July 30, 2002

The Honorable George W. Bush President of the United States Washington, DC 20500

Dear Mr. President:

I am a former Federal Insurance Administrator who advised President Ford on the situation pertaining to the Medical Malpractice crisis of the mid 1970s. At that time, I informed him that the problem was not an explosion in lawsuits, as some had suggested, but the economic cycle of the insurance companies. I am sorry to have to inform you that the Department of Health and Human Services report, upon which you based your recent call for severe limits on victims of medical negligence, is one-sided and full of errors. HHS appears to have relied solely on biased statistics developed by the insurance industry.

The cause of the current crisis is the same as I advised the President and Congress it was back in the 70s and again in the mid 80s (when I was President of the National Insurance Consumer Organization): fallout from the economic cycle and the business practices of the insurance industry. This is a well-known cyclical effect. It is a startling error for HHS to not mention the cycle in its report.

I have documented the cycle and the effects on current insurance rates in a letter to the state insurance commissioners dated July 30, 2002, attached, to show you the history. In a nutshell, during the “soft” phase of the market, rates do not rise as costs do, particularly if financial markets are producing positive results in long-tailed lines like malpractice, where the premium is paid years before claims are paid, giving enormous “float” profits to insurers. In the last decade, medical malpractice rates stayed flat while costs (claims, including jury verdicts) rose by exactly the rate of medical inflation. When interest rates and the stock market tanked, the rates had to catch up. As our letter to the commissioners shows, in order for medical malpractice rates to return to 1991 levels, they would have to rise by about 50%.

Ignoring the economic cycle as a cause of the current situation is an unforgivable error by HHS, given the widespread acceptance of the cycle and its impact on medical malpractice premium increases. Here are five other egregious examples of errors in the HHS report:

1. “The leading study estimates that limiting unreasonable awards for non-economic damages could reduce health care costs by 5-9% without adversely affecting quality of care. This would save $60-108 billion in health care costs each year.”

Comment: The total cost of medical malpractice premiums is $6.4 billion (not just for doctors, as the report says, but for doctors, hospitals and other facilities). This represents about one-half of a percent of total health care expenses. In other words, if an outright ban were placed on medical malpractice lawsuits the total savings would be about $6 billion. The idea that a cap of any kind can save $60 to $108 Billion is pure rubbish. How in the world could “defensive medicine” possibly be more than equal to the total risk measured in premiums, much less 10 to 20 times the risk, as HHS assumes? This makes no economic sense at all. Indeed, the Office of Technology Assessment has studied the prevalence of defensive medicine. It found no statistically significant defensive medicine impacts in its various surveys, with one exception. In that survey, OTA suggested that medical costs resulting from the fear of malpractice litigation represented “certainly less than 8%” of diagnostic procedures…”

The Congressional Budget Office took the position that “defensive medicine is probably not a major factor in the costs of medical care.” In a study of defensive medicine by Lewin-VHI, Inc, the estimate of the cost of defensive medicine was 2.7 times the cost of premiums (based on an AMA study that used self-reported doctor data “which is suspect because physicians have a direct financial incentive to overstate their costs,” according to the VHI study.) If this figure were used, the cost of defensive medicine would be, at most, $ 17.3 billion ($6.4 billion * 2.7).

These studies were conducted before managed care took hold in the mid to late 90s and placed increasing utilization restrictions on physicians. If anything, the studies overestimate the amount of defensive medicine that is occurring at the present time.

If the total cost of the malpractice system is at most $23.7 billion ($6.4 billion in premium and $17.3 billion for defensive medicine,) it is difficult to see how tort reform can cut costs by $60 billion or more.

2. “Insurance premiums are largely determined by the expensive litigation system.”

Comment: Litigation affects a tiny fraction of malpractice claims that are closed. The average cost of all claims closed over the decade that ended December 31, 2000 was $27,823.53. This includes all “million dollar” verdicts. Insurance premiums are determined by the overall costs, of which litigation is a small amount. Also, premiums are greatly influenced by costs other than claims (such as loss adjustment expense and underwriting costs) and investment results.

3. “The average payment per paid claim increased from approximately $110,000 in 1987 to $250,000 in 1999.”

Comment: These numbers do not reflect overall industry statistics and must be a biased sample. As mentioned above, the average claim paid over the decade of 1991 to 2000 was $27,823.53 according to AM Best statistics for the entire industry. This includes costs for insurer defense and claims adjustment. The figures over the decade showed no growth in average paid claim. If one looks at average payout just for claims with payments (as opposed to all closed claims, which include zero payments) the average loss was $112,987. This includes costs for defense of claims settled, adjudicated or otherwise closed with no payment, thereby overstating the cost per claim paid.

Even the incomplete statistics quoted by HHS show little real growth in paid claims. The increase from $110,000 in 1987 to $250,000 in 1999 is a 127% growth in 12 years or a 7.1% annual growth rate. The medical care services index of the CPI-U increased 95.7% during that time, or 5.8% per year. Medical malpractice costs are rising only about one percent more than the expected growth, even under the biased HHS sample, given the increasing number of doctors and medical inflation. It is remarkable that HHS ignored inflation in its analysis.

Had they used industry-wide data HHS would have seen that incurred losses, including insurer estimates of reserves as well as payments, rose from $3,335 per doctor in 1991 to $5,024 in 2000, an increase of 51%. This rise in costs is precisely the same as medical inflation (Bureau of Labor Statistics CPI-U Medical Care Services index). You would expect that treating medical injuries would show cost increases about the level of medical inflation. That is what happened. There is no “explosion” of medical malpractice costs.

However, there is mismanagement of the costs by the medical malpractice insurance companies. During the same decade, medical malpractice premiums per doctor went from $7,701 in 1991 to $7,844 in 2000. In other words, while costs went up by medical inflation, premiums stayed the same. It would take a 50% rate increase to catch up for this inaction by insurers during the decade.

4. “Premiums have increased rapidly over the past several years.”

Comment: As we have demonstrated, premiums have been flat.

5. “There is a substantial difference in the level of medical malpractice premiums in states with meaningful caps, such as California.”

Comment: Malpractice premiums in the USA averaged $7,844 in 2000; in California, rates averaged $7,201. This represents an 8% difference. Between 1991 and 2000, premiums rose by just 0.2% nationally and by 0.4% in California.

I am very surprised that your advisers did not warn you of the large number of errors in the HHS report. You would have received better advice, I am sure, were you governor instead of president. As I served as Texas Insurance Commissioner, I know the quality of the Texas Insurance Department. In order for the American people to trust your proposals, it is imperative that you base your decisions, particularly decisions that would restrict patients’ legal rights, on sound evidence, and not the shoddy, one-sided analysis HHS supplied to you.

Yours truly,

J. Robert Hunter Director of Insurance

CC: Andrew H. Card, Jr. Lawrence B. Lindsey