South Carolina              
Administrative Law Court
Edgar A. Brown building 1205 Pendleton St., Suite 224 Columbia, SC 29201 Voice: (803) 734-0550

SC Administrative Law Court Decisions

CAPTION:
State Farm Fire and Casualty vs. SCDOI

AGENCY:
South Carolina Department of Insurance

PARTIES:
Petitioners:
State Farm Fire and Casualty and State Farm General Insurance Company, Member Insurers of the State Farm Group

Respondents:
South Carolina Department of Insurance

Intervenor:
Philip S. Porter, Consumer Advocate for the State of South Carolina
 
DOCKET NUMBER:
96-ALJ-09-0043-CC

APPEARANCES:
Clara L. McDaniels, Esquire and James C. Gray, Jr., Esquire for Petitioners

Gwendolyn L. Fuller, Esquire for Respondent

Catherine Edwards Heigel, Esquire for Intervenor
 

ORDERS:

ORDER AND DECISION

This matter comes before me pursuant to S.C. Code Ann. §§ 38-73-910, et seq. (Supp. 1995) and S.C. Code Ann. §§1-23-310, et seq. (Supp. 1995) on Petitioners' request for a rate increase of its homeowners property and casualty insurance premium.

STATEMENT OF CASE

State Farm Fire and Casualty Company and State Farm General Insurance Company (collectively referred to as "State Farm") made a filing with the Director of the South Carolina Department of Insurance requesting a rate increase of 3.1 percent for its homeowner's insurance program on December 17, 1995.

The Consumer Advocate moved to intervene and an Order was issued allowing his intervention. After notice to the parties, a hearing on this matter was conducted on March 29 and April 12, 1996.

FINDINGS OF FACT

Based upon all the testimony, evidence and arguments presented at the hearing, by a preponderance of the evidence, I make the following finding of facts:

1. Respondent published notice advising the public that an application for the establishment of rates by State Farm had been made and that a hearing would be held on March 29, 1996, in The State, The Greenville News Piedmont, The Charleston Post and Courier, The Rock Hill Herald and The Darlington News and Press. The Court opened the hearing on that date and no members of the public appeared to comment on the proposed rate increase.

2. The homeowners rate filing was prepared under the supervision of Mark L. Brannon, who is employed by State Farm, as a Senior Associate Actuary.

3. Mr. Brannon was qualified without objection as an expert in actuarial science.

4. The nature of the line of insurance for which the rate increase is being requested is State Farm's Homeowners policy, which is a broad package policy, providing coverage for accidental direct damage to insured property and for the insured's liability for bodily injury and property damage; and policies are available for Tenants and Non-Tenants.

5. Non-Tenants Forms insure owner-occupied one or two family dwellings, including dwellings under construction and seasonal dwellings. Tenants Forms insure personal property, improvements and betterments located in rental dwellings, apartments, or condominium units.

6. State Farm is requesting an overall rate increase of 3.1% for State Farm's homeowners line of business, with requested effective dates of May 15, 1996 for new business and July 15, 1996 for renewals.

7. The rate revision includes changes to State Farm 's rating zones and changes to the basic premiums with the proposed rate changes varying by policy form, rating zone, amount of insurance, and deductible option.

8. All of the changes are described in detail in the Explanatory Memorandum included in Petitioner's filing. The filing contains the necessary evidence and basis for the rate revision filing.

9. The result of State Farm's analysis of South Carolina Homeowners experience is an overall indicated rate increase of 3.31% as shown on Exhibit 1 of the filing.

10. The Statement of Principles regarding Property and Casualty Ratemaking, promulgated by the Casualty Actuarial Society, state that a rate is an estimate of the expected value of future costs. Ratemaking should provide for all costs so that the insurance system is financially sound. The Principles also state that a rate provides for all costs associated with the transfer of risk from the policyholder to State Farm.

11. State Farm's indicated rate level adjustment is developed on Exhibit 1 of the rate filing. This exhibit displays the expected value of State Farm's estimated future costs; losses (non-catastrophe and catastrophe), expenses, and the cost of capital as reflected in State Farm's selected underwriting profit provision. These costs are then related to State Farm's projected premium income at the current rate level.

12. In arriving at the projected premium income State Farm expects to receive in the future the following process is followed: Written premium per policy is projected by starting with the latest available calendar year figure and adjusting it for the effect of any recent rate changes that are not yet fully reflected in it. Any expected effects from inflation and distributional changes are applied to that figure to project written premium for future years. After the written premium per policy is projected, State Farm calculates the earned premium per policy using the 13 month earnings method. The details of these calculations are shown in Filing Exhibit 2.

