B.E.Frechm
H. E. Frech III is Professor ofEconomics at the University of California, Santa
Barbara, where he is a past Chairman. He is also an adjunct professor at
Sciences Po de Paris and Adjunct Scholar at the American Enterprise Institute.
He has been a visiting professor at Harvard and at the University of Chicago
and an economist in the U.S. Government. He has served as a consultant or
expert witness for governmental agencies and private parties. In the area of
health care antitrust, for example, he testified for the physician plaintiffs in
K.artel v. Blue Shield of Massachusetts and also for the Attorney General of
Maryland in its case against the Blue Cross plans ofMaryland and the District
of Columbia.
He is North American Editor of the International Journal ofthe Economics
ofBusiness. He has published numerous articles and written or edited several
books on many topics,. including industrial organization, health economics,
insurance, energy economics, land use controls, the Coase Theorem and the
property rights theory of the finn.
His most recent book is Competition and Monopoly in Medical Care,
published by the American Enterprise Institute. The journals in which he has
published include the American Economic Review, Journal of Political
Economy, Journal ofLaw and Economics, Quarterly Journal ofEconomics,
Journal oflnstitutional and Theoretical Economics,De Economist and Review
d'Economie Politique.
Professor Frech has given lectures at numerous conferences and institutions
in North America and in Europe. H.E. Frech specializes in industrial
organization, economic theory, health economics, and political economy and
holds a Ph.D. in Economics from the University of California Los Angeles.
William G. Hamm
William G. Hamm is an economics consultant with high-level experience in
both business and government. An expert in banking and financial institutions,
he has been the executive vice-president/chief operating officer of an AAArated $50 billion bank. He has also run a $1.5 billion payment processing and
customer service operation for an S&P 500 company. Prior to entering the
private sector, Dr. Hammheaded the non-partisan Legislative Analyst's Office
in California, where he earned a nationwide reputation for objectivity,
expertise and, credibility on public policy issues ranging from taxation to
healthcare. He also spent 8 years in the Executive Office.ofthe President in
Washington, D.C., where he headed a division of OMB responsible for
analyzing the programs and budgets of the Department of Labor, HUD, the
Veterans Administration, and numerous other federal agencies.
As a consultant, Dr. Hamm specializes in helping courts, legislative bodies,
and the public develop a better understanding ofcomplex economic and public
policy issues. He assists businesses and public agencies analyze existing and
proposed government policies, develop sound policy alternatives, and
communicate the results to decision-makers. He is also recogniZed as an
effective expert witness who can clarify complex litigation issues.
Dr. Hamm has a B.A. from Dartmouth College and a Ph.D. in Economics from
the University of Michigan. He is a member of the American Economics
Association and the American Law and Economics Association. He is also
a Fellow of the National Academy for Public Administration, a Founding
Principal· of the Council for Excellence in Government, a member of the
California Institute forCuntyGvem~s
Governing Board, and a member
of Freedom From Hunger's Board of Trustees.
C. Paul Wazzan
C. Paul Wazzan specializes in providing financial and economic analysis in
the areas of securities, options and futures, antitrust, damage analysis, health
and labor economics, statistics and econometrics, and intellectual property.
He holds a B.A. in economics from the University ofCalifornia, Berkeley and
a Ph.D. in finance from the University of California, Los Angeles. Dr.
Wazzan has taught valuation methods at the University ofSouthem California,
Marshall School of Business.
Dr. Wazzan is President and CEO of Wazzan & Co. Investment LLC, a
venture capital firm specializing in semiconductor, optical networking, biomechanical, bio-medical and related technologies.
