Kevin Drum flagged a good Wall Street Journal article on how low interest rates will probably lead to higher medical malpractice insurance premiums.
Over the past year, several major insurers have notified tens of thousands of people of higher costs to keep their policies in force, with increases ranging from midsingle-digit percentages to more than 200%, according to financial advisers. To justify the increases, they blamed the impact on their investments from the Federal Reserve’s decision to keep interest rates lower for longer.
Kevin notes that there is a cycle of medical malpractice “crisis” used to hammer consumer protection where the earnings from investing reserves are low which leads to a premium shock which leads to doctors lobbying for relief in the form of benefit caps and more favorable standards of deference despite there being no significant increaes in claims actually being filed.
I want to bring this out to an even wider picture. All insurance companies are hedge funds with very odd business models. They take money in, they put some of that into immediate pay-outs and the rest goes to either reserves for investment, system administration or hookers and blow. Health insurance companies are far less hedge fund like than major re-insurance companies or property-casualty companies because we pay claims consistently so we always have significant net cash outflow. However there are three major pots of money that just sit on the balance sheet.
The first pot is premiums that are paid early in the year that are in excess of current expenses but will be needed to pay for end of year expenses once more individuals’ out of pocket maximums are hit. This money is usually held as cash or near cash.
The second pot are the mandatory claims reserves and state stability reserves. This is the warchest that state regulators really care about. It should be sufficiently large and sufficiently liquid to pay all claims that could be incurred if the state shut down the insurer this afternoon. Again, this money is not usually invested too aggressively. It will be in short term T-bills, it will be in AAA commercial paper. The primary objective of the company’s treasurer is to make sure this money is still there in three months, not to maximize long run growth even at the risk of volatility. It is very boring money.
The final pool of money is excess reserves. This is money that has been held on the books and not distributed out as dividents or to buy better hookers and more blow for powerful internal stakeholders. This is where insurance companies can become hedge fund like. This money is not needed to pay claims, it is not needed to keep the regulators happy. If it can earn four, five, six percent or more, it can significantly contribute to the bottom line of the company in excess of the core business operating margin. Some insurers have very low excess reserves. Others have multi-billion dollar warchests. Those insurers can rely on their investment income to subsidize the operations of their core business.
As returns on excess reserves go down, total profitabilty goes down. For some companies, that will turn a profitable year into a loser of a year. Those companies can handle that for a year or two, but they’ll raise premiums to cover operating costs as much as the market will allow.