Health Care Providers and Captives:

The Long Romance Continues

A long romance has existed between captives and health care providers, particularly tax-exempt hospitals and hospital systems, and shows every sign of continuing…and getting stronger, even in this somewhat softening market. It’s truly been a long romance, beginning in the late 1970s with the first Cayman-domiciled hospital professional liability captives, and moving on to the early 1990s when increasingly smaller facilities converted their older Medicare reimbursement trusts to captives insurance companies. On the whole, it has perhaps been the most successful story in history of the captive industry.

Recent Changes: Insuring Physicians in Private Practice

Historically, most hospital captives have refrained from underwriting any exposure not directly related to the operations and tax-exempt purpose of their parents, with the possible exception of the largest and most sophisticated hospital captive programs. Not underwriting “unrelated exposure” was thought to be a prudent use of hospital-sponsored captive resources. 

This has changed. Why? Because the insurance market forced the change, and with this change the old romance suddenly took a different course. 

The expansion of a hospital captive into the underwriting of non-employed community physicians, really an expansion of a captive into third-party business, raises many issues that I will discuss in this article. Among these are:

§                     The crisis that provoked the expansion of many health care captives

§                     The successful components of a health care captive writing unrelated business

§                     The underwriting and exposure issues

§                     The domicile issues

§                     To front or not to front?

§                     The legal and regulatory challenges

§                     Who you need to help you

The Physician Insurance Crisis Begins

By mid- 2001, it was becoming clear that, from a claim frequency and, more importantly, a severity standpoint, the health care industry found itself deep in the middle of a medical professional liability insurance crisis.  By 2001, physician professional liability claim experience for all underwriters had developed so adversely as to force the market to constrict – forcing, in turn, significant rate increases and a general reduction in capacity, particularly for high-risk specialties, such as obstetrics and neurosurgery. By late 2001, St. Paul Fire & Marine Insurance Company had decided to leave the medical professional liability insurance market permanently.  St. Paul was, by then, the largest individual writer of physician professional liability insurance in the U.S.  St. Paul’s exit from the market sent shock waves throughout the industry.  In a number of states, the available commercial markets (including those physician-managed members of the Physician Insurers Association of America) dropped from an average of four insurers in each state to two or fewer insurers. As a result, medical professional liability captives continue to be formed and in increasingly greater numbers.

As a result, at dozens of heath care systems across the country, community physicians walked into the hospital’s CEO’s office and effectively proclaimed, “We hear you’ve got a captive – convert it to assume private attending community physician exposure – or we’ll leave your medical staff.”  Though a few CEO’s resisted the pressure, many did not.

Those hospitals that had existing captives rapidly underwent feasibility analyses aimed at expanding or converting an existing hospital captive to an underwriter of what amounted to a significant amount of third-party business. Many of those health care organizations with no captive in place undertook first-time feasibility studies and implementation plans, and expanded directly into the third-party underwriting business…sometimes with no prior captive insurance frame of reference.  In some cases, in just three to four months, a captive was expanded or formed from scratch to fill out an already constricted marketplace.  In my home state of Connecticut, between January 1, 2002 and January 1, 2006, hospital and physician-owned captives underwrote more than 700 new physicians…almost 14% of the market in Connecticut moved from commercial coverage to insurers owned by tax-exempt hospitals and hospital systems. If this had not happened, patient census would have dropped, deliveries decreased, and, almost certainly, significant trauma services to the community would have been curtailed. This also put many physicians and hospitals into a new and possibly precarious business relationship: as partners in a medical professional liability insurance program, where so-called “professional insurers” couldn’t or wouldn’t do it.

Hospital-owned captive physician insurance programs are now, and will be in the future, substantial and viable participants in the capacity available in the physician insurance marketplace.  For many, this market is not an alternative risk transfer market; this is the market. The question we must ask ourselves is will this new type of relationship between the privately employed medical staff of your local hospital and the hospital institution itself be a successful one?

What Are The Successful Components?

First, it is important to recognize that when we speak about expanding hospital-owned captives, we’re referring to the only expansion that makes sense, and that is a move to underwrite the non-employed voluntary attending members of a hospital’s medical staff.

When we speak of underwriting physician business, it is important that the physician premium rates used are calculated by an independent actuary and bear an appropriate relation to the rates in use by the available commercial insurance market in the area in which you will underwrite.  Just as importantly, you should compare the rates proposed in your program, as well, to the major existing hospital-sponsored captive markets operating in your area.  One of the consistent mistakes made in captive program physician rate evaluation is forgetting to include valid rate and statistical information (where available) from established hospital-sponsored, or physician group practice-sponsored, captive arrangements – whether these are fronted or non-fronted programs.  In many states, these captive programs are the market leaders in the area in which they operate.

