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State v. North Carolina Rate Bureau

June 16, 1998

STATE OF NORTH CAROLINA EX REL. COMMISSIONER OF INSURANCE, APPELLEE,
v.
NORTH CAROLINA RATE BUREAU, APPELLANT. IN THE MATTER OF THE FILING DATED MAY 1, 1995 AND AMENDED APRIL 1, 1996 BY THE NORTH CAROLINA RATE BUREAU FOR REVISED AUTOMOBILE INSURANCE RATES -- PRIVATE PASSENGER CARS AND MOTORCYCLES.



The opinion of the court was delivered by: Martin, Mark D., Judge.

Appeal by the North Carolina Rate Bureau from orders entered 4 October 1996 and 31 October 1996 by the North Carolina Commissioner of Insurance. Heard in the Court of Appeals 7 January 1998.

On 1 April 1996, amending its 1 May 1995 filing, the North Carolina Rate Bureau (Bureau) filed a request to increase automobile insurance rates. Included was a request to increase rates for private passenger car insurance by 5.7% and motorcycle insurance by 10.1%. The North Carolina Insurance Commissioner (Commissioner) conducted hearings beginning 9 July 1996 and concluding 20 August 1996. The Commissioner heard testimony from five Department of Insurance (Department) expert witnesses and six Bureau experts and received 61 Department and 87 Bureau exhibits into evidence. The hearing transcript was approximately 3600 pages in length. By orders dated 4 October 1996 and 31 October 1996 the Commissioner disapproved the proposed rate changes and instead ordered a rate reduction for cars of -8.3% and a rate increase for motorcycles of 3.2%. From these orders, the Bureau appeals.

In reviewing orders of the Commissioner we must examine the whole record and determine whether the Commissioner's Conclusions of law are supported by material and substantial evidence. State ex rel. Comr. of Ins. v. N.C. Rate Bureau, 124 N.C. App. 674, 678, 478 S.E.2d 794, 797 (1996), disc. review denied, 346 N.C. 184, 486 S.E.2d 217 (1997). Substantial evidence is defined as "such relevant evidence as a reasonable mind might accept as adequate to support a Conclusion . . . [but] more than a scintilla or a permissible inference." Id. (citations omitted). When there is conflicting evidence in the record, it is not this Court's function to substitute its judgment for that of the Commissioner, since the "weight and sufficiency of the evidence as well as the credibility of the witnesses are determined by the Commissioner." Id. (citing State ex rel. Comr. of Insurance v. N.C. Rate Bureau, 96 N.C. App. 220, 221, 385 S.E.2d 510, 511 (1989)). Any order of the Commissioner that is supported by substantial evidence is presumed correct, N.C. Gen. Stat. § 58-2-80 (1994), and the rates fixed by the Commissioner's order are prima facie correct. N.C. Gen. Stat. § 58-2-90(e) (1994).

I.

The Bureau first contends the Commissioner erred as a matter of law by considering investment income on capital and surplus in his ratemaking calculations. Specifically, the Bureau alleges that the Commissioner improperly "reduc[ed] his target return from a return equal to industries of comparable risk to a return on operations alone" and as a result impliedly considered the invalid information in his calculation.

North Carolina law requires that regulated insurance rates be adequate to provide the industry a fair and reasonable profit. Comr. of Insurance v. Rating Bureau, 292 N.C. 471, 483, 234 S.E.2d 720, 726 (1977). The ultimate question for the Commissioner's determination is whether the proposed rates will, after provision for reasonably anticipated losses and operating expenses, leave the insurers a fair and reasonable profit and no more. Id. Determining a fair and reasonable profit "involves consideration of profits accepted by the investment market as reasonable in business ventures of comparable risk." In re Filing by Fire Ins. Rating Bureau, 275 N.C. 15, 39, 165 S.E.2d 207, 224 (1969).

Insurance companies derive their returns from two branches of the insurance business -- returns generated by the profits earned by insurance operations including investment income on reserves, and returns generated by the profits earned by investing capital and surplus funds. Comr. of Insurance v. Rate Bureau, 300 N.C. 381, 446, 269 S.E.2d 547, 587, reh'g denied, 301 N.C. 107, 273 S.E.2d 300 (1980). In order to make a comparison with industries of comparable risk, the Commissioner attempted to combine these two branches and compare this total return of the insurance industry to total returns of other industries. When setting insurance rates, however, income from invested capital and surplus cannot be considered. Id. at 444, 269 S.E.2d at 586. This fundamental rule is justified, at least in part, because "the required capital assets of a casualty insurance company are primarily reserves to guarantee its ability to discharge its liability rather than for use as working capital in the prosecution of its business." Id. at 442, 269 S.E.2d at 585 (citations omitted). Accordingly, a fair and reasonable profit must be calculated without considering investment income from capital and surplus while considering the returns of businesses of comparable risk.

In State ex rel. Comr. of Ins. v. N.C. Rate Bureau, 124 N.C. App. at 685, 478 S.E.2d at 802, the Commissioner used a methodology that included a line item and calculation for "Income from Capital and Surplus." We remanded his order for recalculation using a formula that excluded investment income earned on capital and surplus. Id. at 685-686, 478 S.E.2d at 802. The Commissioner's attempt to distinguish his present methodology is unpersuasive.

In his brief, the Commissioner explains that in the earlier case he found the target total return of the insurance industry based on the total returns of industries of comparable risk. He then subtracted the investment income on capital and surplus from this total return and arrived at a total return on insurance operations. This return on operations was used to derive the profit provisions.

In the present case, the Commissioner started with a direct estimate and justification of the return on operations, rather than a total return, and derived his profit provisions from this estimated return on operations without explicitly including investment income from capital or surplus in his calculations.

The Bureau argues that the Commissioner simply "repackaged" his calculations by starting with a return on operations as his target in order to avoid the appearance of explicitly considering investment income on capital and surplus, but in essence accomplished exactly what we have previously disallowed. We agree.

The Commissioner admits in his brief that his 5.7% "return on operations may be tested to ensure that it will result in a `total return' commensurate with the `total return' of businesses of comparable risk by adding the income from capital and surplus to the return on operations." Indeed, the Commissioner further acknowledges he "performed this test and determined that the return on operations of 5.7% combined with the income from capital and surplus would result in a `total return' of 13%, which is in the range of returns earned by other industries."

We are bound by the decisions of our Supreme Court and must reject the Commissioner's creative attempt to deviate from such precedent. Mahoney v. Ronnie's Road Service, 122 N.C. App. 150, 153, 468 S.E.2d 279, 281 (1996), aff'd per curiam, 345 N.C. 631, 481 S.E.2d 85 (1977). Therefore, we hold that the Commissioner improperly considered income from capital and surplus in arriving at his total return and remand for recalculation.

II.

The Bureau next contends the Commissioner improperly failed to reflect expected values for policyholder dividends and rate deviations in his rate calculations and consequently ordered rates that do not comply with statutory requirements. Specifically, the Bureau argues that dividends and deviations ...


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