Evaluation of Early Offer Reform of Medical Malpractice Claims: Final Report. Executive Summary.

U.S. Department of Health and Human Services

Executive Summary

Joni Hersch, Jeffrey O'Connell and W. Kip Viscusi

The Lewin Group

June 5, 2006

This report was prepared under contract #HHS-100-03-0027 between HHS’s ASPE/DALTCP and the Lewin Group. For additional information about this subject, you can visit the DALTCP home page at http://aspe.hhs.gov/_/office_specific/daltcp.cfm or contact the ASPE Project Officer, John Drabek, at HHS/ASPE/DALTCP, Room 424E, H.H. Humphrey Building, 200 Independence Avenue, S.W., Washington, D.C. 20201. His e-mail address is: John.Drabek@hhs.gov.

Many observers have concluded that the medical malpractice litigation system needs improvement. Medical malpractice cases are extremely complicated, requiring proof of injury, proof of the health care provider’s fault, and determination of economic and noneconomic damages. Some claimants who are injured through medical error receive significant awards or settlements, but often after long delay. In addition, the current system entails transaction costs, so that substantial shares of the medical malpractice insurance premium dollars go for litigation expenses and insurer overhead. Although many states have enacted medical malpractice litigation system reforms, such as caps on the amount of noneconomic damages, other reforms may have a more fundamental effect on medical malpractice litigation than these reforms. This report analyzes one specific alternative proposal, referred to as “early offers,” by assessing its performance using a database of actual malpractice claims.

Early offers provide a structured process for resolving medical malpractice cases shortly after they have been filed. If the defense chooses to do so, it may make a statutorily-defined financial offer, which the claimant can accept or reject. To comply with the early offer statute, the offer must completely cover the claimant’s economic damages plus appropriate attorneys’ fees. If the offer is rejected, the claimant’s burden of proof at any subsequent trial is increased. If the defense does not make an offer, the current system applies.

The basic goal of the early offer approach is to improve the performance of the system. For claimants, the advantage of the approach is that if they accept the offer, they are assured of compensation for their economic damages within six months after filing a claim, instead of the approximately 2-3 years that cases now require. For insurers and providers, if the offer is accepted, the damages amount paid is generally less than under the present tort system. Litigation expenses will be less, both for plaintiffs and defendants. There is also more predictable and prompter compensation for claimants’ attorneys than the current system provides. For claimants, defendants, and insurers, the early offer proposal reduces the uncertainty associated with the outcome of a prolonged litigation.

The analysis presented in this report indicates that early offers are likely to generate significant insurer savings through reduced payments for noneconomic damages. It will also reduce attorneys’ fees for both parties. Other things being equal, these savings could allow insurers to reduce premiums for malpractice insurance, thus enabling health care providers to reduce their fees. Ultimately, consumers, employers, and governments could benefit from reduced health insurance premiums and the reduced cost of care.

Data

This report uses medical malpractice data on closed claims from Texas and Florida to assess the performance of the early offer proposal. The primary analyses use the data provided by the Texas Department of Insurance because of their greater comprehensiveness. The report uses malpractice data from Florida data to impute data not included, or with incomplete information, in the Texas files. The Texas data are from the time period 1988-2002, before Texas modified its medical malpractice law in 2003, which significantly limited the award of noneconomic damages. Thus the data reflect the potential operation of an early offer law in a state without caps on noneconomic damages.

The Texas data involve all claims that were closed for an award or settlement greater than $10,000. The Texas data document that most claims are settled, with fewer than 1 percent of the settlements or awards the result of trial verdicts. The distribution of closed claims is highly skewed. One percent of the claims involve awards or settlements greater than $5 million, and 10 percent are greater than $1 million, but 38 percent of the awards or settlements are between $10,000 and $100,000. The median closed claim has a settlement amount or court award of $156,707. Thirty-three percent of the closed claims involve the death of the victim and an additional 14 percent involve serious nonfatal injuries. Twenty-one percent involve children under age 18.

The average, as opposed to the median, claim involves a settlement or award of $458,000, of which 28 percent is allocated for economic loss. Only 3 percent of cases involve exemplary damages, with the average settlement or award in those cases being $1,190,000, of which 21 percent is for economic loss. Another 4 percent of cases involve a settlement or award of $404,000, but no economic loss. The vast majority of cases (97 percent) do not involve exemplary damages, with an average settlement or award of $434,000 and an estimated economic loss of $124,000 (28 percent of the settlement or award). The settlement or award includes claimant’s attorney fees, normally set at one-third of any payment.

