STATE OF MINNESOTA

OFFICE OF ADMINISTRATIVE HEARINGS

FOR THE DEPARTMENT OF COMMERCE

          The above-entitled matter was heard by Administrative Law Judge Barbara L. Neilson on August 8, 9, and 29, 2002, pursuant to a Notice of and Order for Hearing dated May 7, 2002. 

Jennifer S. Kenney, Assistant Attorney General, 1200 NCL Tower, 445 Minnesota Street, St. Paul, MN 55101-2130, appeared on behalf of the Minnesota Department of Commerce (“the Department”).  Douglas J. Franzen and Michael Docherty, Attorneys at Law, Rider, Bennett, Egan & Arundel, PLLP, 333 South Seventh Street, Suite 2000, Minneapolis, Minnesota  55402, appeared on behalf of the Respondents, Encompass Insurance Company (“Encompass” or “the Company”), Glens Falls Insurance Company and Kansas City Fire & Marine Insurance Company.  Post-hearing briefs were submitted on September 19, and October 3, 10, and 16, 2002. 

NOTICE

          This Report is a recommendation, not a final decision.  The Commissioner of Commerce will make the final decision after reviewing the record.  The Commissioner may adopt, reject or modify these Findings of Fact, Conclusions, and Recommendations.  Under Minn. Stat. § 14.61, the Commissioner’s decision shall not be made until this Report has been available to the parties to the proceeding for at least ten (10) days.  An opportunity must be afforded to each party adversely affected by this Report to file exceptions and present argument to the Commissioner.  Parties should contact the Office of the Commissioner of Commerce, Minnesota Department of Commerce, 85 Seventh Place East, Suite 500, St. Paul, MN  55101, telephone (651) 296-3528, to ascertain the procedure for filing exceptions or presenting argument to the Deputy Commissioner.

STATEMENT OF THE ISSUES

1.       Is Glens Falls Insurance Company’s 72.0 percent rate increase effective March 1, 2002, for its homeowners policies excessive within the meaning of Minn. Stat. § 70A.06, subd. 1a?

2.               Is Kansas City Fire & Marine Insurance Company’s 98.6 percent rate increase effective March 1, 2002, for its homeowners policies excessive within the meaning of Minn. Stat. § 70A.06, subd. 1a?

3.               Is Kansas City Fire & Marine Insurance Company’s 30.4 percent rate increase effective March 1, 2002, for its automobile policies excessive within the meaning of Minn. Stat. § 70A.06, subd. 1a?

Based upon all of the files, records and proceedings herein, the Administrative Law Judge makes the following:

          FINDINGS OF FACT

1.               Licensed insurance companies offering casualty insurance, fidelity surety and guaranty bonds, fire and allied lines of insurance, and inland marine insurance on risks or operations in Minnesota are required to file with the Commissioner of Commerce all rates and all changes and amendments of rates not later than their effective date.[1]  The Commissioner may require that the insurer also file supporting and explanatory data “which shall include:  (1)  the experience and judgment of the filer, and, to the extent it wishes or the commissioner requires, of other insurers or rate service organizations; (2)  its interpretation of any statistical data relied upon; (3)  descriptions of the actuarial and statistical methods employed; and (4)  any other matters deemed relevant by the commissioner or the filer.”[2]

2.               Whenever an insurer files a change in a rate that will result in a 25 percent or more increase in a 12-month period over existing rates, the Commissioner may hold a hearing under Chapter 14 of the Minnesota States to determine if the change is excessive.  The rate is effective unless, as a result of the hearing, it is determined that the rate is excessive.[3]

3.               In 1999, Allstate Insurance Company, through an asset liability purchase agreement with CNA Financial, purchased CNA’s personal lines business.  The underwriting companies for CNA included Glens Falls Insurance Company (“Glens Falls”) and Kansas City Fire & Marine Insurance Company (“Kansas City”).  These companies are CNA-licensed underwriting companies.  Encompass is not an insurance company but is a trade name that was formed in 2000.  Encompass is in the process of setting up licenses owned by Allstate for Glens Falls and Kansas City.  Encompass’ total business comprises a little less than ten percent of Allstate’s total business.[4] 

4.               Encompass sells its products strictly through independent agents, not on the Internet or over the phone.  Encompass also offers a package product that enables customers to purchase one policy with one deductible to cover a home, boat, car, rental property, etc.[5]  Independent agents are appointed by various companies to be able to market their products and can place business with several companies.  They represent the company and that company’s product line to the customer.[6] 

5.               In 1999, Encompass sought a total homeowners rate increase of 4.3 percent.  In 2000, Encompass sought a rate increase for “other than auto” (OTA), including homeowners, of 10.9 percent.[7] 

6.               Minnesota, Wisconsin, and Texas are the three markets in the United States that are most problematic for Encompass.  T. 45.

7.               For the year 2000, Minnesota ranked last in profitability for homeowners and personal lines of insurance among the 50 states and the District of Columbia.  In terms of the average over the past nine years, Minnesota did not rank last, but did rank 46^th or 47^th.[8] 

8.               During the past eleven years, Encompass and its predecessor companies have had poor financial results in Minnesota.  Between 1991 and 2001, Encompass paid $1.63 in claims for every $1.00 of premium collected.  As a result, Encompass’ losses in Minnesota exceeded its premiums by approximately $48 million during this period.  This figure does not include expenses associated with running the business, paying agency commissions, paying staff to settle and adjust claims, legal fees, operating expenses for underwriting and building, and other salaries.[9]  Encompass’ direct losses incurred have exceeded its direct premiums earned in 1997 through 2001.[10] 

9.               Other insurance companies have also had similar loss ratios in Minnesota during the years 1997 through 2001.[11] 

10.           Encompass’ direct premiums earned increased every year between 1991 and 2000 with the exception of 1999-2000.  Its direct premiums earned increased from $10,537,501 in 2000 to $12,008,200 in 2001, even though Encompass wrote less business in 2001 than in 2000.  The increase is due to increases in the premiums of existing customers as a result of rate increases and increases in the insured value of the property, retaining a larger portion of current customers, and the inflation factor included in insurance policies.[12] 

11.           On a national basis, Encompass paid out approximately $1.16 in loss and expense for every dollar it took in.  Encompass is an underperforming business unit for Allstate, and a drain on capital.[13] 

12.           In response to its losses, Encompass tried some traditional measures like re-underwriting the book of business and not renewing poorly-performing risks when possible.[14]  Encompass also undertook a more aggressive insurance-to-value program by inspecting homes to make sure that they were properly maintained and insured for the full amount.  In addition, Encompass worked with agencies that were performing more poorly than average to try to rehabilitate them and, in some instances, terminated agency contracts.[15] 

13.           Although these traditional methods may have offered some level of mitigation of the losses, the problem continued.  During early 2001, Encompass segmented its Minnesota business into two companies, in a continuing effort to address losses.  Individual policyholders were placed in Glens Falls or Kansas City primarily based upon their loss experience.  Customers who had higher loss experience and higher probability for future loss generally went into Kansas City.  Customers who had better (lower) loss experience generally went into Glens Falls.  Segmentation such as this is fairly standard in the insurance industry.[16] 