Some of the areas in which Dr. Wazzan has conducted substantial economic
and statistical analyses include: the competitive effects of mergers and joint
ventures; monopolization; price discrimination; predatory pricing; market
definition; securities fraud; option valuation; class certification; commodities
price manipulation (e.g., non-ferrous metal price manipulation on the COMEX
and LME exchanges); labor economics (e.g., class certification, wage & hour,
employment discrimination); and intellectual property (e.g., patent and trademark infringement, theft of trade secrets). His analyses have covered a wide
range of industries, including basic manufacturing (e.g., mining, oil and gas,
steel, food processing and distribution); high-tech manufacturing (e.g., aircraft
and avionics, semiconductors, personal computers, computer peripherals); and
services (e.g., banking, metals trading, organized financial markets).
Dr. Wazzan has published on the inipact of socially motivated shareholder
activism, the influence of pension fund investment/divestment on securities
prices, the effects of federal and state legislation on medical care costs and the
use of statistics in labor law analyses. Dr. Wazzan is a member of the
American Finance Association and the American Economic Association.
CONTROLLING MEDICAL MALPRACTICE INSURANCE
COSTS-CONGRESSIONAL AcT·OR VOTER
PROPOSIDON?
H.E. Frech Ill, Ph.D.
William G. Hamm. Ph.D.
C. Paul Wazzan, Ph.D.•
I. INTRODUCfiON
It has been generally established that reducing medical malpractice
insurance costs enhances the public welfare by reducing consumer (i.e.,
purchasers of medical care) costs and increasing access to health services.'
While many states, including: Alaska, California, Colorado, Florida, Hawaii,
Idaho, Indiana, Kansas, Louisan~
Maryland, Massachusetts, Michigan,
Mississippi, Missouri, Montana, Nevada, New Mexico, North Dakota, Ohio,
Oklahoma, South Dakota, Texas, Utah, Virginia, West Virginia and
Wisconsin, have already implemented some form of malpractice insurance
cost controls, federal lawmakers are currently seeking ways to control medical
malpractice insurance. costs on a nationallevel.2 For example, H.R. 4280,
which was pending before the U.S. House of Representatives during the 108th
Congress, provides for a $250,000 cap on non-«onomic damages:
Congress finds that our current civil justice system is
adversely affecting patient access to health care. services,
better patient care, and cost-efficient health care, in that the
health care liability system is a costly and ineffective
mechanism for resolving claims of health care liability and
compensating injured patients, and is a deterrent to the
• William G. Hamm and C. Paul Wazzan are both at LECG, LLC. H.E. Frech is at the
University of California, Santa Barbara. We thank Supakom Chanchaowanich for invaluable
research assistance. We also thank Californians Allied for Patient Protection for financial
support. Corresponding author is C. Paul Wazzan who can be reached at pwazzan@lecg.com.
1. See, e.g., Congressional Budget Office, Economic and Budget Issue Brief: Limiting
Tort Liability for Medical Malpractice (Jan. 8, 2004), available at
http://www.cbo.g<tv/ftpdocs/49xx/doc4968/0 1..08-MedicaJMalpractice.pdt; Kenneth E. Thorpe,
The Medical Malpractice 'Crisis': Recent Trends And the Impact of State Tort Reforms,
HEALTH AFFAIRS (Jan. 21, 2004), QVailable at http://www.healthatrairs.org (follow Quick
Searchauthorequals1borpe)lastvisitedApr.2,2006;andU.S.GENERALACCOUNTING0FFICE,
MEDICAL MAlPRACTICE, IMPLICATIONS OF RISING PREMIUMS ON ACCESS TO HEALTH CARE,
GAQ-03-836 (2003).
2. Determination ofwhether individual states have caps is based on direct review ofeach
state's laws. For example, the Code of Virginia defines a cap on total damages. VA. CODE
ANN.§ 8.01-581.15 (Michie 2006). Otber states are reviewed accordingly.
34
INDIANA HEALTil LAW REVIEW
{Vol. 3:27
sharing ofinformation among health care professionals which
impedes efforts to improve patient safety and quality ofcare. 3
California is often cited as a model for such reform as it was among the
first to take a proactive role in addressing this issue through congressional acts
and voter measure as described below.