13. The main contested issues in this filing are State Farm's catastrophe provision; State Farm's usage of a 2% contingency factor; and State Farm's underwriting profit provision. State Farm's market share and the impact that increase in market share has had upon the contents in the filing was also raised. The Consumer Advocate challenged the provisions relating to taxes, licenses and fees because he believed that State Farm did not use South Carolina costs. At the hearing, State Farm indicated that its calculation were based upon its experience in South Carolina. As a result, this issue was resolved.

CATASTROPHE PROVISION

14. The non-catastrophe incurred loss estimate is derived as follows: First, State Farm estimated the non-catastrophe paid loss per policy based on an in-depth analysis of historical paid loss frequency, severity and loss per policy. This analysis is completed on the historical experience in five separate groups of loss perils: Fire/Lightning, Wind/Hail, Other Extended Coverages, Crime, and Liability. Filing Exhibit 3 shows the historical data through June 1995 as well as the trended and selected values.

15. Exhibit 4 of the filing shows the adjustment of the projected non-catastrophe paid loss per policy to an incurred figure. The adjustment factor from paid to incurred is based on a review of recent ratios of non-catastrophe incurred to non-catastrophe paid losses. State Farm selected the five year average factor as the most indicative of the relationship State Farm expects in the future. 16. Allocated loss adjustment expenses (ALAE) are incurred in investigating and settling certain specifically identified claims, and are allocated to particular claim numbers. Unallocated loss adjustment expenses (ULAE) are those incurred in investigating and settling claims that are not directly assigned to specific claims, such as expenses associated with running and maintaining State Farm's Claims Service Centers and salaries for claims adjusters and management.

17. Loss adjustment expense projections utilize averages of historical relationships to incurred losses. This is also shown on Filing Exhibit 4. State Farm selected the five year average ratio of non-catastrophe incurred Allocated Loss Adjustment Expenses (ALAE) to incurred loss, and the same period average ratio for non-catastrophe incurred Unallocated Loss Adjustment Expenses (ULAE) to incurred loss as its best estimates for the future. These selected ratios multiplied by State Farm's incurred loss estimate yields the estimated non-catastrophe loss adjustment expense per policy shown on Exhibit 1 of the filing.

18. Catastrophe losses by nature are large and fortuitous events that cause widespread property damage. This type of loss occurs less often than the non-catastrophe losses described above. It is appropriate to include a provision for catastrophe losses in State Farm's rates to cover the long-term cost of these events. This long-term provision is determined by analyzing the historical catastrophe loss experience and calculating a provision in the rates.

19. When reviewing annual catastrophe losses, some years will incur substantial catastrophe losses (such as 1989 with Hurricane Hugo) while other years may see no such catastrophic events. State Farm, includes a provision to cover catastrophe losses in the long-run, to eliminate the year-to-year fluctuation in the rates that would occur if its catastrophe provision were determined based on the most recent year or two of catastrophe losses.

20. The catastrophe provision consists of two components: non-hurricane (tornadoes, windstorms, winter storms, freezing) and hurricane. Both components of State Farm's catastrophe provision are based on an analysis and prediction of catastrophe loss data related to exposure rather than to earned premium. The exposure statistic State Farm uses is Amount of Insurance Years, (AIY), which measures $1,000's of insurance coverage in force for one year.

21. State Farm analyzed all available non-hurricane homeowners catastrophe losses related to the amount of insurance coverage, or AIY, as was discussed above. The South Carolina historical non-hurricane catastrophe loss and LAE data used is shown in Exhibit 5A of the filing. Individual events were capped at $0.65 per AIY as explained in Exhibit 5, item II, and the mean, or average, of the "limited" catastrophes per AIY was determined.

22. State Farm capped individual non-hurricane catastrophes at $0.65 per AIY which causes the largest 5.2% of catastrophes per AIY company-wide to be limited in recognition that the most severe catastrophic events can happen in any state and could drastically affect the state's catastrophe provision.

23. The non-hurricane catastrophe losses above the cap are accounted for in State Farm's selection of a 65% confidence interval for each individual state. Without this confidence interval, those losses would not be accounted for strictly by use of the mean of the capped catastrophes per AIY.

24. For South Carolina, this calculation results in State Farm's selected non-hurricane catastrophe provision of $0.3983 per AIY.

