SC Administrative Law Court Decisions

STATEMENT OF THE CASE

This matter is before me upon the Petition of the South Carolina Reinsurance Facility ("Facility") to approve the recoupment calculation previously submitted to the Chief Insurance Commissioner ("Commissioner") in accordance with Sections 38-77-600 and 38-77-610 of the South Carolina Code of Laws (1976), as amended. Pursuant to the provisions of the Administrative Procedures Act, as required by Section 38-77-610, a hearing was held in Columbia, South Carolina on March 1, 1995.

On November 29, 1994, the Governing Board of the Facility, pursuant to Section 38-77-610, filed a recoupment calculation with the Chief Insurance Commissioner ("filing"). This recoupment filing displayed the operational losses of the Facility for the fiscal year ending September 30, 1994, and proposed a recoupment calculation for the fees to be collected from automobile insureds during the twelve-month period beginning July 1, 1995.

On December 15, 1994, a request for a contested case hearing was filed with the Administrative Law Division by the South Carolina Department of Insurance.

On January 3, 1995, the Consumer Advocate for the State of South Carolina filed a motion to intervene in this proceedings based upon the statutory standing conferred by Section 37-6-604(1). Neither the Facility nor the Department of Insurance objected to the Consumer Advocate's intervention and the Consumer Advocate was made a party Respondent to this proceeding by Order dated January 6, 1995.

By Order dated January 18, 1995, a March 1, 1995 hearing on this matter was scheduled in accordance with the Temporary Operating Procedures of the Administrative Law Division. Public notice of the hearing was published more than 30 days in advance of the hearing date in 5 newspapers of general publication within the State. No member of the public appeared or sought to be admitted as a party to the proceedings.

EXHIBITS

The following exhibits were introduced during the course of the hearing: (1) the filing of the South Carolina Reinsurance Facility with the Chief Insurance Commissioner of the Private Passenger Recoupment Charges as calculated for the 1994 Facility fiscal year; (2) the Affidavits of Publication of the Order and Notice of Hearing.

In addition, judicial notice was taken of the Interrogatories of the Consumer Advocate directed to the Facility and the Facility's responses which contained all supporting data for the calculations presented in the filing.

Although not exhibits, but in accordance with the agreements and stipulations of the parties, the written testimony of Allan I. Schwartz with attached schedules, the affidavits in reply by Mr. Leeman and Mr. Mackay, and the written reply of Mr. Schwartz were also received and considered.

SUMMARY OF THE EVIDENCE

Kevin M. Leeman, Manager of Accounting AIPSO, and a certified public accountant, testified with regard to the recoupment filing. AIPSO is the Central Processor for the Facility and performs all accounting and statistical functions for the Facility. The recoupment calculation was prepared by or under the direction of Mr. Leeman utilizing audited and verifiable data of the Facility, together with other data supplied by the Department of Insurance. The filing reflects all data upon which the calculation of recoupment fees is based. Mr. Leeman concluded his description of the filing with his expert opinion that the recoupment calculations submitted comply fully with the statutory directives of Sections 38-77-600, 38-77-610 and 38-77-620.

Mr. Bruce Mackay, Vice President of Operations of the South Carolina Farm Bureau Insurance Companies, testified on behalf of the filing calculations as submitted. As an actuary, Mr. Mackay also offered his expert opinion that the calculations of the filing were in compliance with the statutory formula and all statutory directives. He explained that the methodology utilized by the Facility had been previously approved by the Commissioner and used in each recoupment filing since inception in 1987. In response to questions from the Consumer Advocate, he also explained that the statutory recoupment formula produced a guaranteed under-recoupment due to a flaw in the formula itself and due to changing risk distribution patterns resulting from higher-pointed insureds "dropping out of the system." However, as explained by Mackay, such unanticipated results were beyond the control of the Facility and inherent to the use of the graduated, statutory formula. He also emphasized that the time value of money consideration was conservative, appropriate and necessary to reimburse member insurers for actual assessments made during the Facility's fiscal year to fund the Facility's negative cash flow operation.

Martin M. Simons, Chief Casualty Actuary for the South Carolina Department of Insurance, testified that he had reviewed the recoupment filing and concurred that it met all statutory requirements and directives. He explained that the time value of money consideration utilized in the filing was appropriate, reasonable and effectively meant that insurers were lending the insuring public of South Carolina large sums of money at a simple prime interest rate to assure full insurance availability through continuing Facility operations. Based upon his review of the filing, Mr. Simons, on behalf of the Department, offered no objection to the recoupment calculations as filed.

At the hearing, the Consumer Advocate stated that it had not yet had sufficient time to analyze information produced by the Facility in response to its Interrogatories. With the consent of the Facility and the Department of Insurance, the record was left open to give the Consumer Advocate time to complete its review and to offer, if necessary, written testimony on the expense values utilized in the filing and the reasonableness of the time value of money consideration.