A. The Medical Injury Compensation Reform Act
In 197 5, the California Legislature enacted the Medical Injury
Compensation Reform Act ("MICRA"). The Act sought to improve
Californians' access to health care by stabilizing medical malpractice
insurance premiums, thereby making care more affordable and encouraging
doctors to continue practicing in California.
After MICRA became law, there was great uncertainty as to whether the
measure's cost-savings provisions would withstand court challenges.4 Until
these challenges were resolved, insurers could not be certain that the cost of
malpractice insurance would go down, so as to justify lower insurance
premiums. In 1985, the California Supreme Court upheld the constitutionality
of MICRA, stating:
[I]n enacting MICRA the Legislature was acting in a situation
in which it had found that the rising cost of medical
malpractice insurance was posing serious problems for the
health care system in California, threatening to curtail the
availability of medical care in some parts of the state and
creating the very real possibility that many doctors would
practice without insurance, leaving patients who might be
injured by such doctors with the prospect of uncollectible
judgments. In attempting to reduce the cost of medical
malpractice insurance in MICRA, the Legislature enacted a
variety of provisions affecting doctors, insurance companies
and malpractice plaintiffs.
Section 3333.2, like the sections involved in American Bank,
Barme and Roa, is, of course, one of the provisions which
made changes in existing tort rules in an attempt to reduce
the cost of medical malpractice litigation, and thereby
restrain the increase in medical malpractice insurance
3. Help Efficient, Accessible, Low-cost, Timely Healthcare (HEALTil) Act of 2004,
H.R. 4280, I08th Cong. § 2 (2004).
4. See, e.g., Am. Bank& Trust Co. v. Cmty. Hosp. oflosGatos-Saratoga, Inc., 683 P.2d
670 (Cal. 1984); Barme v. Wood, 689 P.2d 446 (Cal. 1984); Roa v. Lodi Med. Group, Inc., 695
P.2d 164 (Cal. 1985).
2006]
CONTROLLING MEDICAL MALPRACTICE INSURANCE COSTS
35
premiums. It appears obvious that this section-by placing
a ceiling of $250,000 on the recovery of noneconomic
damages-is rationally related to the objective of reducing
the costs of malpractice defendants and their insurers. s
MICRA made four important changes to California's medical malpractice tort
system: (1) it imposed a $250,000 cap on awards for non-economic losses,6
such as pain and suffering, in medical malpractice lawsuits; (2) it allowed
defendants to introduce evidence showing that the plaintiff had already
received compensation for a portion ofhis or her losses;7 (3) it authorized trial
courts to require periodic payments for future damages, in lieu of lump-sum
awards;8 and (4) it imposed limits on the contingency fees that lawyers can
charge medical malpractice claimants.9 MICRA imposes no limits on
economic or punitive damages. 10 Nor does it limit the exposure ofHMOs and
pharmaceutical companies to awards for non-economic damages resulting
from medical malpractice.
B. The Insurance Rate Reduction and Reform Act- Proposition 103
The Insurance Rate Reduction and Reform Act, more popularly known
as Proposition 103, was passed by California voters on November 8, 1988.
Under the measure, insurers were required to reduce rates by at least 20%
from the levels in effect on November 8, 1987. 11 The measure also required
any change in property and casualty insurance rates to be approved by the
Insurance Commissioner, beginning November 8, 1989.
The California Insurance Code indicates that insurance lines subject to
Proposition 103's provisions include: medical malpractice, personal
automobile, dwelling fire, earthquake, homeowners, inland marine, umbrella,
commercial aircraft, boiler and machinery, burglary and theft, business
owners, farm owners, some fidelity, fire, glass, miscellaneous, multi-peril,
other liability, professional liability, special multi-peril, and coverage under
the United States Longshore and Harbor Workers' Compensation Act. 12
5. Fein v. Permanente Med. Group, 695 P.2d 665, 680 (Call985).
6. The law defines non-economic losses as ''pain, suffering, inconvenience, physical
impairment, disfigurement and other non-pecuniary damage." CAL. CIV. CoDE § 3333.2(a)
(2006).