25. State Farm's method for developing the non-hurricane catastrophe loss provision is actuarially sound. It recognizes that states with highly variable catastrophe losses are more likely to experience a non-capped catastrophe and should therefore have a corresponding allowance for non-capped events. State Farm's selected provision is a reasonable projection of State Farm's catastrophe losses in South Carolina for the homeowners program.

26. State Farm has performed tests to measure the reasonability of the calculated non-hurricane catastrophe provision by calculating the dollars of premium that would have been collected over the entire 28 year period had the projected non-hurricane loss provisions been used in the rates. 27. Determining the long range impact of catastrophes based upon past claims history yields rates that are inadequate to provide for the losses produced. The use of catastrophe models is reasonable and provides better information to predict the long range affects and to calculate rates sufficient to cover the projected losses. State Farm's selected catastrophe provision produces a very close match to the actual total catastrophe losses incurred.

28. This comparison with other methods supports State Farm's position that State Farm's selected provision is an actuarially justified and reasonable estimate of the expected value of future non-hurricane catastrophe incurred losses and LAE.

29. The hurricane component of State Farm's catastrophe provision is calculated relying on State Farm's broader company-wide historical data shown in Exhibit 5B to determine a company-wide catastrophe provision per AIY. This company-wide provision is then distributed to the state level based upon relative exposure by location and by volume.

30. Since the hurricane provision is intended to cover the long-term losses due to these events, State Farm needs to be confident that, on a company-wide basis, the hurricane provision in the rates will cover the long-term losses. Choosing a 90% confidence interval provides the level of security in the rates State Farm feels is necessary to cover State Farm's expected long-term hurricane losses. The calculation of State Farm's selected South Carolina hurricane catastrophe provision is $0.0975 per AIY.

31. State Farm's provision for hurricane losses and LAE is actuarially sound and reasonable. The amount State Farm has included in this year's South Carolina homeowners filing is reasonable.

32. State Farm's Exposure Management Program and Reinspection Program did not reduce South Carolina's expected non-hurricane catastrophe losses. Neither the Reinspection Program nor the Exposure Management Program materially affect the expected cost of catastrophe losses per AIY for State Farm's South Carolina Homeowners program.

33. In regard to the Exposure Management Program, State Farm is controlling its growth in exposure (AIY) based on consideration of several criteria, primarily exposure to solvency threatening catastrophic events and overall rate inadequacy in property lines of business.

34. South Carolina's coastal area has not been one of the areas where State Farm has instituted any measure to actually reduce exposure (AIY) such as in Florida and Texas. For the annual period beginning on September 1, 1995, the target policy growth for South Carolina coastal counties was +1%. The expected increases due to inflation coverage in the coastal areas is higher than the state average of 4.4%, running around 6 to 7%. State Farm can expect to grow in exposure (AIY) in the South Carolina coastal counties in the range of 7 to 8% this year.

35. The Exposure Management Program in South Carolina only changes the amount of exposure, not the catastrophe "rate".

36. Regarding the Reinspection Program, the primary purpose of the Reinspection Program has been to make sure State Farm's policyholders whose insured property had not been personally inspected since 1990 still met the qualifications for insurance with State Farm. This program involves three main activities.

37. The first item is the amount of insurance the property is insured for, in comparison with the calculated replacement cost for the property. In South Carolina, for all reinspected homes since June 1, 1993, which needed the amount of insurance updated, State Farm has increased the amount of insurance on more than 75% of them. Thus, the major activity underlying the Reinspection Program has actually increased State Farm's exposure to losses, not reduced them.

38. Another aspect of the program is examining the other classification factors (besides amount of coverage) to ensure the property is properly classified for rating purposes. This primarily involves fire protection class, construction, and rating zone. Any changes made to these classifications only changes the premium for the insured, it does not change State Farm's loss exposure.

39. The third emphasis of the Reinspection Program is to require the insured to take some remedial action to be able to maintain coverage for their property with State Farm. Only 5% of the reinspected properties in South Carolina have been required to make such changes. Moreover, the changes affect liability and fire losses primarily, which are non-catastrophe loss perils.

CONTINGENCY PROVISION

40. The Principles of Ratemaking of the Casualty Actuarial Society state that any systematic variation of the expected costs from projected costs shall be considered in determining the "contingency provision." (See Supplemental Exhibit SFS-2 under RISK in section III. Considerations.). This definition of contingency was adopted by the Actuarial Standards Board in May 1988.

