995 38 0.144 0.097 15 0.057 0.023 28 0.259 0.138 15 0.139 0.037
1996 44 0.161 0.080 13 0.048 0.011 27 0.248 0.139 10 0.092 0.038
1997 39 0.142 0.083 10 0.036 0.007 27 0.257 0.156 9 0.086 0.038
1998 46 0.172 0.076 11 0.041 0.007 30 0.278 0.133 7 0.065 0.018
1999 36 0.134 0.070 10 0.037 0.008 27 0.237 0.117 8 0.070 0.020
2000 32 0.125 0.058 12 0.047 0.006 30 0.263 0.122 9 0.079 0.020
2001 32 0.132 0.063 5 0.021 0.005 26 0.245 0.107 9 0.085 0.015
2002 31 0.124 0.052 18 0.072 0.016 24 0.231 0.089 12 0.115 0.034
2003 49 0.178 0.054 33 0.120 0.021 27 0.241 0.091 18 0.161 0.043
2004 59 0.196 0.071 44 0.146 0.037 32 0.283 0.114 16 0.142 0.049
2005 74 0.239 0.086 42 0.135 0.041 38 0.328 0.144 19 0.164 0.055
2006 85 0.262 0.089 54 0.167 0.043 44 0.358 0.152 19 0.154 0.052
2007 75 0.232 0.088 44 0.136 0.029 46 0.371 0.158 18 0.145 0.050
2008 77 0.228 0.087 45 0.134 0.028 41 0.328 0.149 16 0.128 0.049
2009 71 0.211 0.076 45 0.134 0.032 39 0.320 0.136 16 0.131 0.048
2010 79 0.229 0.082 49 0.142 0.035 43 0.347 0.144 19 0.153 0.051
Source: authors’ analysis of NAIC data.

22
Figure 16: Large Sample: % and P-Share of Only Cap- or PCF- Firms

Figure 17: Small Sample: % and P-Share of Only Cap- or PCF- Firms

23
Table 10: Median Loss Ratios: Only-CAP Firms vs. Others
Large Sample Only-CAP Large Sample All Other Small Sample Only-CAP Small Sample All Other
Firms Firms Firms Firms
Year
Exp Loss Comb Exp Loss Comb Exp Loss Comb Exp Loss Comb
Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio Ratio
1992 0.049 0.701 0.766 0.128 0.742 0.889 0.037 0.864 0.921 0.057 0.888 0.971
1993 0.058 0.798 0.892 0.125 0.733 0.845 0.059 0.940 0.954 0.053 0.848 0.931
1994 0.057 0.749 0.812 0.111 0.693 0.799 0.049 0.789 0.841 0.046 0.766 0.815
1995 0.046 0.625 0.691 0.113 0.779 0.902 0.048 0.693 0.747 0.047 0.896 0.937
1996 0.050 0.699 0.769 0.097 0.719 0.828 0.038 0.739 0.805 0.054 0.816 0.882
1997 0.070 0.639 0.794 0.107 0.727 0.863 0.070 0.813 0.827 0.047 0.864 0.916
1998 0.081 0.553 0.686 0.119 0.759 0.902 0.067 0.796 0.868 0.060 0.908 0.987
1999 0.065 0.732 0.845 0.114 0.854 0.958 0.063 0.806 0.847 0.063 0.900 0.963
2000 0.102 0.537 0.616 0.113 0.816 0.928 0.081 0.850 0.952 0.058 1.097 1.132
2001 0.082 0.847 0.905 0.117 0.986 1.063 0.070 1.101 1.103 0.077 1.074 1.120
2002 0.075 0.670 0.695 0.097 0.857 0.936 0.032 0.809 0.839 0.069 1.027 1.086
2003 0.084 0.711 0.741 0.077 0.741 0.825 0.047 0.807 0.834 0.065 0.892 0.975
2004 0.075 0.564 0.685 0.067 0.659 0.750 0.054 0.653 0.724 0.058 0.722 0.785
2005 0.064 0.580 0.647 0.069 0.659 0.734 0.050 0.634 0.661 0.055 0.682 0.749
2006 0.067 0.478 0.565 0.059 0.580 0.663 0.072 0.505 0.564 0.049 0.612 0.683
2007 0.068 0.489 0.584 0.070 0.506 0.586 0.076 0.488 0.556 0.051 0.529 0.600
2008 0.056 0.454 0.563 0.075 0.498 0.600 0.084 0.487 0.599 0.053 0.541 0.628
2009 0.064 0.436 0.513 0.073 0.520 0.618 0.064 0.500 0.548 0.068 0.545 0.657
2010 0.061 0.390 0.455 0.074 0.524 0.611 0.070 0.428 0.480 0.069 0.548 0.650
Source: authors’ analysis of NAIC data.