7. CAL. CIV. CODE§ 3333.1 (West 2006).
8. CAL.CIV. CoDE§ 667.7 (West2006).
9. CAL. Bus. & PROF. CODE§ 6146 (West 2006).
I 0. Nicholas M. Pace, Daniela Golinelli & Laura Zakaras, Capping Non-Economic
Awards in Medical Malpractice Trials: California Jury Verdicts Under MICRA, RAND
INSTITUTE OF CIVIL JUSTICE (Rand Corp. 2004). There is some evidence (post-cap) that noneconomic awards represent approximately 42% of total awards.
11. Proposition 103, CAL. INS. CODE § 1861.01 (a) (West 2006).
12. Longshore and Harbor Workers' Compensation Act, 33 U.S.C. § 901 (2006).
36
· INDIANAHEALmLAwREvmw
[Vol. 3:27
C. Summary ofFindings
As a result ofthe relatively simultaneous implementation ofProposition
103 and MICRA, there is some confusion as to which of these legal reforms
is respo~ibl
for controlling the cost of medical malpractice insurance, and
which would best serve as a model for Federal reform. 13 In an effort to assist
policymakers, opinion leaders, and the public jn evaluating this argument, we
examine the economic.effect of each of these laws.
Economic theory and empirical evidence show that Proposition 103
cannot explain the relatively modest growth in malpractice premiums, in
California since 1988 and that MICRA must be given credit for controlling
·
these costs.
ll. PR.OPOSmON 103'S IMPACfONTIIECOSTSOF
-MEDICAL MALPRACfiCE INSURANCE
We first test the hypothesis that Proposition 103 is responsible for the
relative stability of medical malpractice insurance rates by comparing the
trends in premiums for all lines of insurance subject·to the proposition's
provisions. If Proposition 103 is primarily responsible for holding down
malpractice insurance premiums, we should observe the same favorable trend
in premiums for homeowners insurance, automobile insl.irance, and other
casualty insurance line~.
A. Proposition 103 's Potential Impact on Medical Malpractice Insurance
. Premiums is Limited
Ex-ante, it is theoretically unlikely that Proposition 103 could be
effective in limiting the growth in medical malpractice insurance premiums
for ·four reasons.
1. Insurance costs determine insurance premiums, and Proposition
103 does not qffect medical malpractice insurance costs.
Insurance premiums must cover the expected cost ofproviding coverage
(including the cost of capital required by insurers to conduct business).
Competition ensures that premiums do not rise to levels where unneeded
surpluses are generated. If unneeded surpluses are generated by a firm's rate
structure, the excess often is returned to policyholders in the form of rebates
13. Sett. e.g., How Insurance Reform Lowered Doctors' Medical Malpractice Rates in
California And How Malpractice Caps Failed, FOUNDATION FOR TAXPAYER AND CONSUMER
RIGHTS (Mar. 7, 2003), available at http://www.consuinerwatchd.org (follow "Medical
Malpractice" hyperlink) (last visited Apr. 2, 2006).
2006]
CONTROLLING Mm>lcALMALPRACI1CE INSURANCE COSTS
37
or dividends. In the insurance business, costs drive premiUIDS-IlOt the ~er
way around. Proposition 103 does not impact insurance costs; consequently,
it cannot be expected to bold down premiums.
2. Proposition 103 pennits rate increases when(fl!er they are
juStified.
Proposition 103 does not prohibit increases in ins~
rates; it simply
requires that the increases be justified. The California IDsurance eom-·
missioner bas ruled that a demonstrable increase in the cost of providing
insurance is sufficient tojustify a rate increase.
It should be noted that, as a matter oflaw, Proposition 103 cannot force
insurers to operate at a loss by keeping reserves below expected. claims.