41. As defined by the Department of Insurance, a "contingency factor" is a factor that is included in the rate calculation to account for criteria that are not otherwise accounted for in the rate making process.

42. State Farm can expect the actual losses and expenses to randomly vary from year to year around the expected costs. If the variation is random and not biased, then over a period of time the actual results will average to the expected. If there is some bias or systematic variation in the rate setting process, then the average actual results will not equal the average expected results. The contingency provision is intended to measure this bias, known as systematic variation.

43. A provision equal to 2% of earned premium was included in the contingency provision in State Farm's filing.

44. State Farm determined its contingency provision by first calculating the average underwriting profit/loss over a ten year period. The average underwriting loss after adjustment for catastrophes was -7.9% for the ten year period 1985-1994. A ten year period is long enough to include a full underwriting cycle, reflecting the full range of results from periods above and below average returns and is reflective of expected future bids in rates under consideration.

45. State Farm then compared the adjusted actual results to the average combined profit and contingency provision of 4.0% over the same ten year period. The difference between the expected and actual results of 11.9% supports the 2% contingency provision, at a minimum.

46. There are several factors that contribute to the difference between expected and actual results including adverse court decisions, legislative or regulatory changes, regulatory delay or reduction of a rate filing and the impact of catastrophic events not recognized in the normal ratemaking process.

47. The Department's independent analysis reveals that the contingency factor is supported by the data. Even if the profit factor is zero, which is the lowest number that one could possibly use, a -7.9 percent overall loss from underwriting would indicate that there have been, in fact, items that have not been considered in the rate making process.

48. State Farm's contingencies provision is based on systematic variation in the expected costs of underwriting items only - incurred losses, incurred loss adjustment expenses, underwriting expenses and premium. State Farm looks at underwriting gain/loss only and not total return in determining its contingency provision. The investment side is not considered.

49. The Consumer Advocate's expert claims that State Farm failed to adjust for catastrophe losses in State Farm's analysis in filing Exhibit 7A. The Exhibit states, however, that actual catastrophes for the period were removed from the results and replaced by the catastrophe provision based on the long-term (28 years) losses. State Farm's analysis takes into account the recent catastrophe history by removing actual catastrophe losses and adding back in the long term catastrophe provision used in the rates. The -7.9% underwriting loss is adjusted, as is clearly stated in the filing exhibit.

UNDERWRITING PROFIT PROVISION

50. State Farm included an underwriting profit provision equal to 3% of earned premium based upon State Farm's analysis of the cost of capital in its filing.

51. The components of the provision for the cost of capital in the rate calculation are as follows: The cost of capital is the amount necessary to provide the company with an after-tax total rate of return commensurate with the risk to which capital is exposed. The return to the insurance company comes from four sources: (1) Underwriting Profit; (2) Investment Income; (3) Capital Gains; and (4) Other Income.

52. The total rate of return is stated as a percentage of surplus (Policyholder Protection Funds). The Property and Casualty insurance industry is required by law and regulation to use Statutory Accounting Principles (SAP) in preparing an Annual Statement of their financial results. These procedures, as determined by the National Association of Insurance Commissioners (NAIC) are designed to allow regulators to evaluate the solvency and financial solidity of insurers. SAP procedures produce a conservative statement of an insurer's financial position, since SAP analysis focuses on the liquidation value of an insurer.

53. Most other industries report their financial results according to Generally Accepted Accounting Principles (GAAP) as dictated by the Financial Accounting Standards Board. GAAP accounting measures the profitability and net worth of a business as a "going concern", as opposed to SAP analysis of liquidation value.

54. State Farm determined its underwriting profit provision based on an analysis of its total financial needs for all lines of business. State Farm added an expected underwriting profit provision of 3% to the expected investment income from all sources to arrive at an expected total return on surplus of 14.6% on a SAP basis, which is 11.4% on a GAAP basis.

55. The 11.4% is commensurate with the expected returns of other investment opportunities with similar degree of risk. The Department of Insurance agrees that the profit provision in State Farm's rates is fair and reasonable. The 11.4% return on net worth or equity is reasonable.

56. State Farm used an expected investment yield of 6.7% before tax on invested assets in his cost of capital analysis. This figure is consistent with the trend over the past ten years of State Farm's yield rate on investments. The yield on the entire portfolio for the past three years as 6.7% in 1993, 6.6% in 1994, and 6.6% in 1995.