14.           Encompass decided to seek a significant rate increase when it submitted its rate filing in December 2001.[17]  In hindsight, Encompass’ Chief Operating Officer believes that Kansas City and Glens Falls should have been taking more significant rate increases in earlier years.  Encompass had not taken significant rate increases in the past based in part upon competitive concerns and in part upon an expectation that the market would turn around and the pattern would not continue.[18] 

15.           During the fourth quarter of 2001, Encompass’ actuarial department began to prepare a rate proposal for review and discussion with its home office and its field operation to begin the process of determining what the need was and preparing a rate filing to submit to the Department of Commerce.  A document was prepared for review and discussion containing the recommendations of the actuarial department.[19] 

16.           Encompass contacted the Department in early December of 2001 to let the Department know that the Company was going to put in a filing with a very significant rate change and discuss the reasons why the Company was seeking the increase.  The amount to be sought was higher than the level that some people in the Company thought the Department of Commerce might approve.[20] 

17.           On or about December 13, 2001, Respondents filed four rate increases with the Commissioner.  The Department has challenged three of these rate increases: (a)  a rate increase of 72.0 percent for Glens Falls’ homeowners policies (Ex. 6); (b)  a rate increase of 98.6 percent for Kansas City’s homeowners policies (Ex. 7); and (c)  a rate increase of 30.4 percent for Kansas City’s automobile policies (Ex. 8).[21] 

18.           Because Minnesota is a “file and use” state, the rates filed by Glens Falls and Kansas City took effect on March 1, 2002.  The rate increases are currently being implemented as individual policies come up for renewal.[22] 

19.           Encompass believes that the rates have been inadequate for a number of years and that not only it but also other carriers will be aggressively raising rates in the future.  If the market gets to a stable, reasonable rate level, then Minnesota will, in the view of Encompass, be a state in which it could do business successfully on a long-term basis.[23] 

20.           Beginning in January of 2002, Encompass management conducted several conference calls and meetings with agents in Minnesota to discuss the magnitude of the rate change, the reasons for the rate increase, and ways in which the Company could provide support to them.[24]  Encompass’ President, Vice President and Chief Operating Officer, and Regional Vice President traveled to Minnesota to meet with agents.[25]  Encompass also sent a fax to agents in Minnesota dated January 23, 2002, concerning the rate increases.[26] 

21.           Encompass provided the agents with data on their customers and provided information regarding how an increase in the amount of their deductible would help them lower their premium and mitigate the effect of the rate increase.[27]  The base deductible is $250.  If an Encompass customer moved to a $500 deductible from a $250 deductible, they would save approximately 12 percent on the overall premium.  If they moved to a $1,000 deductible from a $250 deductible, they would save approximately 25 percent on their overall premium.[28]  There is a limit to how high an Encompass insured can increase his or her deductible in order to offset the amount of premium, since certain caps come into play.[29]  Encompass also provided the agents with information regarding how to approach the rate increase with their customers and what to say to them about it, including pointing out the value of being with the same insurance company for a period of time, such as the ability to receive renewal discounts and the ability of the company to see a longer term history when considering renewal; emphasizing the unique features associated with Encompass policies, such as the one-deductible-per-loss feature; and underscoring Encompass’ good claims service.[30] 

22.           Tom Baker, the Department’s Manager of Property Casualty Insurance and Self-Insurance, reviewed the three rate filings of the Respondents that are at issue in this proceeding because of the amounts of the requested increases.  He determined that they should be immediately forwarded to the Department’s Property Casualty Actuary, Nancy Myers, for review.[31] 

23.           Ms. Myers reviewed the rate filings because the rate increases were unusually large.  She reviews any rate increase greater than 25 percent, in accordance with Minn. Stat. § 70A.06.[32]  In Ms. Myers’ opinion, each of the rate filings was excessive.[33]

24.           The Department sent notice to Encompass dated February 8, 2002, of its intent to hold a hearing to determine if the requested rate increases were excessive.  The present contested case proceeding was initiated on May 8, 2002.[34]  

Rate Setting Process

25.           The goal of ratesetting is to predict what the loss ratio will be for the period in which the rates are going to be in effect so that the rates may be set appropriately to cover those losses and also the expenses and allow for profit.[35] 

26.           To determine the amount of rate it needs in order to write a line of business in the future in a particular geographical area such as Minnesota, an insurer typically projects the following components of rate:  (1)  anticipated premiums paid by customers for their insurance coverage; (2)  anticipated losses (funds paid out in direct payment of claims); (3)  anticipated loss adjustment expenses (“LAE”) consisting of expenses associated with settling claims such as claims adjustors’ salaries, defense costs, lawyers fees, and underwriting reports related to claims; (4)  anticipated underwriting expenses consisting of all expenses not directly related to the adjustment of losses, such as salaries, rental payments, supplies, and premium taxes; and (5)  the profit from underwriting the business.[36] 

27.           The primary job in preparing a rate filing is projecting future losses.  It is the largest item, and the one that takes the most time to determine.[37] 

28.           In determining projected losses, actuaries develop “loss ratios” for previous years.  The loss ratio for a given year expresses the relationship between current losses and earned premiums, i.e., losses are divided by premiums and expressed as a percentage.  Thus, if a company paid out $.67 in losses for every dollar of premium collected, the loss ratio for that year would be 67/100, or 67 percent; if a company paid out $2.04 in losses for every dollar of premium collected, the loss ratio would be 204/100, or 204 percent.[38] 

29.           The “rate level indication” is the amount by which a company would need to change its current rates to achieve its target rate of return.  It is the final number at which a company is trying to arrive as it goes through the ratemaking process.[39] 

30.           Homeowners’ loss experience includes large and infrequent losses that are called “catastrophic” losses.[40]  In order to properly reflect these unusual large losses and avoid upward and downward shifts in loss costs that would result from reflecting large, unusual losses only in the year in which they occur, insurers use some type of “catastrophic” procedure looking at long-term history.[41] 

31.           Catastrophe losses are treated separately from non-catastrophe losses in the ratemaking process because catastrophe losses by their nature are more erratic and unusual in nature.  They tend to be very large in some years and lower in other years.  They are treated separately in order to smooth out their impact and provide more stable rates over time.[42] 

32.           Different insurance companies define catastrophe losses in different ways.  Encompass uses the definition of the Insurance Service Office (“ISO”) and thus defines a catastrophe loss as any occurrence that produces insured losses of $25 million or more.[43]  In Minnesota, catastrophe losses typically include wind and hail storms and perhaps some winter storms.[44] 

33.           The phrase “ex-cat” losses means “excluding catastrophe” losses and is used to refer to losses other than catastrophe losses.[45]  The “ex-catastrophe loss ratio” is the ratio of losses over premiums not including catastrophe losses.[46] 

34.           Encompass’ selection of the ex-cat loss ratio in the December 2001 rate filing is shown on Ex. 6 at Ex. 1B, page 4.  The Company applied a series of adjustments to bring historical losses to year 2000 cost levels and to bring historical premiums to year 2000 rate levels.[47]  Loss ratios at 2000 levels for the years 1996-2000 were as follows:

1996:            67%

1997:            74%

1998:            74%

1999:            82%

2000:            95%[48]

35.           Partial year 2001 data available to Encompass at the time of the rate filing showed that the loss ratio was greater than 95 percent.[49] 

36.           Based upon the upward trend in the 1996-2000 loss ratios and the available 2001 data, Encompass selected an ex-cat loss ratio of 95 percent.[50] 

37.           A “selection” means that the actuary has used actuarial judgment in picking a component of the rate level indication such as what the future base loss ratio will be, rather than simply doing a calculation and getting the product of that calculation.  The use of selections is an accepted methodology within the actuarial profession and is stated in the Casualty Actuarial Society Statement of Principles as a factor that should be included in the ratemaking process.[51] 

38.           Based upon the fact that there was no apparent upward trend in the loss ratios for the OTA balance between 1996 and 2000, Encompass selected 37 percent as the ex-cat loss ratio for OTA balance.[52] 

39.           The ratio of catastrophe losses to non-catastrophe losses is referred to as the “cat factor,” “cat ratio,” or “cat load.”[53]  T. 105-06.  Different insurance companies use different methodologies to arrive at a cat factor.  Some use a weighted average methodology; others may employ some explicit capping methodology or a host of other methods.[54]  Although ISO uses the weighted average method to determine an ex-cat ratio,[55] not all insurance companies follow the ISO methodology in their ratemaking.[56] 

40.           In the past, Encompass used a weighted average method to calculate its July 27, 2001, homeowners filing for Kansas City, applying weights of 10 percent, 15 percent, 20 percent, 25 percent, and 30 percent respectively for years 1996 through 2000.[57]  Encompass did not use the weighted average method to calculate the ex-cat loss ratio in the filings at issue in this proceeding because Encompass believed that the weighting methodology used in the July 2001 filing was inappropriate given the increase in the trend of the loss ratios from 1996 through 2001.[58] 

41.           Exhibit 6 at IID shows the Encompass’ derivation of the cat factor for the rate filings at issue in this proceeding.  Column 8 on that page shows the historical cat factors for the 15-year period 1986-2000.  That column shows that the cat factors between 1986 and 1995 were generally ten percent or less. Starting in 1996, the cat factors increased significantly.  In 1998, there were an unusually high number of storms; the cat factor for that year was 474 percent.  The five-year average of the cat factors between 1996 and 2000 was 128 percent, the ten-year average between 1991 and 2000 was 67 percent, and the fifteen-year average between 1986 and 2000 was 46 percent.[59] 

42.           Based on the increase in cat factors over the most recent six years (including 2001), Encompass selected 35 percent as the cat factor for the future period when the proposed rates would be in effect.[60]  Encompass wanted to temper the very unusual 1998 year with its high level of catastrophe experience by discounting that 474 percent and selecting a cat factor that was lower than the five, ten, and fifteen year averages.[61]  No explicit methodology was used by Encompass in tempering the 1998 year.  The 35 percent selection is only slightly higher than the 30 percent cat factor selected in Encompass’ previous filing of July 27, 2001.[62] 

43.           Encompass later determined that the cat factor for accident year 2001 was actually at the 70 percent level.[63] 

44.           At least two other insurance companies selected higher cat factors than Encompass.[64]  However, none of the 10 to 15 companies whose filings were reviewed by Encompass’ actuary had a higher indicated rate increase than Encompass.  All were less than Encompass.[65] 

45.           After Encompass selected the ex-cat loss ratio and the cat factor, it multiplied the 35 percent cat factor by the 95 percent ex-cat loss ratio to derive a 33 percent catastrophe loss ratio.[66]  This catastrophe loss ratio was then added to the 95 percent ex-cat loss ratio to derive a total base loss ratio (the projected loss ratio at the 2000 level) of 128 percent.[67]  The base loss ratio was then projected out to 2001, the future period when the proposed rates would be in effect, by applying adjustments to both the loss (numerator) and premium (denominator) sides of the ratio.[68]  The result is a ratemaking loss ratio of 108 percent.  This is the loss ratio projected by Encompass for the period when the proposed rates would be in effect.[69] 

46.           Encompass then made certain adjustments to the ratemaking loss ratio and compared the projected ratemaking loss ratio to the budgeted or expected loss ratio to arrive at the rate level indication.  This process resulted in an overall homeowners rate level indication of 80.6 percent.[70] 

47.           Encompass made a similar series of calculations for the other components of OTA coverage which, when combined with homeowners, resulted in a preliminary overall OTA rate level indication of 71.2 percent.[71] 

48.           To reflect the fact that the loss experience of customers in Glens Falls is significantly better than the loss experience of customers in Kansas City, the Respondents allocated the combined companies’ base loss ratio of 88 percent between the two companies.  Sixty-seven percent of Encompass’ customers are in Glens Falls and 33 percent are in Kansas City.  After considering the historical loss ratios of the two companies (based on nine months of 2001 data), Respondents arrived at preliminary OTA rate indications of 61.9 percent for Glens Falls and 83.9 percent for Kansas City.[72] 

49.           The allocation between the companies was based on nine months of data, from the time Encompass first segmented its Minnesota business into the Glens Falls and Kansas City companies.  The only data available to Encompass at the time for 2001 was the calendar year loss ratios for Kansas City and Glens Falls for 2001 through the end of September.[73]  The Company did not use full fiscal year data ending in September of that year but merely used the first nine months because the underwriting guidelines for the two companies were changed in early 2001.[74] 

50.           Encompass made an actuarial adjustment by adding 15 percent to the preliminary rate indications for Glens Falls and Kansas City to reflect the fact that Encompass was able to see that accident year 2001 with nine months of data was approximately 30 percent worse than accident year 2000 at the same point in time.  Given that Encompass’ ratemaking methodology could not account for the fiscal year, an adjustment was made to account for the continued deterioration in the results in 2001.  Thus, the final OTA indications were 76.9 percent for Glens Falls and 98.9 percent for Kansas City.[75] 

51.           At the time of the filings, Encompass was not able to get fiscal year data with existing computer programs.  Encompass has subsequently changed the programs so it can incorporate a fiscal year approach.[76]  When Encompass ran a fiscal year indication through September of 2001, that data resulted in an indication that was even higher than the indications in the filings that incorporated the 15 percent adjustment.[77] 

52.           Encompass used the same methodology for the automobile allocation as for the allocation of the homeowners rate increase.[78]  Encompass reviewed the available loss data for the first nine months of 2001 and made the allocation on that basis.[79] 

53.           Credibility weighting refers to applying a credibility standard to a given set of data to reflect the fact that you don’t believe that it is 100 percent credible.  Encompass does not believe that credibility weighting was necessary, since they were only trying to get a relative difference between the two companies to reflect that one has worse experience than the other.  If Encompass had used credibility weighting, the Kansas City base loss ratio would have come down and the Glens Falls base loss ratio would have gone up.[80] 