Moreover, the evidence shows that loss reServes maintained by California
medical malpractice insurers are not significantly different ftom the reserves
held by insurers in other states. As Table 1 illustrates, Califoniia insurers rank
eighteenth out ofthirty states in terms ofreserve adequacy, and their reserves
are within two percent of the national mean.
38
[Vol. 3:27
INDIANA HEALTH LAW REVIEW
Table 1: 2003 Ranldngs: Net Income; Policyholder's Surplus;
Loss Reserves; Underwriting Income14
State•
AZ
CA2
co
Average
of Net
Income
($000)
Rank
Max=
30
Average of
Policyholders'
Surplus ($000)
Rank
Average
of Loss
Rank
Max=
Reserves
Max=
30
(%)
30
Average of
Net
Underwriting
Income
($000)
Rank
Max=
30
$1,739
9
$127,250
8
69%
13
($13,067)
18
($5,170)
27
$119,572
9
64%
18
($18,561)
22
($274)
22
$84,608
14
44%
28
($4,564)
7
CT
$345
19
$67,689
17
87%
2
($14,993)
20
DC
($4,900)
26
$70,372
8
64%
16
($13,899)
19
FL
$1,021
15
$75,532
15
62%
22
($7,685)
12
GA
$52
20
$177,177
4
64%
17
($25,744)
25
lA
($332)
23
$14,286
27
12%
30
($860)
4
IL
$2,537
8
$172,211
5
76%
9
($58,746)
28
LA
$2,588
6
$62,120
18
75%
10
($4,896)
10
MA
$13,229
2
$230,000
3
78%
6
($63,658)
29
MD
$1,258
14
$113,427
11
68%
14
{$25,478)
24
14
($6,364)
29
$48,407
21
63%
20
($9,094)
Ml
$9,615
3
$170,915
6
76%
7
($12,077)
17
MN
$4,273
4
$118,158
10
80%
4
($8,206)
13
MO
($2,159)
25
$29,145
26
61%
25
($2,805)
6
MS
$999
16
$60,244
19
83%
3
($1(),617)
16
ME
NC
$2,553
7
$35,084
24
63%
21
$462
NJ
($2,051)
24
$45,952
22
48%
27
($15,767)
21
NY
($89,150)
30
$266,391
2
80%
5
($153,829)
30
OH
($6,208)
28
$145,653
7
72%
12
($25,833)
26
OR
$834
17
$9,756
30
61%
24
$133
2
PA
$1,738
10
$106,716
12
88%
($19,290)
23
14. AM BEST Key Rating Guide (2004). Data represents all insurance companies where
medical malpractice was listed as the first line of business (i.e., majority of business generated
from medical malpractice insurance). Total states represented equals thirty. "State" indicates
first state of business (i.e., majority of revenue generated in indicated state).
The insurance companies in California include: Everest Indemnity Insurance Co.;
Claremont Liability Ins. Co.; American Healthcare Indemnity Co.; SCPIE Companies; SCPIE
Indemnity Company; Doctors Company Ins. Group; Dentists Insurance Company; MIEC
Group; Medical Insurance Exchange of Ca.; Doctors Company Interinsurance Exchange;
California Healthcate Ins., RRG; NORCAL Group; NORCAL Mutual Insurance Co.;
Professional Undrw. Liab.; Health Providers Ins. Recip. RRG; Podiatry Ins. Co., America Mut.
Co.; MedAmericaMutual RRG Inc.; Underwriter for Professions; NCMIC Group; and NCMIC
Insurance Company.
2006]
1N
$1,738
TX
$19,154
UT
$1,457
13
$36,428
VA
$665
18
$10,284
WA
$2,909
5
$30,442
WI
$1,587
12
$54,048
($42)
21
$10,202
29
wv
Mean
39
CONTROLLING MEDICAL MALPRACTICE INSURANCE CoSTS
10
$85,442
13
61)0.4
26
($9,461)
15
74%
11
($26,660)
27
23
76%
8
($4,715)
9
28
61%
23
($983)
5
25
63%
19
($4,675}
8
20
67%
15
($5,819)
II
34%
29
($71)
3
$357,760
($18,715}
($1,545)
$97,842
66%
Max
$19,154
$357,760
88%
$462
Min
($89,150)
$9,756
12%
($153,829)
3. Most malpractice insurance in California is exempt from
Proposition 103.