Subsequently, the Consumer Advocate submitted the written testimony of Allan I. Schwartz, a consulting actuary, who opined that the time value of money consideration should be zero, thus producing a small reduction in the safe driver recoupment from $49.48 as calculated in the filing to $45.90. His conclusion was based upon an analysis of discounted cash flows within the Facility, utilizing all sources of income including collected recoupment to pay anticipated losses. Recoupment fees were not considered in the cash flow of the Facility's filing. According to Schwartz, if recoupment collections were held by the Facility to pay future anticipated losses, this would offset the need for advanced funds from member companies and the need to include a time value of money consideration.

In reply to Mr. Schwartz's analysis, Mr. Leeman and Mr. Mackay took exception to the assumption that collected recoupment dollars should be combined with net premiums for purposes of cash flow analysis.⁽¹⁾ Mr. Schwartz replied that under his discounted cash flow methodology, all cash from whatever source, including recoupment collections, should be utilized to capture the flows through the Facility. All were apparently in agreement that negative cash flows resulted when recoupment collections were viewed as funds earmarked to repay companies for past advances rather than as current premiums.

The Department of Insurance filed no rebuttal testimony but, after review of Schwartz's analysis, advised that it "[stood] upon its direct presentation made during the scheduled public hearing" in support of the filing.

At issue is whether recoupment collections should be considered premiums to be used in paying current or future Facility losses or whether recoupment collections should be considered as recouped funds to be used in repaying member companies for past advances which funded losses on Facility policies in prior years. Based upon the evidence, testimony and exhibits presented at the hearing, including the post-hearing submissions and affidavits, I make the following findings of fact and conclusions of law.

FINDINGS OF FACT

1. The Filing submitted by the South Carolina Reinsurance Facility complies with the statutory directives and presents all data required to calculate recoupment fees. The filing data reflected actual earned premiums and losses by coverage on policies ceded to the Facility during the twelve-month period ending September 30, 1994. Actual premiums and losses by coverage were adjusted for all miscellaneous expenses⁽²⁾, penalties and operating revenues⁽³⁾, including under-recoupment of anticipated fees that were not collected in prior years⁽⁴⁾

, to arrive at the net Facility operating loss for the period. The net Facility operating loss was then adjusted to reflect applicable on-average premium taxes and commissions to be charged on the anticipated recoupment fees to be collected.⁽⁵⁾

2. In accordance with the statutory directives, a "time value of money factor" (i.e., interest charge) was included in the recoupment calculation to cover the eighteen month period during which operating funds were advanced to the Facility by its member insurers until recoupment fees can be collected and the advances refunded. Consistent with past calculations approved by the Commissioner, the factor used to determine the time value of money consideration was the average quarter-ending annual prime interest rate as published by the Wall Street Journal during the Facility's fiscal year.⁽⁶⁾

3. The total operating loss by coverage, including all adjustments for taxes, commissions and time value of money considerations, was then arithmetically expressed in accordance with the formula stated in Section 38-77-600(1), to arrive at a recoupment charge by coverage based upon a risk distribution by surcharge points under the Uniform Merit Rating Plan. The resulting "on-level" recoupment was then calculated and the statutory "safe driver" factor of 0.386 applied to determine the "safe driver" recoupment.⁽⁷⁾ The total "on-level" recoupment, reduced by the total "safe driver" recoupment, by coverage, produces the "remaining recoupment" or the value "R" in the statutory formula which is ratably distributed among all pointed risks by Merit Rating Point in the percentage each bears to the total of all earned exposures in 1993. This methodology produces a value for "X" (the dollar amount by coverage to be charged all risks having one surcharge point under the Merit Rating Plan) in the statutory formula.⁽⁸⁾ Attached hereto as an Appendix to this Order, and incorporated herein as part of these findings, is the resulting dollar amount of the recoupment charges, by coverage, by Merit Rating Point, when the appropriately calculated values are placed in the statutory formula. The first page of the Appendix displays the Facility recoupment charges without rounding and the second page displays the Facility recoupment charges rounding the charge to the nearest whole dollar value.

4. Utilization of the average quarterly prime interest rate as published in The Wall Street Journal represents an objective, conservative and reasonable methodology for determining a time value of money factor for use in the recoupment calculation. This methodology has been utilized by the Facility and approved by the Chief Insurance Commissioner since 1987 when the statutory recoupment requirement was first imposed.

5. There exists an eighteen month lag between the time the Facility's member insurers are required to advance funds to pay negative operating results and the time when such operating losses are the subject of recoupment collection and distribution. It is appropriate to adjust the average prime rate factor to account for this eighteen month time differential.