54.           Kenneth Carlton, a consulting actuary, was asked by Encompass to review the two property insurance rate filings of Kansas City and Glens Falls (Exs. 6 and 7).[81]  He reviewed the filings for reasonableness by checking the methodology, underlying assumptions, and calculations.[82]  In Mr. Carlton’s opinion, the overall rate indications in the property insurance filings of Kansas City and Glens Falls, including the 15 percent adjustment to account for the first nine months of 2001, are reasonable, supported by actuarial data, and not excessive.[83]  In Mr. Carlton’s opinion, the selection of the 35 percent cat factor was conservative.  Using a weighted average methodology and tempering the impact of the unusual 1998 year, Mr. Carlton selected a cat factor of 50 percent.  Mr. Carlton tempered the 1998 year by limiting the impact of any year to no more than three times the 15-year weighted mean ratio.[84] 

55.           In Mr. Carlton’s opinion, the allocation of the indication between Kansas City and Glens Falls was reasonable since the loss ratio for Glens Falls (106.2 percent) was much better than that for Kansas City (143 percent).[85]  Mr. Carlton would have been more comfortable if it had been possible to use five years of experience.  However, based on the fact that only nine months of data was available and the underwriting criteria is different between Glens Falls and Kansas City, the results derived were, in his opinion, reasonable.  If Kansas City were reduced, Glens Falls would have to be increased and Glens Falls policyholders would pay more even though their experience is better and, in essence, subsidize the Kansas City policyholders.[86] 

56.           Mr. Carlton confirmed the reasonableness of Encompass’ rate filings by using fiscal year data for the most recent five years ending September 30, 2001, that subsequently became available and applying his own re-selections of the ex-cat loss ratio and the cat factor.  This was the sameinformation that formed the basis for Encompass’ filings, but in a different format.  Rather than using the two-step methodology employed by Encompass (arriving at an initial indication through year 2000 and then adjusting it for the partial year 2001 data), Mr. Carlton obtained fiscal year data through September 2001 from Encompass, which also incorporated his reselections of the ex-cat loss ratio and the cat factor.  More current information was used to adjust the loss ratios to March 1, 2002, the effective date of the filing.  Based on this more current data and his two reselections, Mr. Carlton derived an overall rate level indication for the combined companies of 121.3 percent, compared to the 86 percent indication derived by Encompass in the original filings.  Based upon his review, Carlton concluded that the Encompass indication, which included the 15 percent adjustment for 2001, was reasonable.[87] 

57.           Although he felt that Encompass’ methodology was reasonable, Mr. Carlton selected his own independent ex-cat loss ratio (95 percent for the homeowners experience and 52.7 percent for the OTA balance) and his own cat to ex-cat ratio (50 percent as compared to the 35 percent selected by Encompass).  He selected the 95 percent ex-cat loss ratio after calculating three different loss ratios using different weighting schemes (a three-year weighting scheme which resulted in a weighted loss ratio of 104.1 percent, a four-year weighting scheme which resulted in a weighted loss ratio of 99.95 percent, and a five-year weighting scheme which resulted in a weighted loss ratio of 86 percent), reviewing those three values, and using actuarial judgment to select 95 percent as his ex-cat loss ratio.  He selected 95 percent because the more current years were showing some worse experience and he did not want to go with the five-year weighted loss ratio for that reason.  In his opinion, 95 percent is reasonable.  He selected the 50 percent cat to ex-cat ratio after limiting the impact of any year to no more than three times the 15-year weighted mean ratio, in order to reduce the impact of the 1998 year, and arriving at a weighted average cat to ex-cat loss ratio.  He then ran the same calculations using just the most recent five years of experience because the ratios for those years are significantly higher than the prior years, and selected 50 percent as a reasonable cat to ex-cat loss ratio.[88] 

58.           In the view of the Department, the Respondents’ homeowners rate increases for both Kansas City and Glens Falls are excessive.[89]  The Department, through its Property Casualty Actuary, Nancy Myers, takes issue with the selection of the 95 percent ex-cat loss ratio by Encompass because it contends that Encompass failed to account for the previous five years of experience, i.e., the selection was not based on five years of data.[90]  The Department believes that the loss ratios for 1996 through 2000 should have been weighted and that the weights should increase over time so that weights of 10, 15, 20, 25, and 30 are appropriate.[91]  When the Department’s actuary made the calculation using the five-year weighted average method, she arrived at an ex-cat loss ratio of 82 percent.[92] 

59.           The Department does not believe that selecting a number is a reasonable process.[93]  In the Department’s opinion, it is very problematic to select numbers because it is too easy to select numbers that give you the answer you want rather than selecting a number on a more objective basis.  The Department believes that a calculated number, such as a number calculated after using a five-year weighted average approach, places more discipline on the process and is more appropriate.[94]  In addition, in the Department’s view, the selection of 95 percent by Encompass is not a reasonable or appropriate way to account for trend.  The Department believes that there are other places in the filing where trend should be considered.  For example, there is a trend factor that adjusts for changes in frequency and severity.  Encompass had a trend factor in its filing as well.  In addition, the five-year weighted average approach reflects increasing trend by placing more weight on the most recent year.[95] 

60.           Although there are other reasonable methods to calculate an ex-cat loss ratio, such as a simple average without weights taking into account five years of experience, the five-year weighted average method is frequently used and is probably the most common method used to determine the ex-cat loss ratio in homeowners filings.[96]  In fact, Encompass used the same weighted average method that Ms. Myers suggested in a document dated March 1, 2002, that was provided in response to discovery, which calculated an ex-cat loss ratio of 69.1 percent.  Encompass also used the five-year weighted average method to calculate its ex-cat loss ratio in the July 2001 filing.[97] 

61.           Since most losses on property coverage are weather losses and since weather can vary greatly from one year to another, it is necessary to look at a longer time period, typically five years, to develop a stable estimate of what will happen in the next year.[98]  This is in accordance with the advice contained in a publication by Mark Homan entitled “Homeowners Insurance Pricing.”  Mr. Homan states, “To compensate for [the] variation in property coverages, a longer time period, here a five-year period, is needed for stability.”[99]  Mr. Homan also states, “A longer time period is less responsive to recent changes in the underlying hazard of the book.  This loss of responsiveness is balanced in two ways.  First, the five-year period is selected rather than an even longer one.  Second, the five years are weighted differently.  The typical weights used are 30 percent, 25 percent, 20 percent, 15 percent, and 10 percent from the most recent year to the oldest year.  By giving greater weight to the more recent years, the indication is more responsive to recent changes in the book.”  These are the same weights that the Department used in its calculation, and the same weights Encompass used in Exhibit 41.[100] 

62.           Allstate used the same five-year weighted average formula recommended by the Department in its rate filing to determine a number to use for its projections for the next policy period.[101]  ISO, in its homeowners filing for Minnesota, used a similar five-year weighted calculation with the same weights used by the Department regarding data from 1996 through 2000.[102] 