Secondly, physicians need risk management and practice management assistance, and these services and their various components should be built into your captive’s budget as major service commitments.  There are a number of professional risk management service providers who can give you hands-on assistance in supplementing your physician underwriting and risk management efforts.

With respect to underwriting and administration, it is very important that these services be unbundled to a professional underwriting organization outside the boundaries of the hospital’s risk management or finance departments.  There are many reasons to unbundle these services.  First, as hospital administrators can attest, any relationship between a hospital and its medical staff is always a highly politicized one. Hospital management should probably stay away from any decisions related to the acceptance or rejection of medical staff members for insurance program underwriting purposes.  Also, few hospital risk management or finance departments are equipped to handle such issues as the billing and collection of premium, the issuance of policies, endorsements, and certificates, and the labor-intensive work associated with answering telephone and written inquiries from physicians or, more usually, from members of their staff.

The life-blood of any insurance program, indeed, of any captive program, is how claims are managed and adjusted. In this critical area, it is important to understand, in advance, what resources are needed, what they will cost, and when they need to be employed in support of a physician program captive underwriting effort.  Because under an effective hospital-sponsored captive underwriting initiative, the hospital risk manager must ultimately be responsible for the integrity of the claims program and its management, the risk manager’s ability, and, most importantly, his or her time availability to supervise and manage this program is of paramount importance.  I know of no hospital risk manager with either a current surplus of staff or time – and physician programs are usually claim-activity intensive.  Additionally, physician claims require intensive hand-holding, as there is the added problem of the physician’s fear that each incident report will eventually result in an actual claim and the outcome that all physicians dread: a report to the National Practitioner Data Bank. 

All this adds up to the need to budget for a sound and effective claims management effort, most probably handled, in part, if not entirely, by a third-party administrator with sufficient physician professional liability claim experience, who will report directly to the risk manager and assist in the process of the reserving, management, and ultimate settlement of claims.

Having said all of this, with the important component of mandatory joint defense of those losses involving both the hospital and the insured physician, the hospital risk manager must allocate sufficient time to manage these difficult and highly politicized claims, and see them through to complete adjustment. 

What Are the Underwriting and Exposure Issues?

Hospitals credential their medical staffs based on objective clinical and experience-based criteria. Re-credentialing generally occurs every two years – in some places annually.  No distinction is made between community physicians in private practices, who are part of the medical staff, and those physicians employed by the hospital.  The process is intended to choose the “best and the brightest” among these physicians, who will admit patients and work within the confines of the hospital’s orbit. The credentialing process is not, however, an insurance underwriting process.  Hospital captives have not traditionally insured community physicians, so deciding on who to insure and who not to insure has never been, in a commercial sense, part of a hospital risk manager’s responsibility. When a hospital decides to underwrite some of its private medical staff members through a captive, the process can get complicated and requires professional assistance.

It’s important to recognize the unique relationship a physician has with his or her hospital. In many respects, they can be said to be the same economic risk, and this concept exists only in the health care industry, and nowhere else.  In no other industry segment will you find an example of closer “risk profile proximity” than that of a hospital and its medical staff.  In the surgical specialties in particular, the risk of the hospital and the privately employed (and usually privately insured) physician are already so close and contain such weakly defined boundaries, that in many cases they are pretty much the same exposure.  There is no other parallel like this in our industry.

On an automobile assembly line, when it comes time to install the car’s windshield, the assembly worker does not step back and hand off all or part of the windshield’s  installation to an independent party standing there on the assembly line who represents the windshield manufacturer, and who is, on top of it, independently insured for liability purposes.  In the hospital delivery room, the delivery room nurses work for the hospital (as may, for example, the anesthesiologist, if present), but the obstetrician – a many-times independently employed and, up until now, independently insured exposure – delivers the baby.  To the expectant mother the process is seamless.  No one has a sign hung around his or her neck stating his or her employment status or insurance status – but two sets of insurance coverage limits may apply, with some coverage occurrence-based, some claims-made, etc. To a patient, the hospital and the OB/GYN are the same exposure. When the non-employed OB/GYN and the hospital are actually insured in the same captive arrangement, it’s absolutely the same exposure. Make no mistake: no parallel “risk profile proximity” issue exists in any other field of endeavor. 

