Physician-Owned Carriers Invest to Benefit Those Who Are Insured, not Shareholders

TC Wilson, Chief Investment Officer, The Doctors Company and TDC Group

As experts in caring for patients, physicians generally focus on risk management in terms of patient safety. Yet there’s a hidden risk—to themselves and their practices—that physicians should consider: their medical malpractice insurer’s investments. Physicians should understand the risks of their medical malpractice carrier’s investments and make sure they are covered by an insurer who has their interests at heart and, therefore, takes a prudent and relatively conservative approach to investing.

Through responsible asset management, an insurer should be able to generate results from its investments to meet its core obligation: to pay the claims of its insured physicians. A responsible carrier may also have the opportunity to use its surplus—funds in excess of those needed to pay claims—to benefit the physicians who pay premiums. The scale of a company’s loyalty program for its insured physicians, for example, may be linked to the financial performance of its surplus investments.

In a way, physicians are investors in their insurer, just as their insurer is an investor in various markets. Physicians should choose a medical malpractice carrier that is physician-owned, because it has an affinity of interest with those who are insured. They should consider a carrier that structures investments to meet the financial obligations of the company, takes advantage of investment opportunities to protect and grow surplus, and makes prudent investment choices to ensure the company’s stability—so that it can prosper and protect a physician’s practice for the long haul.

A Success Story of a Conservative and Disciplined Investment Strategy

Over the past 25 years, The Doctors Company, the nation’s largest physician-owned medical malpractice insurer, has seen its general account assets grow from $700 million to nearly $7 billion with surplus increasing from $350 million to $2.85 billion.

In addition to positive flows from acquisitions, this rise in assets reflects steady and measured growth from a relatively conservative and disciplined investment strategy that generates passive income consistent with market conditions, focuses on downside risk protection, and participates in the upside moves of the market.

How Medical Malpractice Insurance Is Different

As an insurance company, we invest conservatively compared to pensions, endowments, foundations, or other pools of assets that have time horizons in perpetuity. However, within the realm of insurance, a medical malpractice carrier has longer tail liabilities, which allows investments to carry longer duration, generate investment income well above what is offered by government-issued paper, and, if properly structured, absorb excessive short-term market fluctuations without causing undue stress to overall operations.

For The Doctors Company, our strong capital position means that, relative to our liabilities, we have some surplus to invest more aggressively than simply holding highest quality investment-grade bond issues. That said, it’s important to specify what is meant by “aggressive” in the realm of an insurer’s investments. In addition to prioritizing downside risk protection, we always consider how much of our surplus is exposed to the daily fluctuations of the markets. In simpler terms, how much of our surplus is invested in equity. We work well within our capacity, in terms of what we could, in a worst-case scenario, lose in valuation, and continue to meet our obligations.

To give a simple-math hypothetical example: Consider an insurer that uses statutory accounting and practices prudent downside risk protection. If 50 percent of the insurer’s surplus is invested in stocks, and the stock market declines 40 percent, then the total surplus value should decline 20 percent. This is because only 50 percent of surplus is exposed to the 20 percent decline, while the balance is carried at cost and not impacted by daily market fluctuations. However, downside risk protection typically translates into giving up capturing 100 percent of the upside, but the benefits of a long-term strategy outweigh the potential losses of opportunity costs.

We manage our assets responsibly and ensure that any losses from investment of members’ assets do not jeopardize our ability to pay their claims over the long term. Overly aggressive investment shifts, trying to time the market, or booking short-term gains are not prudent practices for us.

A Diversified Portfolio

We pursue a mix of active and passive strategies. We are strong proponents of, and investors in, Exchange-Traded Funds (ETFs). As an insurance company, we are very conservative with our overall investment program—we have historically targeted about 75 percent in fixed income or similar strategies and 25 percent in equity or equity-like investments.

In fixed income, we are well diversified. We have U.S. investment-grade public bonds and private placements, a dedicated U.S. Treasury portfolio, ETFs that invest in non-traditional bond, short-duration higher quality high-yield bonds, middle market private credit, an allocation to convertible bonds, and a short-term/liquidity portfolio. Over the past three years, we have steadily increased our exposure to funds with rated feeder note structures that provide income and accounting benefits without materially adding to our risk profile.

For real assets, we have a strategic target of 12.5 percent, which covers real estate equity and debt, infrastructure equity and debt, and renewable energy. We target 9 percent in a well-diversified long-only equity portfolio that includes mostly passively managed U.S. and non-U.S. stocks.

We have a 5 percent target to less-liquid strategies including private equity, venture capital, opportunistic credit, and environmental, social, and governance (ESG) and diversified, equity, and inclusion (DEI) investments.

Risk Management

We determine how much risk, or equity/equity-like exposure, we can take with our surplus. We run strategic asset allocation scenarios that consider our overall enterprise risks. We balance our underwriting risks with our investment risks—in a given year, if we are not taking as much risk on the underwriting side, then we can consider being more aggressive with our investments. And that’s defined by how much downside risk we can withstand from equity market declines. The same holds true if the overall enterprise risks are reversed.

Best Practices When Investing Insurance Assets

In evaluating the specifics of a medical malpractice carrier’s portfolio, a physician or practice manager should look for an insurer who is also a prudent investor and has the interests of those they insure, not shareholders’ interests, at heart.

Prudent Practices When Investing Insurance Assets

• Balance underwriting risks with investment risks.
• Establish investment objectives for after-tax total return, considering income, volatility, and time horizon.
• Identify an acceptable level of surplus volatility through annual stress testing.
• Ensure sufficient liquidity by actively managing cash needs and flows.
• Manage risk-based capital impact of different investment strategies.
• Have an awareness of statutory investment codes.
• Collaborate with accounting to determine reporting impact.

Imprudent Practices When Investing Insurance Assets

• Chasing total return when enterprise risk study dictates a more conservative investment philosophy.
• Chasing income when enterprise risk study dictates a much higher acceptable level of volatility.
• Having insufficient diversification, i.e., having concentration risk.
• Being a forced seller of bonds at a loss.
• Missing an investment opportunity due to deficient approval protocol.
• Carrying too much or not enough liquidity.
• Attempting to please shareholders with high returns from risky investments.

Considering the potential risks—and benefits—of an insurer’s investment strategy can only improve the security of a medical practice.

TC Wilson was the lead investment consultant to The Doctors Company for 18 years prior to becoming its Chief Investment Officer in 2017. He has over 30 years of investment experience.

This material is intended for illustrative purposes only, and should not be construed as advice to buy or sell an investment, or as advice regarding how to allocate across your investment options.