57. Income from current insurance operations refers to the investment income generated from assets funded by premiums which will be used to pay claims and expenses. They include the investable reserves in unearned premiums and the investable reserves for losses and loss adjustment expenses.

58. Policyholder Protection Funds are earnings retained by the insurance company to support the insurance business it writes. They represent the capital required to ensure the financial solvency and soundness of the insurance enterprise as well as provide stability in the rate level.

59. The Policyholder Protection Funds are the same as the Surplus as Regards Policyholders as that term is used in Insurance Accounting.

60. Using a 6.7% investment yield, State Farm could expect investment income before taxes for South Carolina homeowners of 4.9% from current insurance operations.

61. Investment income on Policyholder Protection Funds is expected to contribute an additional return of 4.36% of earned premium.

62. State Farm considered the impact of Realized Capital Gains on the expected total return. In filing Exhibit 7A, column 6, State Farm presents Net Realized Capital Gains for the period 1985-1994. The table shows that realized capital gains have fluctuated from -.3% to 2.2% of earned premium, with a ten year average of 0.5%. State Farm cannot depend on realized capital gains to contribute to the expected return, and thus has used an expected contribution of 0% of earned premium.

63. Other Income consists primarily of service charges for premium installment plans, and has averaged around 0.6% of earned premium during the past ten years. In 1995, State Farm reduced these charges, and the resulting 1995 Other Income to earned premium ratio was in fact 0.3% (see Supplemental Exhibit SFS-6). This supports State Farm's selected provision of 0.3% before taxes. 64. Combining the 3% expected underwriting profit, the 4.9% expected investment income, and the expected Other Income provision of 0.3% results in an expected insurance operating profit of 8.2% of earned premium before taxes.

65. The Expected Total Return after taxes is as follows: Adding the 8.2% operating profit and the 4.36% earnings from the Policyholder Protection Funds, and subtracting federal taxes of 3.05% results in an expected total return of 9.51% as a percent of earned premium. This translated into a total return as a percent of the Policyholder Protection Fund of 14.6% (SAP basis) based on a ratio of Policyholder Protection Fund of $65 to $100 of earned premium. Adjusting this figure to a GAAP basis results in an adjusted expected total return of 11.4%.

66. State Farm's calculations in accordance with a GAAP basis return of 11.4% is reasonable based on State Farm's review of current returns of other industries. The 3% provision for underwriting profit, along with the expected contributions from other sources of income, produces a reasonable rate of return.

67. State Farm arrived at the $65 of Policyholder Protection Fund (PPF) to $100 earned premium used in State Farm's total return calculations as follows: State Farm needs $65 of PPF per $100 of Premium as a minimum to feel secure in being able to meet State Farm's obligations to State Farm's policyholders. The company's PPF is a single fund available to pay losses and expenses that exceed premium income, if needed, in any state or line of business that State Farm writes.

68. The property and casualty insurance industry stood at a surplus to premium level of $86 per $100 as of September 30, 1995 as noted in the December 8, 1995 issue of Operating Resultspublished by Insurance Services Office, Inc. The industry as a whole includes all lines of business, and many are not as prone to disaster as the property insurance to which State Farm Fire and Casualty is heavily exposed. Therefore, a goal of $65 per $100 of premium is a reasonable target range for State Farm.

69. A review of the market as a whole, Exhibit SFS-5, shows that the range of returns varied from 5.5% up to 16.8% in the past ten years for a variety of markets in the United States, with most falling in the range of 10% to 15%. This comparison can be valid only if the net worth is stated on a common basis, which is why insurance returns on a statutory surplus basis must be adjusted to a GAAP basis.

70. The analysis by the Consumer Advocate's actuary (Mr. Allan Schwartz) is not persuasive relating to the calculations on rate of return, the inclusion of capital gains, and his conclusion that a 2 to 1 ratio of premium to surplus ($100 premium for $50 surplus) is appropriate.

71. Regarding Mr. Schwartz's conclusion that a 2 to 1 ratio of premium to surplus is appropriate for use by State Farm, Mr. Schwartz provided only two cases in which State Farm's premium to surplus ratio was questioned. No evidence was presented to determine the background and foundation of these cases. Only excerpts were provided and there was no connection to the statutory criteria of those jurisdictions.

72. State Farm Group surplus should not be utilized in any analysis of contingencies or underwriting profit, because most of that surplus is in the State Farm Mutual Automobile Insurance Company. Using only State Farm Fire and Casualty Company surplus is relevant here.