To gain some basic understanding of potential comparative advantage insurers that choose to write
malpractice only in safer states, we compare the underwriting performance of Only-Cap firms to that of their
counterparts. Table 10 reports the median values over time. We notice that firms that only sell medical
malpractice insurance in CAP-states have lower expense ratios for most years in Large Sample, but such
advantage is not as evident in Small Sample. In terms of loss ratios, from 1995 to 2010, firms that operate in
only CAP states have lower loss ratios than their counterparts. This is consistent with our observation when we
compare CAP-states versus No-CAP states and find that states that impose limits on general damages on
average have better underwriting performance in their jurisdictions than states with no such limits on awards.
This shows that caps on general damages indeed have effects on mitigating the crisis. The same pattern
regarding loss ratio and combined ratio is also observed in Small Sample, as evidenced in Figures 18 and 19.

24
Figure 18: Large Sample Loss Ratios: Only-CAP Firms vs Others

Figure 19: Small Sample Loss Ratios: Only-CAP Firms vs Others

25
CHOICE OF PROSPECTIVE POLICYHOLDERS TO COVER
The last aspect of the underwriting strategy we study is the types of health care providers insurers
choose to cover. Ideally, we want to find out what kind of high- or low-risk specialties carriers tend to cover
less or more. However, we do not have such information. In this study we utilize the best available data to do
some preliminary analysis. For this purpose we turn to Supplement “A” To Schedule T Exhibit Of Medical
Malpractice Premiums Written Allocated By States And Territories, which is an exhibit the NAIC didn’t start
providing until 2001. This exhibit shows premiums and losses each insurer incurs in medical malpractice in
each state each year for each of the following four policyholder types defined by NAIC: PH (= physicians); OP
(= other health care professionals); HS (= hospitals); OF (= other health care facilities). In Table 11 we show
the total number of malpractice insurers each year 3 and the percentage of premiums written to cover each type
of health care providers. We also show the median loss ratios of these providers. For instance, in 2001, 64% of
premiums are written to cover physicians who as a group have a median loss ratio of 0.83. Note that the loss
ratios discussed in this section are losses incurred divided by premiums earned since there is no information on
loss adjustment expense and underwriting expense by types of providers.

Table 11: Mean Premium Share and Median Loss Ratios to Cover Each Type of Provider
Small Sample Large Sample
% of Premiums Written to % of Premiums Written to
year Median Loss Ratios of Median Loss Ratios of
Cover Cover
N PH HS OP OF PH HS OP OF N PH HS OP OF PH HS OP OF
2001 87 0.64 0.22 0.09 0.06 0.83 0.94 0.33 0.85 188 0.45 0.17 0.30 0.09 0.71 0.84 0.35 0.55
2002 90 0.57 0.25 0.09 0.09 0.66 0.81 0.48 0.56 208 0.42 0.18 0.30 0.10 0.60 0.72 0.35 0.52
2003 97 0.58 0.28 0.06 0.08 0.66 0.61 0.30 0.46 227 0.45 0.17 0.57 -0.18 0.54 0.62 0.34 0.41
2004 102 0.60 0.28 0.05 0.07 0.50 0.54 0.31 0.51 251 0.49 0.21 0.18 0.12 0.47 0.49 0.31 0.48
2005 106 0.62 0.26 0.06 0.07 0.44 0.47 0.29 0.36 254 0.51 0.23 0.14 0.12 0.44 0.44 0.27 0.43
2006 109 0.61 0.26 0.06 0.07 0.38 0.49 0.38 0.31 269 0.49 0.21 0.15 0.15 0.37 0.43 0.32 0.31
2007 115 0.61 0.24 0.08 0.07 0.32 0.41 0.23 0.13 289 0.51 0.17 0.17 0.15 0.35 0.40 0.20 0.12
2008 115 0.61 0.25 0.06 0.08 0.31 0.34 0.28 0.37 309 0.52 0.17 0.17 0.14 0.31 0.33 0.22 0.27
2009 120 0.57 0.28 0.08 0.06 0.33 0.42 0.34 0.36 326 0.51 0.18 0.12 0.20 0.32 0.40 0.31 0.20
2010 122 0.58 0.28 0.08 0.06 0.33 0.33 0.24 0.23 327 0.50 0.19 0.17 0.14 0.33 0.32 0.19 0.33
Source: authors’ analysis of NAIC data.

