The casualty segment of the property-casualty industry continues to see double-digit price increases, even as the property segment appears to be leveling off. Within the casualty segment, medical liability is possibly the hardest, with many physicians, physician groups and hospitals having to scramble to find good malpractice insurance options.

Steve Shea

The Medical Injury Compensation Reform Act (MICRA) was enacted almost 30 years ago in California. Without MICRA, or if MICRA is rewritten with much higher caps as some legislators are proposing, the marketplace would get even harder, with some carriers choosing to leave the state altogether.

In its present form, MICRA is a tremendous help to the health care and insurance industries, keeping the severity of claims at a manageable and much more predictable level. According to Weiss Ratings, an independent rating organization based in Florida, there are only three states in the union with lower median medical malpractice payouts than California (Indiana, Kentucky and Vermont). This provides a strong argument that MICRA is containing malpractice costs in California.

According to the Insurance Information Institute, however, California has the highest frequency of malpractice claims per licensed physician. This high frequency has virtually the same effect as severity would have, in that carriers are still hesitant to provide malpractice coverage in California. There are a handful of specialty underwriters writing malpractice coverage, from stock insurance companies (GE Medical Protective) to mutuals (NORCAL Mutual, SCPIE, The Doctors Co.).

There are alternatives to traditional, guaranteed cost insurance programs provided by insurance companies. The health care industry, as a whole, has always been a leader in these alternative risk vehicles, which include risk retention groups, risk purchasing groups and captives. However, these vehicles do not come without risk, and careful planning and due diligence is required to determine if such an approach is appropriate, or even feasible, for your group. And none of these vehicles are designed to save you premium dollars in the short term -- on the contrary, for the first three to five years, you will most likely pay more in combined premium and collateral than you would pay to an insurance company in a guaranteed cost structure.

Here are the benefits of self-insuring:

* Save money over traditional commercial insurance over time.

* Buffer cycles in the marketplace.

* Obtain direct access to quality reinsurance/excess markets.

* Control claims handling.

* Reap the financial benefits of good loss experience.

* Have the opportunity to positively impact quality of patient care through loss prevention activities.

Any of these alternatives can be formed for individual corporations or for groups of similar corporations. All of them require a minimum commitment of three to five years. And the minimum premium, either for a group or individual corporation, is $5 million.

The most popular alternative risk vehicle for health care-related companies is a captive. The most popular domicile for health care captives is Grand Cayman. Of the 344 new health care captives formed in 2002 (the most ever in any year), 197 were domiciled in Grand Cayman. Other domiciles include Bermuda, Vermont, Hawaii and South Carolina, a new captive domicile that is the hottest U.S. domicile.

The captive you form acts as a reinsurer of the primary insurance company, who issues the policy of insurance. A contract is negotiated and put into effect between the captive and the primary insurer, which dictates the level of risk retained by the captive.

Although not required, it is recommended that the participant(s) purchase aggregate reinsurance, which will cap the financial risk at a certain loss ratio in a given program year (e.g., at a 90 percent loss to premium ratio). The participant(s) will be charged a premium commensurate with their exposure and loss experience, probably close to what they would pay to an insurance company for a guaranteed cost program.

In addition to the premium payment, the participant would also be required to collateralize the "gap" between what is available in the loss fund (premium payments minus expenses) and the attachment point of the aggregate reinsurance. As a general rule, you can anticipate having to post a letter of credit in the amount of 30 percent to 40 percent of premium each year. That collateral will not be released back to you until the primary insurer is confident it will not need the funds -- in other words, the program was profitable in a particular year. Once the program matures and you (hopefully) have realized some underwriting profits, those profits can be used as collateral in future program terms, eliminating the need to post LOCs.

Critical in the formative stages of a captive is the insurance broker, who will perform preliminary pre-qualification of the participant(s) and should also arrange for a formal feasibility study, especially if a company is forming a member-owned captive. The broker will also be invaluable in introducing a company to claims third party administrators, actuaries, attorneys and captive managers, all of whom will either need to consult you or be retained by you initially or on an ongoing basis.

Once formed, your broker is your main liaison with the captive manager and claims TPA, and performs risk management and analysis functions for the captive.

In conclusion, an alternative risk transfer solution may be appropriate depending upon the risk appetite, financial health and goals and objectives for the prospective participant. Whichever form they take, these alternative solutions are long-term strategies for risk management and transfer, and should be viewed as a way to save money in this hard market we are in now.

Shea is program executive in Barney & Barney's Program Group. For information, call (858) 550-4982 or e-mail steves@barneyandbarney.com.