73. Comparing surplus growth, which Mr. Schwartz refers to as "rate of return", with returns from the stock and bond markets in the 7-10% range is entirely inappropriate. Even he agrees with this in his pre-filed testimony where he states that he considers returns on statutory surplus from 11% up to 13.5% reasonable. Also, the stock and bond returns reflect no underwriting risk, which is what separates an insurance company from an investment bank.

74. Based on State Farm's estimates of premiums, losses, and expenses, and taking into consideration a reasonable provision for underwriting profit and contingencies, the indicated rate level change for the South Carolina Homeowners program is a 3.31% increase. State Farm proposes an overall 3.1% increase.

DEPARTMENT OF INSURANCE'S INDEPENDENT REVIEW OF FILING

75. Based on the information provided with the filing request, the Department of Insurance did not oppose the rate increase for the homeowners program.

76. Martin M. Simons, the Deputy Director and the Chief Actuary, of the South Carolina Department of Insurance testified as an expert in actuarial science for the Department of Insurance. 77. Mr. Simons is responsible for the approval of all property casualty insurance rates, forms, and rules in South Carolina. He is also responsible for the life and accident and health division. 78. Mr. Simons reviewed the filing to determine if the assumptions and the calculations contained in the filing were reasonable and whether the 3.1 percent overall increase as derived from those calculations in the filing would produce rates that were not excessive, inadequate or unfairly discriminatory. He also reviewed the analysis performed by the expert for the Consumer Advocate's filing and conducted his own independent analysis of the filing.

79. As a regulator, one of Mr. Simons's prime considerations is the financial solvency and the continued financial solvency or the long-term financial solvency of the insurance industry, in addition to the fairness of price from the consumer's viewpoint.

80. The Department of Insurance defines an "excessive" rate as a rate that will earn the insurer a return that is too high in comparison to other industries with similar risk levels to that of the insurer. The Department's definition is consistent with the evidence produced by the Petitioner and by the Department of Insurance.

81. The Department of Insurance defines an "inadequate" rate as a rate that is too low to insure that the coverage can be provided without adversely impacting upon the financial condition of the insurer. The Department's definition is consistent with the evidence produced by the Petitioner and by the Department of Insurance.

82. When not statutorily defined, the Department of Insurance defines "unfairly discriminatory" rates as those where the differences between the rates for classifications are not supported by differences in statistical justification between those classifications. The Department's definition is consistent with the evidence produced by the Petitioner and by the Department of Insurance.

83. The Department defines a "target rate of return" in this case, as the return on invested assets that would be derived by the writing of homeowners insurance in South Carolina. The target rate of return is the rate of return that is necessary to maintain that the rates are not excessive or inadequate. The Department's definition is consistent with the evidence produced by the Petitioner and by the Department of Insurance.

84. The Department defines a "catastrophe loading" as a portion of the rate that is meant to cover catastrophes, which are occurrences that may happen infrequently, but which may have a large severity or a large impact upon the results of the insurance company. The Department's definition is consistent with the evidence produced by the Petitioner and by the Department of Insurance.

85. In this case, "market share" is the percentage of homeowners business in South Carolina being written by State Farm.

86. The two percent contingency factor is provided for in the statutory terms "profit and contingencies", and also could fall under the phrase "all other relevant factors within and outside of the state of South Carolina."

87. State Farm has always included that factor in its homeowners filings.

88. Following Hurricane Hugo, the state had 43 companies pull out of South Carolina for personal lines; 33 of those companies used to write homeowners insurance; and some companies went insolvent following Hurricane Hugo.

89. Although some companies neither became insolvent nor ceased doing business in South Carolina following Hurricane Hugo, those companies nevertheless seriously curtailed the writing of homeowners business in this State.

90. State Farm has an increasing market share because they continue to provide homeowners insurance in this state. Based upon his eleven years with the Department of Insurance reviewing rate filings, Mr. Simons believes that most companies fail to adequately prepare the company for catastrophes. This results in conditions that lead to insolvency.

91. State Farm's increased market share has actually saved South Carolina consumers a great deal of money by providing insurance to thousands of State Farm consumers that otherwise would not have had the opportunity to purchase homeowners insurance at the prices that State Farm charges.

92. A reduction in the rates by six to seven percent, as suggested by Mr. Schwartz, will produce a rate that is inadequate under the statutory standards.