63.           The Department also believes that the 35 percent cat loss ratio selected by Encompass was too high and was not reasonable.[103]  The Department does not believe that the methodology used was reasonable, or that selecting a number is a reasonable process.  In the Department’s opinion, the number selected was too high.[104]  The Department contends that no calculation or rationale was given to support the selection of 35 percent.[105]  In its opinion, relying on the ISO filing, the Department believes that the catastrophe losses from 1998 should be viewed as a one-in-100 year event.[106]  The ISO filing took this approach:  “An unusually severe wind/hail storm occurred in the year ended June 1998.  We believe that the available historical experience period, 40 years through 9-2000, is not sufficient to account for this storm.  We have therefore modified the excess calculations to reflect the assumption that such a storm occurs once in 100 years.”[107]  The Department agrees with ISO’s approach.[108] 

64.           Although not all of the filings the Department’s actuary has reviewed have viewed the 1998 storm as a one-in-100 year event, they have reflected the unusual nature of that storm in some way.[109]  For example, Allstate spread its losses over a 20-year period, has a countrywide adjustment for castrophes, and capped the state numbers in order to account for the unusual nature of the 1998 losses.[110]  Nothing in Encompass’ filing indicates how or if Encompass accounted for the unusual nature of the 1998 storms.  The 1998 catastrophe loss ratio appears to be given the same weight as all of the other years.[111] 

65.           In the Department’s recalculation, the Department’s actuary took a straight average of the 14 years of Encompass data excluding 1998 (which amounted to 16 percent) and then applied a 5 percent load each year for the 1998 storm (based upon a presumption that such a storm occurs once in every 100 years, so 474 percent divided by 100 is approximately 5 percent), to arrive at a cat load of 21 percent (16 percent plus 5 percent).[112]  She then multiplied the 82 percent ex-cat loss ratio that she had calculated by the 21 percent cat load to get a cat loss ratio of 17 percent, as opposed to the 33 percent cat loss ratio derived by Encompass.[113] 

66.           In the Department’s opinion, Mr. Carlton’s selection was not reasonable because he depended a lot upon the actual dollar amounts in calculating what he thought the load for catastrophe should be.  The use of dollars in place of ratio is problematic because dollars are not comparable over time (i.e., a dollar 20 years ago is not worth a dollar today), the demographics have changed (today there are more insureds and more exposure to loss arising out of the same storms), and the use of dollars places more weight on the years involving large amounts, rather than analyzing catastrophes over a long period of time.[114]  The Department also objects to Mr. Carlton’s use of a selection rather than a calculated method.[115] 

67.           The Department’s actuary used the same data and methodology as Encompass, calculated a different ex-cat loss ratio and cat loss ratio, and arrived at a rate level indication of 43.4 percent for homeowners as opposed to Encompass’ rate level indication of 80.6 percent.[116] 

68.           In the Department’s opinion, Encompass’ 15 percent adjustment for 2001 experience was also unsupported and unreasonable.[117]  The Department did not make any adjustment for 2001 in its calculation.[118]  In the view of the Department, Encompass failed to provide the necessary analysis to make the 15 percent adjustment.  In order to compare losses over time, they need to be adjusted for large losses and also need to be raised to a current cost level.  Encompass did not put the nine months of 2001 data used to support the 15 percent adjustment through the same adjustments and calculations as it did the data for 1996 through 2000, which was adjusted in various ways to determine the loss ratios at the 2000 level.  Despite the limitation in Encompass’ computer program, the Department is of the view that Encompass could have made those adjustments manually, put a higher priority on revamping its computer programs, or waited to make a later filing once it had complete 2001 data.[119] 

69.           Even without the 15 percent adjustment, the Department believes that Encompass’ calculations for Kansas City and Glens Falls are excessive.  In the Department’s opinion, the Respondents’ overall indication of 71 percent was excessive, based on its opinion regarding their selections of the ex-cat and cat loss ratios.[120] 

70.           Encompass arrived at a final indication of 86.2 percent while the Department arrived at a final indication of 35.5 percent.[121]  In the view of the Department’s actuary, 35.5 percent would have been a reasonable rate increase.[122] 

71.           The Department also does not believe that the allocation between the two companies was reasonable or appropriate because it was based on nine months of 2001 data, and does not believe that the limited amount of data has enough credibility to support the difference in rate levels.  The Department also pointed out that Encompass’ allocation of 76.9 to Glens Falls and 98.9 to Kansas City is different than the numbers of 72 percent for Glens Falls and 98.6 percent for Kansas City that were actually reflected in the rate filing.[123] 

72.           Encompass’ credibility standard for homeowners is 60,000 earned house years.  Encompass was not close to this level when it made its allocation.[124]  Glens Falls had 14,753 property policies in force, and Kansas City had 6,532, for a total of 21,285 for both companies.[125]  Assuming that those policies were in force for the entire first nine months of 2001, Encompass would have had 75 percent of 21,285, or approximately 16,000 earned house years, far less than the 60,000 for full credibility.[126]  Encompass made no adjustment for the limited credibility of its data in its allocation between the companies.[127]  In the Department’s opinion, Encompass could have taken the same rate indication for both companies, which the Department believes would have been appropriate or, in the alternative, could have adjusted the indications for credibility.  In addition, the Department is of the opinion that Encompass should also have taken into account the fact that it had already increased Kansas City’s rates more than Glens Falls in the filing it made in July of 2001, which was effective in October 2001.[128]  The increase for Kansas City was 11.7 percent; the increase for Glens Falls was 3.9 percent.[129]  Therefore, some of the differences observed between the two companies had already been accounted for in that earlier rate filing.[130]  Even though accounting for the limited credibility of the data or changing the allocation would result in a higher increase for Glens Falls, the Department believes that that would be reasonable because the data at this point in time does not support that much difference between the rates, and the nature of insurance is subsidization of losses.[131] 

73.           The Department is not arguing that the amount of profit Encompass is seeking in the filing is unreasonable or contending that an insurance company is not entitled to a reasonable profit.[132]  The Department did not take issue with the profit margin allowed for in the filings.[133] 

74.           Although actuaries can use judgment in their ratemaking methodology, the Department does not believe that Encompass’ selections of the ex-cat loss ratio and the cat loss ratio were appropriate.[134]  There must be data and a rational reason to support the judgment.[135] 

75.           To support its opinion that the Glens Falls and Kansas City rate increases were excessive, the Department compared some other companies’ homeowners rate filings to those of Kansas City and Glens Falls.  Exhibit 42 shows the top 26 insurance writers in Minnesota during the year 2001, which is the year when Glens Falls and Kansas City made their filings.  In addition, the data for the Kansas City and Glens Falls rate filings was only fully analyzed through 2000.  The Department wanted to look at rate filings filed in 2001 because the companies would be relying on similar data.[136]  It would not be fair to compare the filings of two different dates because the data is different.[137]  Most of the increases for the other companies were less than 25 percent.  Prudential had a 30 percent increase and Austin Mutual made two filings for a combined increase of about 34 percent.[138]  The filing for Glens Falls effective in October 2001 of 3.9 percent and one for Kansas City of 11.7 percent should have been included on Exhibit 42 but were omitted due to a computer problem.[139] 

