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Even in an industry as highly cyclical as reinsurance, medical malpractice stands out as a risk class in which the market is getting shorter, more volatile and, as a result, potentially more interesting to a greater variety of players. As the cycle turns down, competition increases and rates begin to fall, so everyone in the class is looking at how they can stay ahead of the pack.

The 'bedpan mutuals' have been a constant presence in the market since their formation in the 1970s. Traditional insurers, by contrast, have continued to dip in and out of the market at broadly 15-year intervals, usually entering the market when losses have been comparatively well controlled (for example following reform to tort law, or the introduction of more detailed policy forms) but before prices were corrected to reflect the improved loss record.

In 2006 another period of profitability in the medical professional liability insurance sector has once again attracted more competitors and new capital, thus producing a return to a soft market. But this time two things are different. Firstly, the recovery has been much quicker than in previous cycles, and secondly, in addition to the traditional companies that enter and exit this line in accordance with its cycles, this recovery has brought with it a dramatic increase in new entrants - the alternative risk finance vehicles.

Profitability has once again attracted more new capital, thus producing a return to the soft market

The arrival of this new capital, in addition to the existing players, is causing rates to fall more sharply than anticipated, leaving the mid-size players which have been the mainstay of the market scrambling to maintain share. So what should such companies do to prosper in this tougher, soft market?

The first lesson is to look at how companies survived previous soft markets. The fundamental disciplines of focus on the customer, strict underwriting guidelines, adequate pricing, aggressive loss control and robust defense of claims can sometimes get overlooked when the pressures of a soft market are present. Focus on these should provide for a lower cost structure, enabling businesses to remain profitable and maintain market share without the need to chase new business.

The fundamental disciplines of focus on the customer, strict underwriting guidelines, adequate pricing and aggressive loss control can sometimes get overlooked

Secondly, businesses should evaluate a variety of reinsurance programs in order to decide how best to protect their capital and to manage their image with the ratings agencies. By using DFA (dynamic financial analysis) to replicate the different claims scenarios, evaluate capital needs, test various pricing scenarios and conduct cost/benefit analyses on alternative reinsurance programs, insurers can carry out more accurate forward planning which provides for a better chance to succeed during difficult soft markets.

Companies should ensure that their investment portfolio is well balanced and capable of yielding stable returns

Last but not least, companies should ensure that their investment portfolio is well balanced and capable of yielding stable returns. Marginal pick up in investment returns provides insurers with the ability to compete on price without sacrificing profitability.

The combination of a well controlled cost base, stable underwriting results, an improved investment return and an effective reinsurance strategy gives companies the opportunity to emerge from the soft market with the financial strength needed for the future.

R. Ray Pate, Jr.