93. A reduction in rates, as suggested by Mr. Schwartz, would cause a potential decline in the surplus of State Farm Fire Insurance Company. Even if surplus condition of the company remained the same, there would be questions about the company's ability to meet claims and remain financially solvent.

94. Mr. Simons, standing independent of the testimony of experts for the petitioner and intervenor, established that Petitioner's filing satisfied the statutory standards in every respect.

CONCLUSIONS OF LAW

Based upon the foregoing Findings of Fact, I conclude, as a matter of law, the following:

1. The South Carolina Administrative Law Judge Division is empowered to hear this case pursuant to S.C. Code Ann. § 38-73-910 and S.C. Code Ann. § 1-23-320, as amended.

2. The law governing the making of rates is well defined. Insurance rates are regulated under Title 38 of the South Carolina Code of Laws, 1976, as amended. The pertinent statutory requirement is that rates may not be excessive, inadequate or unfairly discriminatory. S.C. Code Ann. Section 38-73-430(4).

3. The Administrative Law Judge's powers are granted by the Administrative Procedures Act, S.C. Code Ann. §§ 1-23-310 et seq., and the standards for the making of rate set forth in the insurance code by virtue of the law requiring that no rate may be excessive, inadequate, or unfairly discriminatory. § 38-73-430 (Supp. 1995). The filer must simply prove that the standard is met by a preponderance of the evidence.

4. Pursuant to S.C. Code Ann. § 38-73-910, notice of the filing and of the public hearing was given in all newspapers of statewide circulation at least 30 days in advance of the hearing.

5. Pursuant to the responsibilities charged to the Department of Insurance, an independent investigation was made of the proposed filing. All findings of fact are based exclusively on the evidence and on matters officially noticed. S.C. Code Ann. § 1-23-320. Due consideration has been made to the numerous exhibits and extensive testimony in the record and on the basis of the independent analysis of the rate filing formulated by the Insurance Department.

6. State Farm's expert witness, Mark Brannon, and the expert witness of the Department of Insurance, Martin Simons, were more credible than the Consumer Advocate's expert on fundamental issues that the Court must consider in determining whether the requested rates are excessive in this rate filing.

7. The language of the South Carolina statute governing the proper considerations in rate-making provides:

Rates must be made in accordance with the following provisions:

(1) Due consideration must be given to past and prospective loss experience within and outside this State, to catastrophe hazards, if any, to a reasonable margin for underwriting profit and contingencies, to dividends, savings, or unabsorbed premium deposits allowed or returned by insurers to their policyholders, members, or subscribers, to past and prospective expenses, both countrywide and those specially applicable to this State.

S.C. Code Ann. § 38-73-430(1) (Supp. 1995).

8. "The starting point in every case involving construction of a statute is the language itself." United States v. Jackson, 759 F.2d 342, 344 (4th Cir. 1985) (citing Blue Chip Stamps v.Manor Drug Stores, 421 U.S. 723, 756 (1975) (Powell, J. concurring)). "[W]here a statute is clear and unambiguous, it must be applied according to its literal meaning[,]" Berkebile v. Outen, 311 S.C. 50, 426 S.E.2d 760, 763 (1993) (citation omitted), and a court reviewing the statute has no right to look for or to impose another meaning thereto. See e.g., Paschal v. Election Comm'n, __ S.C. __, 454 S.E.2d 890, 892 (1995); see also, McNeely v. South Carolina Farm Bureau Mut. Ins. Co., 259 S.C. 39, 190 S.E.2d 499, 501 (1972)(providing that a court is not permitted to interpret that which is not in need of interpretation).

9. A statute is unambiguous if it employs clear and precise terms. McNeely v. South Carolina Farm Bureau Mut. Ins. Co., 259 S.C. 39, 190 S.E.2d 499, 501 (1972). The pertinent part of the South Carolina insurance law clearly and unambiguously requires that due consideration must be given to, inter alia, a reasonable margin for underwriting profit and for contingencies. S.C. Code Ann. § 38-73-430(1) (Supp. 1995). The Court assumes that the terms "underwriting profit" and "contingencies" are used in their technical meaning if they have acquired one and in their popular meaning if they have not. Poole v. Saxon Mills, 192 S.C. 339, 6 S.E.2d 761, 764 (1940).

10. An underwriting profit generally is defined as "the excess of the company's income over its expense and loss from the underwriting business." Massachusetts Bonding & Ins. Co. v. Lundy, 160 F.2d 680, 682 (8th Cir. 1947).