6. The discounted cash flow methodology utilized by Mr. Schwartz in his analysis of Facility cash flows treats recoupment collections as cash available to the Facility to pay future losses on current policies rather than as collections to be used to repay member insurers for funds advanced during prior years. However, I agree with the Facility's definition and interpretation of the "Time Value of Money" consideration, as explained by Mr. Leeman and Mr. Mackay and concurred in by the Department of Insurance.

CONCLUSIONS OF LAW

1. This action is a contested case as defined by Section 1-23-310 and involves the determination required by Section 38-77-610 of whether the Facility recoupment charges filed with the Commissioner were properly calculated in accordance with the provisions of Section 38-77-60. See S.C. Code Ann. §§ 38-77-610 (requiring a contested case hearing); 1-23-310 et seq. (setting out the requirements of a contested case hearing); and 38-77-600 (setting out the statutory formula for calculating recoupment charges). Subject matter jurisdiction of the Commissioner is established by Section 38-77-610. See S.C. Code Ann. §38-77-610 (Cum. Supp. 1993). Jurisdiction of the

Administrative Law Judge Division over the contested case hearing is established by Section 1-23-600(B). See S.C. Code Ann. §1-23-600 (Cum. Supp. 1993).

2. Public Notice of this Hearing was provided by publication of the Hearing Order dated January 18, 1995, in newspapers of general, statewide circulation at least thirty (30) days in advance of the scheduled hearing date. The notices so published stated the time and place of the hearing and the subject matter that was to be considered.⁽⁹⁾

3. The Consumer Advocate of the State of South Carolina sought, and was granted permission, to be admitted as a party to the proceedings. No other person or member of the public sought admittance as a party or offered any public comment during the hearing.

4. The Facility is an automobile insurance residual market mechanism established by statute and required to reinsure eligible risks covered by policies of automobile insurance written in South Carolina. See S.C. Code Ann. §§38-77-510 et seq. (1976). It provides a method of insuring high risk drivers at a subsidy, the costs of which are redistributed among all drivers in the State by a recoupment fee assessed annually on all insured private passenger automobiles as part of the applicable rate or premium charged. S.C. Code Ann. §38-77-620 (Cum Supp. 1993).

5. The method of annually computing the recoupment charges is set by statute. See S.C. Code Ann. §38-77-610 (Cum. Supp. 1993). Prior to December 1 of each calendar year, the Facility's Governing is required to calculate the recoupment amount, "by coverage, by dividing the net facility operating loss, adjusted to reflect prudently incurred expenses, consistent with the provisions of Section 38-73-465, and the time value of money, by mandated coverage for the preceding facility accounting year, by the total number of earned car years in South Carolina, by coverage, for the same period of time." S.C. Code Ann. §38-77-600(1) (Cum. Supp. 1993). The resulting recoupment amount is to be apportioned among risks according to Merit Rating Points as delineated by the statutory formula defined in Section 38-77-600.

6. The Facility's Governing Board is charged with the responsibility of performing the calculation and filing it with the Commissioner on or before December 1 of each calendar year. A contested case hearing is required to determine whether the recoupment charges were calculated in accordance with the provisions of Section 38-77-600. If it is determined that the calculations were properly performed, the recoupment charges must be approved for use and be added to the base rate or objective standards rate for all mandated automobile insurance risks. If the Facility recoupment charges were improperly calculated, it is the province of the Administrative Law Judge to establish the appropriate recoupment charges. S.C. Code Ann. § 38-77-610 (Cum. Supp. 1995).

7. Facility recoupment charges, added to the approved base rate and/or approved objective standards rate in effect for each automobile insurer, are not considered "premium" except for the "purpose of calculating premium taxes and commissions." S.C. Code Ann. §38-77-620(1) (Cum. Supp. 1993). To consider the recoupment collected during a twelve month period as part of a "premium cash flow" and available to pay losses would give no effect to this statutory directive.

8. Amounts recouped during any twelve month period, less commission and premium tax expenses and time value of money considerations, are paid to the Facility which must then "redistribute the funds to the insurers based upon each insurer's share of the Reinsurance Facility losses." S.C. Code Ann. §38-77-620(3) (Cum. Supp. 1993). Recoupment "must be used solely for

the purpose of recovering past Facility operating deficits," not for payment of future losses. S.C. Code Ann. §38-77-620(3) (Cum. Supp. 1993).