76.           The Department acknowledged that, if the weighted average approach it prefers were applied to the first four years of loss ratios shown on Exhibit 6, Ex. IB, page 4, it would have resulted in a final value less than 95 percent, which was the actual loss ratio for 2000.[140]  However, the Department’s actuary testified that there is no method that will guarantee that predictions will be accurate.[141] 

77.           Allstate did not explicitly state that it would treat the 1998 year as a one-in-100 year event, but its methodology may have possibly had a similar effect.[142]  Allstate did attempt to temper the effect of the 1998 unusually high loss.[143]  The Department’s actuary has not reviewed the entire State Farm filing and cannot tell from looking at a single page of the filing what methodology State Farm used.  The rate increase sought by State Farm was 14.8 percent.[144]  State Farm increased its rates by another 21.6 percent in April of 2002, which would compound the 14.8 percent increase in October of 2001.[145] 

78.           ISO is a service organization, not an insurance company. Insurance companies are members of ISO and it is controlled by the insurance industry, not a governmental agency.  There is no requirement that companies must follow ISO’s approach.  In addition, the Department does not prescribe methodologies that insurance companies must follow.[146]  The Department agreed that different actuaries use different methods in trying to come up with what the loss ratio will be for the period in question.[147]  The Department’s actuary has not reviewed the filings of the top 26 homeowners insurers, so she could not say whether any of them had treated the 1998 year as a one-in-100 year event.[148]  Because the ISO has only 40 years of loss data, the ISO in effect made an assumption that storms like those that occurred in 1998 occur only once in 100years, thereby making a type of selection.[149]  However, the Department’s actuary does not believe that it is the same sort of selection made by Encompass because it is possible to follow the thought process and replicate what ISO did; it was not a selection in which one is unable to tell where the number came from.[150]  Although State Farm appears to make a selection in its rate filing for OTA homeowners in Minnesota in 2001, it is unknown what was in the rest of the filing.[151] 

79.           The Department believes that the Kansas City auto filing is excessive because the allocation of the rate change between Glens Falls and Kansas City was inappropriate and unsupported, primarily because, in its opinion, the allocation between the two companies is based upon insufficient data.  In the Department’s opinion, the first nine months of calendar year 2001 is simply not enough data to support the allocation, and lacks sufficient credibility to support the rate change.  In the Department’s opinion, Encompass did not provide sufficient support for the allocation between companies.[152]  The Department also believes that the allocation of the rate change in the homeowners filings for Kansas City and Glens Falls were excessive for the same reasons.[153] 

80.           The Department’s only disagreement with respect to the automobile filing was with the allocation of the rate increase between Glens Falls and Kansas City.[154] 

Impact of Rate Increase

81.           Encompass’ agents tried to retain as many customers as they could or place them with another carrier if retention was not possible.[155]  Some were successful in retaining customers and some were not.[156]  Some customers would not accept the rate increase.[157] 

82.           The FAIR Plan is a residual market mechanism in Minnesota for those who cannot find a carrier in the voluntary or standard market who is willing to insure them.[158]  There is no evidence that any of Encompass’ agents have had to place business with the FAIR Plan. 

83.           William Srenaski, who owns an independent insurance agency in Eagan, is renewing 80-85 percent of his Encompass customers.  Of the remaining 15 percent, he is rewriting 6-7 percent to different companies at their request due to the rate increase, and he is losing 7-8 percent to other companies in the marketplace.  He typically has to place Kansas City customers in specialty markets because they have had multiple losses or their insurance credit score is low.  None of these customers have gone into the FAIR plan.[159]  A handful of Mr. Srenaski’s customers have renewed with Kansas City or Glens Falls for some period of time and then cancelled the policy after getting quotes from other companies.[160]  Some of Mr. Srenaski’s Kansas City customers have seen increases that were greater than the 98.6 percent increase indicated in the filing.  In part, this was due to the fact that there was also an 11.7 percent increase last October.  Those renewing in March of 2002 received the brunt of both increases.  Thus, people who did not renew since the October 2001 increase are seeing an increase in excess of 110 percent.  For the same reason, Glens Falls customers have seen increases greater than the 72 percent increase indicated in the filing.[161]  Increases have also been seen due to insurance to value, i.e., the insurance amount of a home may be raised either due to the house being inspected to determine the actual replacement cost or application of a formula that is used each year to increase the value.[162]  Surcharges have also been applied for claims.[163]  Accordingly, the increases that Mr. Srenaski is seeing for the most part are greater than the 72 percent for Glens Falls and the 98.6 percent for Kansas City.[164] 

84.           Metropolitan Property and Casualty has had a series of three rate increases during 11 months in 2001-02, placing their total rate increase, when compounded, in the range of 60 or 65%.[165]  No other companies, to Mr. Srenaski’s knowledge, have had rate increases effective on or around March 2002 that compare to those filed by Encompass.[166] 

85.           Willard Buhler, who owns an independent insurance agency in Eden Prairie, has found that the increases for his customers generally have been much higher than 98.6 percent for Kansas City or 72 percent for Glens Falls.  The increase has ended up being well over 100 percent in most cases.  He believes that this is due to the fact that the new increase was applied after the October 2001 increase was calculated.[167]  One customer ended up with a rate increase of under 90 percent; all of his other Encompass customers had increases that were over 90 percent.  Most were 100 or 110 percent or higher.[168] 

86.           Mr. Buhler sent a facsimile transmission to the Department with examples of premium increases of over 100% for his customers.[169]  For example, the coverage of D.H. and K.H. under Kansas City was raised from $171,000 to $177,000, but their premium went from $681 to $1,593, a 130 percent increase.[170]  The premium of M.P. and V.P. for a Glens Falls policy went from $559 to $1207, a 117 percent increase.[171]  The coverage of J.M. and K.M. under Glens Falls went from $164,000 to $169,000, but their premium went from $489 to $1,003.[172]  The coverage of R.D. under a Kansas City policy went from $285,000 to $294,000, but his premium went from $1,282 to $3,230, a 150 percent increase.[173]  The coverage of C.W. under a Kansas City policy went from $86,000 to $89,000, but her premium went from $417 to $1,198, an increase of over 185 percent.[174]  Mr. Buhler checked with Encompass and was told that these rates were correct.[175] 

87.           Many factors go into the premium of any individual policyholder.  Some may be looking at surcharges based on claims.  Mr. Buhler is not suggesting that Encompass is taking more rate than it asked for.[176]  He believes that the October increase along with the new increase and the surcharges added at renewal caused the increase.[177] 

88.           Mr. Buhler has renewed approximately 70 percent of his Encompass customers.  He has raised deductibles to try to bring the premiums down a little bit and has told customers that the rate increase has gone to hearing.  Certain caps, or maximum discounts, are involved when deductibles are increased.[178]  His customers feel like they cannot go anywhere else.[179]  It is especially difficult for customers who are on fixed incomes.[180]  Encompass’ rates are at least double that of most of the other companies that Mr. Buhler represents.  There is at least $500 difference between Encompass rates and those of the other companies.[181]  Mr. Buhler has not written any new homeowners policies for Encompass during the last eight months.[182] 