As we can see from both samples, the majority of premiums are written to cover physicians, followed by
hospitals. Over the years, there is some fluctuation in physicians’ premium share, though hospitals’ premium

3
Note the total numbers somehow differ from our earlier analysis based on the State Page. The reason is that not every firm provides
information on both the State Page and the Supplement “A” page.
26
 share remains relatively stable. Also hospitals tend to have higher loss ratios which explain why insurers cover
less of them. As a matter of fact, many hospitals formed self-insured entities and do not report to NAIC.
Since there are no earlier years of premiums/losses breakdown by types of health care providers, we do
not observe significant trend during the years 2001-2010 by examining providers’ premium share and loss ratios.
We next turn to specialists that cover only one type of health care providers. Table 12 shows the percentage of
such specialist-insurers as well as their premium shares. We graph the same information in Figure 20.
Table 12: Analysis of Specialists Covering Only One Type of Health Care Providers
Large Sample Small Sample
% of Number of Firms Premium Share of Firms % of Number of Firms Premium Share of Firms
Year
Covering Only Covering Only Covering Only Covering Only
HS PH OP OF S HS PH OP OF S HS PH OP OF S HS PH OP OF S
2001 0.04 0.13 0.17 0.03 0.36 0.09 0.04 0.03 0.00 0.16 0.03 0.12 0.02 0.01 0.18 0.08 0.05 0.02 0.00 0.14
2002 0.05 0.15 0.17 0.03 0.40 0.08 0.05 0.03 0.01 0.17 0.07 0.13 0.03 0.01 0.23 0.08 0.06 0.03 0.00 0.16
2003 0.07 0.18 0.12 0.05 0.41 0.09 0.02 0.01 0.01 0.14 0.07 0.13 0.01 0.02 0.23 0.09 0.02 0.01 0.01 0.12
2004 0.06 0.21 0.07 0.07 0.41 0.13 0.02 0.01 0.01 0.16 0.06 0.16 0.01 0.02 0.25 0.12 0.02 0.00 0.00 0.14
2005 0.06 0.22 0.06 0.06 0.40 0.13 0.02 0.00 0.01 0.17 0.07 0.20 0.01 0.03 0.30 0.12 0.02 0.00 0.00 0.15
2006 0.08 0.21 0.07 0.08 0.44 0.18 0.03 0.01 0.01 0.23 0.08 0.21 0.01 0.02 0.32 0.17 0.03 0.00 0.00 0.20
2007 0.06 0.25 0.09 0.08 0.48 0.16 0.03 0.02 0.01 0.22 0.07 0.21 0.02 0.02 0.32 0.14 0.03 0.00 0.00 0.17
2008 0.06 0.26 0.09 0.08 0.51 0.15 0.04 0.02 0.01 0.21 0.06 0.20 0.02 0.02 0.29 0.13 0.04 0.00 0.00 0.17
2009 0.07 0.29 0.10 0.10 0.57 0.17 0.07 0.03 0.01 0.27 0.08 0.23 0.03 0.02 0.36 0.14 0.07 0.01 0.00 0.23
2010 0.08 0.28 0.11 0.08 0.55 0.13 0.06 0.04 0.01 0.24 0.08 0.22 0.03 0.02 0.35 0.12 0.07 0.01 0.00 0.20
Note: S refers to specialists that cover only one type of health care providers. Source: authors’ analysis of NAIC data.

Figure 20: Analysis of % of Specialist-insurers

27
 In 2001, 4% of firms in Large Sample cover only hospitals (HS), representing 9% of the total premiums
written in medical malpractice. Similarly, 36% of firms in Large Sample are specialists covering only one type
of health care providers in 2001, yet on average their premium share is 16% among all medical malpractice
insurers. In both samples, we see a largely increasing trend in the number of specialist-insurers over time, yet
their premium shares do not go up that much. Overall, we’re seeing more and more insurers covering only
physicians in their malpractice business, close to 28% in the Large Sample and about 22% in Small Sample by
2010, though their premium shares are still relatively small and stable. Figure 20 shows that for most years
(except 2010), the percentage of insurers only covering physicians and that of all specialist-insurers display an
opposite trend to that of the combined loss ratios. When we see insurers’ underwriting performance improve in
recent years, we also observe an increasing percentage of specilist insurers.