9. The "time value of money" consideration is designed to reimburse participating insurers for their loss of investment income on money advanced to support Facility operating losses. It recognizes that the funds being recouped represent a previously incurred debt of the Facility, not additional premiums to be collected to pay future losses. Specifically, collected recoupment fees must be redistributed by the Facility to member insurers to repay this debt. See S.C. Code Ann. §38-77-620(3) (Cum. Supp. 1993). The interest rate utilized in the Facility's filing is conservative and consistent with the statutory directives. See S.C. Code Ann. §§ 38-77-600, 38-77-610 and 38-77-620 (Cum. Supp. 1993). The net effect of treating recoupment collected as premiums to be used to pay anticipated losses is to overstate Facility cash flows available to fund future negative operating results and to ignore debts arising out of prior year operations. When recoupment was established in 1987, a Facility debt was created which the legislature intended to be repaid to member companies funding Facility operating losses. This Facility debt exists for eighteen months before it can be recouped and repaid. Considering recoupment collections as part of cash flows which are available to pay future losses rather than to repay funds advanced in the prior year is inconsistent with Section 38-77-620 and would require member insurers to absorb the funding burden of Facility operations without any time value considerations. Because recoupment must be used exclusively for the recovery of past operating deficits and redistributed to insurers based upon their past funding contributions, it is inappropriate to treat recoupment as part of a premium cash flow which funds future losses. To do otherwise would violate the statutory directive of Section 38-77-620 and mischaracterize the legitimate, intended use of recoupment.

10. Based upon the filing materials, the exhibits and the testimony presented at the contested hearing, I find and conclude that the recoupment charges prepared and filed by the Governing Board with the Commissioner were properly calculated in accordance with the provisions of Section 38-77-600. The recoupment amount correctly reflects the operating losses of the Facility for the twelve month period ending September 30, 1994, and has been properly adjusted to reflect prudently incurred expenses and a reasonable time value of money factor based upon the average prime rate. The recoupment amount has been, consistent with the statutory formula, distributed properly among risks based upon the statutory factors and the actual distribution of risks by Merit Rating Plan points.

11. The final recoupment charges, by coverages and Merit Rating Plan points, are properly calculated and displayed in the attached Appendix pages from the Facility filing and should be approved for use effective July 1, 1995.

ORDER

NOW, THEREFORE, IT IS HEREBY ORDERED that the recoupment charges set forth in the filing of the Facility's Governing Board, as displayed in the attached Appendix, were properly calculated in accordance with all statutory directives and are hereby approved as filed. The Chief Insurance Commissioner and/or the Governing Board is authorized to publish the recoupment charges as filed and approved herein to be added to the applicable base rates and objective standards rate in effect for each automobile insurer for the twelve month period commencing July 1, 1995.

________________________________

Marvin F. Kittrell

Chief Administrative Law Judge

Columbia, South Carolina

April 3, 1995

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Fn.1. In his written reply, Mr. Leeman pointed out:

[R]ecoupments collected in 1994 are for losses incurred in fiscal years 1992 and 1993. Recoupment collected on a prior period loss should not be used to reduce the current year's operating loss. To do so would artificially increase the cash flow of the current year. Recoupment represents funds which belong to the member companies, not the Facility, as reimbursement for the operating losses advanced or incurred in prior years [and] are immediately redistributed through quarterly settlements of balances to the member companies advancing the funds. Recoupment during the current year does not become part of the Facility's "cash flows" or funds, and are not available to augment [time value of money] considerations for Facility operations.

Mr. Mackay, agreeing with this view, also added that Schwartz's paid cash flow model ignored the under-recoupment factor inherent to the statutory formula which has, to date, produced in excess of $57 million of recoupment shortfall. Since such funds are not recouped until a carry-forward year, the actual "reimbursement lag is now 30 months, instead of 18 months" which would require a higher interest rate factor than utilized in the filing or in the discounted cash flow model applied by Schwartz.

2. Miscellaneous expenses refer to actual operating costs of the Facility, including such items as staff salaries, audit expenses, central processing fees, taxes, rents, equipment and licenses.

3. Penalties and operating revenues reflect various charges made by the Facility against its member insurers during the accounting period such as overcession penalties, membership fees, keypunching fees, and other late submission charges as well as investment income on funds held in the Facility's Central Bank Account before disbursement.

4. Since 1987, actual recoupment collected has fallen $57,636,013 short of the amounts that were anticipated under the statutory formula. Reasons for this shortfall include flaws in the statutory formula, changing distribution patterns of pointed risks and the elimination of certain coverages from the mandate to write, such as Personal Injury Protection (PIP) coverages, which made collection impossible.

5. The industry average commission ratio was used to calculate commission expense by coverage. Premium tax ratios were determined by coverage based premium tax information supplied by the Department of insurance. Such adjustments are required because recoupment fees are subject to premium taxes and agent commissions.

6. The average annual prime interest rate during the Facility fiscal year was 6.3750% which, when converted to an eighteen month period, produces a factor of 9.7133%.

7. The "safe driver" recoupment is the recoupment charge applicable to drivers without any Merit Rating Plan points and produces the following calculation:

8. The value of "X", by coverage, was calculated as follows:

9. Affidavits of Publication, together with a copy of each notice printed, were submitted by the Department of Insurance and made an exhibit to the proceedings.

APPENDIX