89.           Kevin Hawkins is an independent insurance agent in Minnesota. Mr. Hawkins’ customers who are insured under Encompass homeowners policies have seen premium increases that are typically double those in the prior year.[183]  Thus, the typical increase for Glens Falls customers has been in excess of 100 percent.[184]  The typical increase for Kansas City has been approximately 150 percent.[185]  The Encompass rate increase is much higher than that of the other companies Mr. Hawkins represents.  His other companies are generally in the 20 to 40 percent range.[186]  The increase has been very devastating for many of Mr. Hawkins’ customers.[187]  It has been difficult to move customers to other companies because the market is hard.[188] 

90.           Mr. Hawkins has retained probably 85 to 90 percent of his Encompass customers.[189]  He has been telling his customers that the rate increases might not be approved and believes that that is one of the reasons that they are staying with Encompass.  If the rate increases are approved, he thinks that they will try to leave Encompass, but believes that many of them are not going to be able to do it.  Some are staying with Encompass because they want to stay with Mr. Hawkins’ agency, and because the Encompass policy is a good policy.[190] 

91.           The Department has received numerous calls and letters from insurance agents, Encompass insureds, and others regarding the Encompass rate increases.  The telephone callers generally alleged that the rates were excessive.[191]  The written inquiries[192] have asserted that  (1)  coverage under a Kansas City policy increased $5,000, but the premium went from $464 to $1,150;[193] (2)  coverage under an Encompass policy increased $4,000, but the premium went from $489 to $1,139;[194] (3)  the Kansas City and Glens Falls increases are unfair and excessive;[195] (4)  coverage under a Kansas City policy increased by $8,000, but the premium went from $589 to $1,569;[196] (5)  the Encompass rate increase seems unfair and excessive and should be lowered or spread out over a period of time;[197] (6)  coverage under an Encompass homeowners policy increased $11,000, but the premium went from $884 to $1,944;[198] (7)  coverage under a Kansas City policy increased from $405,000 to $462,000, but the premium went from $1,680 to $4,434;[199] (8)  premiums under an Encompass policy went from $900 to $2241;[200] and (9)  premiums under a Glens Falls homeowners policy increased from $298 to $581, a 95% increase.[201]  An e-mail from Kenneth Neal Moyer of Encompass to a Minnesota insurance agent dated February 13, 2002, indicates that “[s]ome of the factors contributing to the large increases were new tier factors, change in the Special factor and reduction of the deductible credit due to a cap” and that he “would figure 100% minimum increase in Glens Falls and 150% minimum in KC.”[202] 

92.           The Department is not familiar with the individual circumstances of the policyholders who complained, their history of traffic violations or homeowners claims, or whether they were negligent.[203]  It is allowable for companies to impose surcharges for such things as motor vehicle accidents, speeding tickets, and increases in home values as long as a surcharge disclosure statement has been filed.[204]  The Department has not filed an enforcement action asserting that the Respondents have charged customers rates higher than those lawfully filed with the Department.[205] 

The Degree of Price Competition in the Minnesota Market

93.           Under Minn. Stat. § 70A.04, subd. 2, it is presumed that a reasonable degree of competition does not exist if less than five insurers write more than 75 percent of the direct written premium.[206] 

94.           In the homeowners insurance market in Minnesota in 2001, the four largest companies in terms of market share wrote 54.89 percent of the direct written premiums.  Seventeen companies made up the top 75 percent of the homeowners market in terms of direct written premium.  State Farm had the highest market share, 21.98 percent. Glens Falls had roughly one percent of the market share, and Kansas City had .68 percent of the market share.[207]  Comparing information in Exhibit 50 relating to 2001 with that in Exhibit 51 relating to 1996-2000, it is evident that State Farm has lost market share to smaller companies and the market share of companies like American Family and Farmers Group has increased.[208]  State Farm has lost market share over the period of 1996-2001 because it is restricting its underwriting in homeowners.[209]  There was an increase of approximately one percent in the total market share of the top five companies from 1996 to 2000, which does not reflect much change.[210] 

95.           State Farm had the largest market share in Minnesota’s automobile market in 2001.  Fourteen companies made up 76.36 percent of the market share for automobile premiums in Minnesota.[211]  The four largest companies had 56.41 percent of the market.  Glens Falls had .58 percent and Kansas City had .54 percent.[212]  State Farm’s market share declined from 26.56 percent in 1996 to 19 percent in 2001, and smaller companies increased their market share and changed ranking.[213] 

96.           The Herfindahl-Hirschman Index is a standard measure of concentration used by economists to evaluate the degree of competition in the marketplace.[214]  Under the merger guidelines used by the Department of Justice, a market is not concentrated if the Herfindahl-Hirschman Index for that market is less than 1,000; the market is moderately concentrated if the index is between 1,000 and 1,800; and the market is concentrated if the index is above 1,800.[215] 

97.           The Herfindahl-Hirschman Index for the homeowners market in Minnesota in 2001 is 978.  The Index for the automobile market in Minnesota in 2001 is 768.  Consequently, neither market is considered concentrated.[216] 

98.           Based on market share, both the Minnesota homeowners market and the Minnesota automobile market are more than reasonably competitive.[217] 

99.           The more companies that are selling insurance policies in a market, the greater the degree of competition, because each company offers a product that is price-differentiated and consumers thus have more choices.[218] 

100.       There are 330 companies that are licensed to write property insurance in Minnesota.[219]  During 2001, 151 companies wrote at least $1,000 worth of homeowners policies and 202 companies wrote least $1,000 worth of private passenger automobile insurance policies in Minnesota.[220] 

101.       Approximately 28,000 agents are licensed to sell either homeowners or automobile insurance in Minnesota.[221]  Most of these agents sell both types of insurance.[222]  Approximately 6,000 of these agents are independent agents, i.e., they represent more than one insurance company.[223]  The number of agents facilitates competition in the marketplace.[224] 

102.       The fact that Glens Falls and Kansas City use independent agents to market their policies facilitates price competition because consumers have access to a number of companies.[225] 

103.       There are a number of channels through which consumers can price-shop for homeowners and automobile insurance in Minnesota, such as exclusive agents, independent agents, the mail, 800 phone numbers, AARP and military associations, and Internet web sites that provide price information.[226]  The Minnesota Department of Commerce and the National Association of Insurance Commissioners publish shoppers’ guides for homeowners insurance. The existence of multiple marketing channels promotes competition by helping consumers shop and keeping the pressure on prices.  It is easier to shop on a price competitive basis for insurance than it was five years ago.[227]  

104.       Some homeowners insurers, such as American Family, are increasing the amount of business they are writing in Minnesota.[228]  Although American Family’s market share increased only slightly from 2000 to 2001 (from 15.58 percent in year 2000 to 15.65 percent in 2001), the absolute number of its writings have increased.[229]  Some companies are increasing their writings even for people who have had a number of claims.  For example, even though the Company’s market expert, Dr. Andrew Whitman, has had three claims on his homeowners insurance during the past three years, he has been able to get quotes on homeowners insurance from independent agents representing Farmers and other companies.[230] 

105.       Some insurers, such as American Family, Glens Falls, Foremost, Harleysville, Geico, and Progressive, are pursuing new homeowners business in Minnesota.[231] 

106.       No evidence was presented at the hearing concerning whether there has been any increase in the number of consumers who are placed in the FAIR plan due to their inability to gain coverage elsewhere.

