What drives the wild swings in medical malpractice premiums? Insurance premiums are no different in bonds in how they fluctuate in prices based on the return in investments.

Each bond pays a fixed coupon payment, usually every six months. That payment determines the rate of return, or the interest. For instance, if a bond pay $50 every six months and costs $1,000 to buy then the interest rate is $100/$1000 = 10%.   However, if investors bid up bond prices then the interest rate falls because the coupon payment does not change. For example, if the bond price is bid higher to $2,000 then the interest rate is $100/$2000 = 5%

Insurance companies have to invest the premiums they receive from doctors. This means that they have to adjust their rates based on the return on investment because they have to maintain their reserves.

So how does it work? If I can invest $1.00 at 8%, I’ll have $1.71 in seven years. If I can only invest at say 3%, I’d need $1.39 to have $1.71 in seven years. That would imply a 39% rate increase just on that factor.

You can easily see that large fluctuations in premiums could very well be driven by the insurance companies investments.

Advertisements