Methodology

The early offer proposal is a legal reform approach designed to provide prompt coverage of claimants’ economic losses and to reduce litigation costs.¹ Under the early offer proposal for medical malpractice claims, within 180 days after a claim is filed, liability insurers for health care providers (hereafter referred to as insurers and providers) may offer claimants a payment equal to the claimant’s net economic loss (i.e., the loss beyond any other insurance applicable to the claim), plus reasonable legal fees, but nothing for pain and suffering damages. If the claimant does not accept this offer, the claimant can proceed with a normal tort claim for both economic and noneconomic damages, but the legal standards of both the burden of proof and level of misconduct applied to the claim would be raised, and the claimant would have to prove the defendant’s gross negligence beyond a reasonable doubt.

Insurers would decide whether to make an early offer by comparing the cost of the early offer to their expected cost under normal tort rules if the claim is not settled under the early offer proposal. This expected cost would equal the net economic damages (medical expense and wage loss but, as stated, not pain and suffering) plus an allowable payment of the claimant’s lawyers, which as an illustrative calculation is presumed to be 10 percent of the value of the early offer. That is, the insurer will make an offer if the expected liability and litigation costs if the claim is not settled under the early offer proposal are greater than the net economic damages and allowable claimant’s legal fees.

Thus, the insurer will make an early offer when the amount of the early offer is less than the insurer’s expected exposure from a full-scale tort claim. This formulation assumes that insurers act in a rational economic manner, are risk-neutral, and value payoffs according to their expected value. This report emphasizes the amounts that would be saved by insurers by making early offers, since such savings are a prerequisite to making early offers. But savings to insurers do not necessarily imply losses to claimants of an identical magnitude. Some of the savings are in terms of lowered transactions costs, such as attorneys’ fees, which will be reduced. Although claimants lose their normal recourse to full-scale tort litigation, such litigation has inherent uncertainties, delays, and transaction costs, as well as legal fees, which are deducted from any payment. Under the early offer proposal, claimants lose any rights only after they are guaranteed prompt payment of medical expenses and wage losses, plus reasonable attorney’s fees.

Calculation of potential savings from the early offer reform requires a reference point for the computations. Three different points are possible using the Texas data: the insurer’s initial reserve set aside for payment of the claim, its final reserve, and the ultimate settlement or award. Both initial and final reserves include estimated defense attorneys’ fees, but the final reserve may be the most useful reference point because it is calculated at a point when more is known about the actual settlement or award and about actual defense attorneys’ fees. However, the savings computed from this reference point involves several key assumptions. Most notably, we must assume that the defense correctly estimates the expected value of the claim, and that the claimant accepts the early offer if one is made. An alternative reference point is the initial reserve. This measure proved to be less useful in the analyses, as many insurers typically underestimate this amount, thus making an early offer less likely.

Results

If the final reserve is the appropriate reference point for computing savings, the early offer reform could generate substantial savings. For those claims for which an early offer is desirable, the average insurer savings are $550,000 if based on the final reserve. Overall, insurers would find it desirable to make an early offer in 97 percent of the cases.

This report contains additional information on the early offer reform, including the likely impacts by type of injury (fatality, serious injury, etc.), and by whether deductions for collateral sources are included. If economic damages are reduced by deductions for other insurance, the results will be similar. The report also explores the effect of setting minimum amounts for cases of serious injury or death. A minimum of, say, $250,000 would often result in higher payments to the claimant if the offer were accepted than under the basic early offer computations. However, the higher the minimum offer, the less likely the insurer would be to make an offer, therefore reducing the savings from the reform.

Conclusion

Based on the assumptions used in this report, the early offer reform could lead to insurer savings and speedy resolution of many cases if it were adopted. The main benefit to the claimant of the early offer reform is that if an offer is made and accepted, the claimant receives assurance of payment that covers their economic damages approximately six months after the claim is filed. For the average case, payment will be received approximately two years sooner than under the current system.

The disadvantage to the claimant of accepting the early offer is that the possibility of receiving noneconomic damages is eliminated. Since noneconomic damages often involve greater sums than economic damages, this loss is significant. In about 3 percent of the cases, the possibility of punitive plus noneconomic damages remains more likely if the offer is rejected and the claimant wins a verdict, but victory would not be assured since the burden of proof would be greater than it is now.

Insurers would only make offers in cases where the expected value of the outcome would result in savings. However, no offer for less than the amount of economic damages, plus appropriate attorney’s fees, would gain the advantages of an early offer under the statute.

The extent to which these savings would be passed on through lower malpractice insurance premiums is unknown. However, assuming a competitive marketplace, one would expect that to happen.

NOTES

1. This theoretical model differs in several key ways from the U.S. Department of Health and Human Services (HHS) early offer pilot program, which attempts on a voluntary basis to promptly resolve claims that have been submitted to HHS for alleged medical malpractice by its employees or at HHS-sponsored community health centers.