What Are The Domicile Issues?

For many years, most captive domiciles (with the exception of Cayman) had significant problems with health care captives underwriting even limited amounts of third-party exposure – such as the exposure of community physicians in private practice.  As a result, the Cayman Islands became, and still are, a welcoming environment for hospitals contemplating third-party exposure expansion.  Most hospital system captives are single-parent, pure captives, with no third-party exposure that would require regulatory oversight or a complex approval process. When they expand to include third-party exposure, the regulatory issues change. In the mid-1990s, Bermuda began to take a more enlightened view of this issue. Vermont has taken a progressive and reasoned position on pure hospital captives writing limited amounts of controlled physician business, particularly where a strong commitment to integrating the insured physicians into the risk and claims management program of the hospital is in evidence.  Bermuda has an easy solution to these captive expansions, or new formations, with its defined class license structure and the ability to understand, pretty much from the beginning, which class of license to apply for in one of these expanded hospital captive programs. 

These days, depending upon the soundness of your plan, a variety of domiciles is available for consideration. This variety of location alternatives will benefit you in organizational and implementation planning, as well as expense planning as it relates to markup for tax and other traditional general and administrative expense components.

To Front or Not To Front?

Many hospital system sponsored captives use an issuing carrier for their voluntary attending physician insurance programs.  The primary reason to use a fronting insurer, in the case of these programs, is the perceived notion that admitted paper is necessary in these circumstances in order to satisfy the credentialing requirements not only of the sponsoring institution, but of competing hospitals within the same or a contiguous service area.  Secondly, there is a history of received information that, if the program is not fronted, it will not meet insurance regulatory scrutiny in the state where the physician policies are delivered.  These notions have been, and should be, challenged by professionals in our industry as possibly outdated, certainly expensive, and absolutely requiring more time to implement than may required. I’d like to propose a radical idea: that there is entirely too much fronting in the health care captive insurance business.  As part of the feasibility process, due consideration should be given to whether the captive insurer in question can create a structure where the physicians insured can access this coverage utilizing the various states’ industrial insured exemption laws, or other reasonable alternative modalities, rather than incur the expense and complication of a fronted arrangement.

The Legal and Regulatory Challenges

This is a whole other article, for a whole different edition of this publication. However, as you consider expanding an existing captive or developing a new one to underwrite private physician insurance exposure, you’ll want expert help in examining the following issues:

§                     The Federal Anti-Kickback Statute: This is all about what is prohibited by statute when you provide illegal remuneration to a physician (which might be defined as lowered professional liability insurance costs).

§                     Possible Safe Harbor provisions through the Office of the Inspector General of the Department of Health and Human Services: There are certain safe harbors that have been established by the OIG under certain circumstances (usually connected with obstetricians) and well worth your consideration before you engage in a captive feasibility analysis.

§                     The “Stark Law”: This law prohibits a physician from making referrals to an entity (such as a hospital) if that physician has a “financial relationship” with that entity, unless one of a few applicable exemptions applies.

§                     Possible challenges to the tax-exempt status of a hospital underwriting community physicians: It’s important to remember that there is nothing more sacrosanct than the tax-exempt status of a hospital. To lose tax-exempt status is catastrophic. Careful consideration should be given to a captive sponsored by a tax-exempt organization using that organization’s tax-exempt funds (in the form of a captive’s surplus, for example) to underwrite taxable exposure…namely, privately employed physicians in the community.

As you can see, these are serious issues requiring a serious examination as part of the captive feasibility process. Most hospital-based attorneys have little expertise in these areas. It will be important to obtain advice from experienced and qualified counsel before proceeding.

Who You Need to Help You

In order to consider expanding an existing hospital captive or creating a new one to underwrite third-party exposure, you’ll want to consider the following table, which should help you understand who you need to assist you.

Your captive manager will play an integral role in this entire process, and should be consulted at every step of the way.

In Summary

The medical professional liability insurance market crisis has prompted the expansion or creation of a large number of hospital captive programs. As hospitals consider underwriting beyond their four walls – to include members of their private attending medical staffs – these captives have expanded to accommodate this crisis and this challenge. It is the best example we know of of the use of captives for the public good: for if these captives had not expanded, the result would have been significant shortages of obstetricians and other surgeons in high-risk specialties needed in all our communities. We expect this expansion to continue as the face of medicine changes, and as physicians look more and more to the hospitals where they admit their patients to provide them with solutions to the cost and availability of professional liability insurance coverage.

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