Academic journal article Journal of Risk and Insurance

The Case for Experience Rating in Medical Malpractice Insurance: An Empirical Evaluation

Academic journal article Journal of Risk and Insurance

The Case for Experience Rating in Medical Malpractice Insurance: An Empirical Evaluation

Article excerpt

ABSTRACT

Experience rating is largely absent from medical malpractice insurance contracts. This article presents evidence that physician risk differences persist, and it develops an empirical model for experience rating with a semi-parametric estimator. Estimating the model using claims history data from Florida, the authors obtain improved prediction of individual claims over several years and provide a detailed picture of the incidence of surcharges under experience rating. This evidence suggests that an experience rating system would be feasible and would greatly reduce the subsidization across physician risk types that exists under most current medical malpractice insurance contracts.

INTRODUCTION

Experience rating, i.e., adjusting premiums based on claims history, is the norm in many insurance settings such as workers compensation, and automotive and health insurance. In workers compensation, for example, the amount firms must contribute depends on the rate at which their employees have made claims in the past. In medical malpractice insurance, however, it is rarely found (Weiler et al., 1993). Adjusting insurance premiums through experience rating has two benefits: (1) cross-subsidization of high-risk subscribers by those subscribers of low risk is reduced and (2) high-risk subscribers are given incentives to find cost-effective ways to reduce risk. For these reasons, economists have advocated the adoption of experience rating in medical malpractice insurance, and two states have made a limited form of experience rating mandatory (Weiler et al., 1993).

Earlier experiments with experience rating in malpractice insurance, whether initiated by private insurance carriers or mandated by states, were abandoned in the face of strong physician opposition (Sloan, Bovbjerg, and Githens, 1991). Such strong resistance to experience rating is surprising given the expected gains to most physicians. Sloan (1990) observes that opposition by physicians may derive from uncertainty about the extent of the cross-subsidization in the current system or from beliefs that apparent differences among physicians are because of chance or misinformation. In addition, the feasibility of estimating risk components for individual physicians has been questioned because malpractice claims arise with relatively low frequency. Also, the variation in the aggregate level of these claims over time renders implementation more difficult. [1] This study considers the feasibility of experience rating using data on malpractice claims from 1985 through 1992 for a panel of Florida physicians. This allo ws the authors to assess how experience rating would affect the cost structure of insurance for physicians.

Existing studies have not adequately addressed the desirability of experience rating from the viewpoint of the affected parties. In particular, the consequences of using fitted parameters from an econometric model to design contracts that incorporate individual heterogeneity have not been shown. This study addresses a number of related questions. First, the authors present empirical models with and without experience rating to determine the extent of cross-subsidization in the current, nonexperiencerated insurance contracts. The estimates reveal remarkable detail about the distribution of benefits and costs that would accompany adoption of experience rating.

Second, this article presents a new measure for the individual-specific determinant of claims history that can be used in rating. The authors examine the correlation between heterogeneity and the observable characteristics of the physicians, such as the number of patient visits or geographic region. If observable characteristics could be incorporated into a priori (non-experience based) risk classification ratings, there would be no case for experience rating. Indeed, others have reported that some such a priori rating is the norm (Blair and Makar, 1988). …

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