Proposition 103 only applies to regulatedmedical malpractice insurance
companies. It does not apply to risk retention groups or to institutions that
self-insure against claims. Many physicians in California are covered by a
combination of risk retention groups and self-insured institutions, both public
and private (e.g., Med.America Insurance Co.). Consequently, Proposition 103
can have no effect on premiums charged by these groups.
4. Malpractice insurance is provided by non-profit and providerownedfirms that have no incentive to generate excess profits.
Given the characteristics of California's medical malpractice insurance
market, one would not expect Proposition 103 to have a material impact on
insurance premiums. Most malpractice insurance in California is written by
non-profit, mutual insurance companies that have no incentive to generate
excess profits. ts This type of insurer simply charges premiums that are
sufficient to cover its expected losses and maintain a small surplus. To the
extent that surpluses become too large, the firm can be expected to pay
dividends to its customers (who are also the "owners" in the case of mutual
insurance companies).
1S. "Excess profits" means revenues in excess ofcosts. including the market-determined
cost of capital.
INDIANA ~TH
40
LAW REviEW
[Vol. 3:27
B. California Medical Malpractice Premium Rates Have Grown More
Slowly than Ratesfor Other Proposition 103-Regulated Lines.
If Proposition 103 is effective in controlling medical malpractice
it should be equally successful in limiting the premiums charged
for other lines of insurance that are subject to the measure's provisions. This
hypothesis is tested by. comparing the trend in premiums for medical
malpractice insurance with the trend for these other insurance lines. See
Figure I..
premi~,
Figure I: Cumulative Premium Change (By Line) Since the
Adoption of Proposition 103 16
~
-~
16. Data provided by National Association oflnsurance Commissioners, NAIC Reports
on Ptofitability By Line By State, 1976- 2002; California data (on file with author).
2006]
CONTROUJNG MEDICAL MALPRACTICE INSURANCE COSTS
41
As Figure 1 demonstrates, following Proposition 103 's effective date,
medical malpractice premiums declined, while the average premium for "all
lines except medical malpractice" increased. Within the first three years, the
decline in medical malpractice premiums amounted to more than 20%.
The obvious explanation for the opposing trends shown in Figure 1 is
the relative changes in claim costs. Medical malpractice insurance rates went
down because claim costs went down. Premiums for "all lines except medical
malpractice" increased because claim costs increased. This inference is
economically sound because if costs had not gone up, the California Insurance
Commissioner would have refused to approve the higher rates.
Since Proposition 103 had no effect on the cost of providing medical
malpractice insurance, while MICRA reduced medical malpractice insurance
costs-but not auto insurance or homeowners insurance costs-the premiums
charged for these and other forms of coverage moved in different directions.
When the period of analysis is extended to 1998, the same disparate trends in
premiums are observed: medical malpractice premiums remained below the
1988 level (-1.6%), while the rates for both "all lines except medical
malpractice" and "other liability'' were significantly higher than the 1988 rates
(13.9% and 11.6%, respectively) notwithstanding Proposition 103.
Since 1988, the trend in medical malpractice insurance rates has been
significantly more favorable than the trend in rates for other Proposition 103regulated lines. From 1988 to 2002, medical malpractice premiums increased
by 19% while premiums for "all lines except medical malpractice" grew by
57% and premiums for "other liability" grew by 74%.
ill. CONCLUSION
In sum, the data demonstrates that MICRA, rather than Proposition 103,
is responsible for controlling medical malpractice insurance rates and the
resulting moderation in health care costs. This finding is not surprising given
the fact that Proposition 103, unlike MICRA, does nothing to limit the actual
cost of providing medical malpractice insurance.