11. The underwriting profit is wholly distinct from underwriting contingencies. The Casualty Actuarial Society of Principles Regarding Property and Casualty Ratemaking states that systematic variation of the expected costs from projected costs is to be considered in the contingency provision. The NAIC contemplates that contingencies may be determined separately from underwriting profits.

12. Regarding the contingency factor, the NAIC Study of Investment Income states that the contingency factor began as a catastrophe allowance. Most states make special allowances for catastrophes in estimating future loss. Therefore, the possibility of catastrophes is no longer a valid basis for including contingency provisions in arriving at a target return or profit loading. More recently, contingency provisions have been used to correct potential shortfall between targeted and actual returns. Such shortfalls have been significant. The present practice of most insurers is to use a 5% allowance for profit and contingencies, however, the indicated rates are usually not implemented. Instead, a lesser rate is used in recognition of competition and the expected investment income. NAIC Study of Investment Income, Supplement to the Proceedings, 1984, Vol. II, pp. 24-25. Therefore, according to the NAIC report, the addition of a contingency revision is not necessary in any total return ratemaking methodology.

13. The profit and contingency factor proposed by State Farm is 5%. The contingency factor of 2%, although based upon underwriting loss and shortfall, is reasonable. The filings reveal that State Farm looks at underwriting gain/loss only and not total return in determining its contingency provision. In addition, State Farm's past filings have not as a matter of course requested a 5% profit and contingency factor as is accepted by standard practice according to the NAIC report. The fact that State Farm is requesting 5% at this time does not render the request actuarially flawed.

14. In the most simplistic terms, contingencies are unforeseen events that can cause an insurance company's actual costs to be greater than anticipated. Contingencies are expected costs and, therefore, are neither contributors to income nor extra underwriting profit. Because the clear and precise terms "underwriting profit" and "contingencies" have distinct and separate technical meanings in the insurance industry, they are to be used in a manner consistent therewith.

15. The separate inclusion of the clear and precise terms "underwriting profits" and "contingencies" in the rate-making statute renders the statute clear and unambiguous. "When, as here, the statute is plain and unambiguous, it becomes the duty of the court to apply it literally because the legislative design is unmistakable." Martin v. Ellisor, 266 S.C. 377, 223 S.E.2d 415, 417 (1976). Thus, the contingencies and underwriting profit provisions in the rate-making section of the insurance law should remain separate and distinct factors in rate-making considerations, as listed in the rate-making statute.

16. The two percent contingency factor may also fall under the phrase "all other relevant factors within and outside of the state of South Carolina," and therefore, is an appropriate consideration in rate-making.

17. Although the Consumer Advocate has taken the position that State Farm's market share warrants heightened regulatory scrutiny, the Consumer Advocate failed to offer credible evidence that the market is not competitive, or that homeowners in South Carolina are restricted from obtaining homeowners coverage with other insurers.

18. In addition, the Consumer Advocate presented testimony that State Farm's inflation adjustment obviates the need for a rate increase. However, this testimony was not persuasive. As exposure increases due to inflation, State Farm must increase the premium for homeowners to cover the additional replacement costs. This does not change the rate used to calculate premium.

19. The Department of Insurance's expert actuary, Martin Simons, testified in favor of State Farm's requested rate increase. As the Department's expert, Simons' "experience, technical competence, and specialized knowledge may be utilized in the evaluation of the evidence." S.C. Code Ann. § 1-23-330(4) (Rev. 1986). Accordingly, the Court notes that Simons testified that State Farm's projections were reasonable with respect to contingencies, catastrophes, and underwriting profit.

20. The rates produced by State Farm's rate request were determined using generally accepted actuarial techniques.

21. State Farm met the burden of proof in this rate increase request by establishing by a preponderance of the evidence that the revised rates would not be excessive, inadequate, or unfairly discriminatory. S.C. Code Ann. § 38-73-430(4) (Supp. 1995).

ORDER

Based upon the foregoing Findings of Fact and Conclusions of Law, it is hereby ORDERED,

that the proposed rates meet all statutory requirements and the request by Petitioners for an overall 3.1% increase in its homeowners property and casualty insurance rates is approved effective on the date of this Order.



AND IT IS SO ORDERED.

_______________________________

ALISON RENEE LEE

Administrative Law Judge



May _____, 1996

Columbia, South Carolina.


Brown Bldg.

 

 

 

 

 

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