Test of Capacity Constraint Theory

Having discovered some aspects of insurers’ underwriting strategy display certain cyclical nature, we
now test whether the capacity constraint theory can explain such phenomenon in the medical malpractice
industry. The causes of insurance cycles have been extensively studied and in this section we want to focus on
the capacity constraint theory, while keeping in mind that tests of other cycle theories could be future research
topics.
Weiss and Chung (2004) summarize the capacity constraint theory well, “The capacity constraint
hypothesis postulates that capital does not flow freely into and out of the insurance indutry due to market
imperfections As a result, insurers will be inclined to hold on to seemingly excess capital in profitable years, so
as to have capital available to pursue opportunities in lean years. The capacity constraint hypothessi assumes
also that claims are uncetain and correlated across policies, and insurers’ (combined) equity determins industry
supply. Because losses are correlated, all insurers will be affected similarly by a loss chock (e.g., adverse
interpretation of tort law for general liability insurers in the 1980s leading to a general liability crisis). Thus
industry-wide soft and hard markets will occur. In soft markets capital is plentiful, while in hard markets it is
relatively scarce. As a result, in periods of excess capacity, insurance price is relatively low, and it is relatively
high in periods with relatively low capitabization. Therefore prices are hypothesized to be sensitive to industry-
wide capital.” (p442)
In our study we do not intend to examine how malpractice prices change in response to capacity change.
Instead, we will test the capacity constraint theory by examining whether an increase (or decrease) in capacity

28
will expand (or shrink) insurance supply. More specifically, we will use the following general form of
regression equation:
Y = f (lagged total surplus, lagged overall loss ratio, lagged firm-specific loss ratio).
We have the following four dependent variables, which are all binary variables.
Single_line: equals 1 if an insurer only sells medical malpractice in a particular year.
Single_state: equals 1 if an insurer sells medical malpractice in one single state in a particular year.
Only_CAP_state: equals 1 if an insurer only sells medical malpractice in states that have caps on general
damanges.
Specialist: equals 1 if an insurer only covers one type of health care providers.
The major independent variable is the capacity, which we measure using insurers’ surplus. Since we
have four different dependent variables, we have also four corresponding surplus variables, which are
constructed in the same manner though.
When we analyze how capacity affects insurers’ decision to go single-line, the surplus we are looking at
is the total surplus of all single-line insurers in a particular year. Similary, the surplus variable for the dependent
variable of Single_state (Only_CAP_state) is the total surplus of all single-state (Only_CAP_state) insurers.
The loss ratio variables in the regression equation refer to combined loss ratios when the dependent
variables are Single_line, Single_state or Only_CAP_state. When the dependent variable is Specialist, the loss
ratios are simply loss incurred divided by premiums earned.
The overall loss ratio variables are constructed in a similar manner to that of surplus variables. When the
dependent variable is Single_line, the overall loss ratio is the combined loss ratio of all single-line insurers.
Lastly, firm-specific loss ratios are firm-year level loss ratios.
Given the binary nature of our dependent variables, we run four firm-year level logistic regressions and
report our results in Tables 13 and 14, respectively. Table 13 shows the regression results of dependent
variables Single_line, Single_state and Only_CAP_state. We group them together because the relevant
information is all from the State Page. We have 4807 observations in Large Sample and 1891 in Small Sample.
The probability modeled here is Y equal to 1, which is the probability that an insurer is a single_line insurer,
single-state insurer or Only_CAP_state insurer. To account for potential endogeneity issue, we use lagged
values for all independent variables.
Our results show that lagged surplus has a positive relationship with the three dependent variables
derived from the State Page. A lower surplus in the previous year will reduce the probability that a firm will be

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 a single-line insurer, single-state insurer or Only_CAP_state insurer. This is consistent with the capacity
constraint theory in that a shrinking capacity will suppress the insurance supply. Our innovation here is that
instead of studying the entire malpractice industry’s surplus, we look at segments of the industry and see how
capacity in a particular segment affects supply of insurance in that segment. When we divide the industry into
single-line and multi-line insurers, we have segments of single-line insurers and multi-line insurers. Similarly,
when we study geographic concentration and distribution of malpractice insurance between safer and less safe
states, we have different segementations. We show that capacity of a particular segment does positively affect
supply of insurance in that segement. Our empirical study provides evidence to support the capacity constraint
theory in the malpractice market.

Table 13: Logistic Regression of Underwriting Strategy: Probability modeled is Y=1

Large Sample (N=4807)
Lagged Firm-
Lagged Total Lagged Overall
Y Results Intercept specific Loss
Surplus Loss Ratio
Ratio
Estimate 0.3463 <0.0001 -2.0295 -0.0002
Single_line Prob(ChiSq) 0.4277 0.0198 <0.0001 0.5769
-2 Log L 5215.868
Estimate -1.0250 <0.0001 0.1734 -0.0001
Single_state Prob(ChiSq) <0.0001 <0.0001 0.3965 0.6294
-2 Log L 6172.015
Estimate -1.6052 <0.0001 -0.4031 -0.0011
Only_CAP_state Prob(ChiSq) <0.0001 <0.0001 0.3078 0.1149
-2 Log L 4356.357
Small Sample (N=1891)
Lagged Firm-
Lagged Total Lagged Overall
Y Results Intercept specific Loss
Surplus Loss Ratio
Ratio
Estimate -1.1540 <0.0001 -0.3573 -0.1739
Single_line Prob(ChiSq) 0.0129 0.0047 0.3429 0.1022
-2 Log L 1993.447
Estimate -0.1234 <0.0001 0.2170 -0.1398
Single-state Prob(ChiSq) 0.6750 0.0599 0.4518 0.0788
-2 Log L 2598.044
Estimate -0.7378 <0.0001 -0.0794 -0.3798
Only_CAP_state Prob(ChiSq) 0.0657 0.0406 0.8528 0.0003
-2 Log L 2215.859
Note: total surplus refers to the total surplus of all single-line insurers (or single-state insurers, etc.) each year. Similarly,
overall loss ratio is that for all single-line insurers (or single-state insurers, etc.)
Source: authors’ analysis of NAIC data.

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 In the large sample, we also find that overall loss ratio of single-line insurers has a negative impact on
firms’ decision to go single-line. In other words, if loss ratios for single-line insurers go up, insurers are less
likely to just sell medical malpractice. This makes sense since insurers tend to move away from less profitable
business. In our small sample, we find that firm-specific loss ratios play a more significant role in determining
insurers’ likelihood of becoming single-state or only_CAP_state firms.
Table 14: Logistic Regression: Y=Specialist, Probability modeled is Y=1
Large Sample N=2424 Small Sample N=947
Variables
Estimate ProbChiSq Estimate ProbChiSq
Intercept 0.6348 0.0849 -0.3988 0.2755
Lagged Total Surplus <0.0001 0.4920 <0.0001 0.9275
Lagged Overall Loss Ratio -1.3382 0.0003 -0.9989 0.0218
Lagged Firm-specific Loss Ratio -0.0002 0.4237 0.0244 0.8551
-2 Log L 3299.446 1122.922
Note: total surplus refers to the total surplus of all specialist insurers each year. Similarly, overall loss ratio is that for all
specialist insurers
Source: authors’ analysis of NAIC data.

With regard to our last dependent variable “Specialist,” since the data is drawn from Supplement A, our
large sample has 2424 observations and small sample has 947 observations. Again here the surplus is the total
surplus of all specialist insurers. In both samples, we find no evidence that surplus has a significant impact on
insurers’ decision to be a specialist. This is not too surprising given the data is only available since 2001 and
there is no significant cyclical market swing since then. Yet we do find that overall loss ratio negatively affect
insurers’ decision to cover just one type of health care providers, which is consitent with our observation earlier
on.

Conclusion
This article examines the underwriting strategy movement during the medical malpractice underwriting
cycle. Even though underwriting cycles have been extensively studied, one area seems to receive little attention.
This article fills the gap by examining whether medical malpractice insurers’ underwriting strategy exhibits any
cyclical behavior. Our analysis of the NAIC data indicates that some aspects of malpractice carriers’
underwriting strategy do show certain degrees of cyclical nature and they display trend that seem to be opposite
that of the combined loss ratio in medical malpractice insurance, which we use in this study as a measure of the
underwriting cycle. We find that when insurers’ underwriting performance worsens, there are fewer insurers
offering medical malpractice, there are more exits than entries, insurers are less geographically concentrated in
selling malpractice, and the significance of malpractice in terms of this line’s premium share declines.
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Moreover, when we look at which states in which malpractice carriers do business, we see that the percentage
of safer states (states that have caps on general damages or patient compensation funds) in which insurers write
malpractice and the percentage of insurers that choose to do business only in safer states are both negatively
associated with the combined loss ratio of the medical malpractice insurance industry. Taken all together, it
seems that at the industry level, insurers’ underwriting performance has a negative association with their risk
taking behavior in terms of how much to focus on malpractice line of business and where to write such business.
Less focus on malpractice and wider distribution of malpractice products are seen to accompany worsened
underwriting performance.
We also test whether the capacity constraint theory can help explain the cyclical nature of medical
malpractice insurers’ underwriting strategy. We find that when the total surplus of all single-line insurers (those
only selling medical malpractice) shrinks, insurers are less likely to go single-line. We observe the same trend
when we examine single-state insurers (those selling medical malpractice in just one state) and ONLY-CAP-
State insurers (those selling medical malpractice only in states with caps on general damages). In other words,
our results provide some support for the capacity constraint theory which predicts an inadequate capacity will
shrink insurance supply.

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