107.       There is anecdotal evidence that the homeowners market in Minnesota is currently becoming tighter in the sense that some insurance companies are unwilling or less willing to write new business, have tightened their underwriting standards, are looking more carefully at underwriting their existing book of business, and are not renewing policies for the reasons permitted by Minnesota rule.[232]  Some companies, such as State Farm, Farmers, Metropolitan, Travelers, Austin Mutual, Safeco, and Western National, are limiting new business in Minnesota, and other companies, such as One Beacon and Kansas City, are not accepting any new homeowners business in Minnesota.[233]  Some companies, such as Hartford, Travelers, and Kemper, will only issue package policies for both auto and homeowners or will accept only customers with top credit ratings or no loss history.[234]  Some companies are not willing to take a large mass of new business.[235]  Some customers are having trouble finding policies, particularly certain sub-groups such as customers who have poor credit ratings or a loss within the past three years.[236]  However, this anecdotal evidence did not establish that the homeowners market in Minnesota has reached the point where a reasonable degree of competition does not exist. 

108.       The Department does not take the position that the automobile insurance market in Minnesota is not competitive.[237] 

109.       Based upon market share, the number of companies writing policies, the number of insurance agents in the marketplace, the existence of multiple marketing channels, and the ease with which consumers can shop among different companies, the Minnesota homeowners and automobile insurance markets are reasonably competitive at the consumer level.[238]  As a result, the rates charged by the Respondents are presumed not to be excessive, in accordance with Minn. Stat. § 70A.04, subd. 2.

110.       The Administrative Law Judge  adopts as Findings any Conclusions that are more appropriately described as Findings.

Based upon the foregoing Findings of Fact, the Administrative Law Judge makes the following:

CONCLUSIONS

1.          The Administrative Law Judge and the Commissioner of Commerce are authorized to consider this matter pursuant to Minn. Stat. §§ 70A.06, subd. 1a, and 14.50.

2.          The Respondents received due, proper and timely notice of issues in this proceeding and the time and place of hearing. This matter is, therefore, properly before the Commissioner and the Administrative Law Judge.

3.          The Department has complied with all relevant substantive and procedural legal requirements.

4.          Every licensed insurer in Minnesota is required by Minn. Stat. § 70A.06, subd. 1, to file any rate changes with the Commissioner of Commerce.  The rates do not become effective unless they have been filed with the Commissioner.  The Commissioner may require the insurer to file supporting and explanatory data, which is to include “(1)  the experience and judgment of the filer . . .; (2) its interpretation of any statistical data relied upon; (3)  descriptions of the actuarial and statistical methods employed; and (4)  any other matters deemed relevant by the commissioner or the filer.” 

5.          Under Minn. Stat. § 70A.06, subd. 1a, the Commissioner may hold a hearing to determine if a change in rate is excessive “[w]henever an insurer files a change in a rate that will result in a 25 percent or more increase in a 12-month period over existing rates.”  The Commissioner is required to give notice of intent to hold a hearing within 60 days of the filing of the change in rate.  The statute specifies that “[i]t shall be the responsibility of the insurer to show that the rate is not excessive” and that “[t]he rate is effective unless it is determined as a result of the hearing that the rate is excessive.”  Because each of the three rate increases involved in this hearing is greater than 25 percent, the Respondents have the overall burden of proving by a preponderance of the evidence that the rate increases are not excessive.

6.          Minn. Stat. § 70A.01, subd. 1, states that Chapter 70A of the Minnesota Statutes “shall be liberally construed to achieve the purposes stated in [Minn. Stat. § 70A.01] subdivision 2, which shall constitute an aid and guide to interpretation but not an independent source of power.”  Subdivision 2 indicates that the purposes of Chapter 70A are:

(a)            To protect policyholders and the public against the adverse effects of excessive, inadequate or unfairly discriminatory rates;

(b)            To encourage, as the most effective way to produce rates that conform to the standards of (a), independent action by and reasonable price competition among insurers;

(c)            To provide formal regulatory controls for use if independent action and price competition fail;

(d)            To authorize cooperative action among insurers in the ratemaking process, and to regulate such cooperation in order to prevent practices that tend to bring about monopoly or to lessen or destroy competition;

(e)            To encourage efficient and economic practices.

7.          Minn. Stat. § 70A.04, subd. 1, declares that rates “shall not be excessive, inadequate or unfairly discriminatory, nor shall an insurer use rates to engage in unfair price competition.”

8.          Under Minn. Stat. § 70A.04, subd. 2, “[r]ates are presumed not be excessive if a reasonable degree of price competition exists at the consumer level with respect to the class of business to which they apply.”  The statute goes on to specify that the Commissioner “shall consider all relevant tests” in determining whether a reasonable degree of price competition exists.”  The statute also states that, “[i]n addition to any other manner of determining whether a reasonable degree of price competition exists with respect to any class of insurance, it is presumed that a reasonable degree of competition does not exist if less than five insurers write more than 75 percent of the direct written premiums.” 

9.          In determining whether rates comply with Minn. Stat. § 70A.04, “[d]ue consideration shall be given to past and prospective loss and expense experience within and outside this state, to a reasonable provision for catastrophe hazards and contingencies, to clearly discernible trends within and outside this state, to dividends or savings allowed or returned by insurers to their policyholders, members or subscribers, and to all other relevant factors, including the judgment of underwriters and raters.”[239]  The statute also states that “[r]isks may be classified by any reasonable method for the establishment of rates and minimum premiums.  Classifications may not be based on race, color, creed or national origin.  Rates thus produced may be modified for individual risks in accordance with rating plans or schedules which establish standards for measuring probable variations in hazards, expenses, or both.”[240]  In addition, the rates “may contain an allowance permitting a profit that is not unreasonable.”[241] 

10.          Minn. Stat. § 70A.08, subd. 1, permits an insurer to “itself establish rates and supplementary rate information for any or all kinds or lines of insurance or subdivisions thereof or classes or risks or combinations thereof, based on its own experience, modified by other relevant experience to achieve credibility, or it may use rates and supplementary rate information prepared by a rate service organization . . . .

11.          It is undisputed that, within 60 days of the date on which the Respondents filed their rate changes, the Commissioner gave notice to Encompass of its intent to hold a hearing to determine if the requested rate increases were excessive, in accordance with Minn. Stat. § 70A.06, subd. 1a.  Notice of and Order for Hearing, ¶ 5.

12.          The Respondents have failed to show by a preponderance of the evidence that the three rate increases at issue in this proceeding are not excessive under Minn. Stat. § 70A.06, subd. 1a. 

13.          The bases and reasons for these Conclusions are those expressed in the Memorandum that follows, and the Administrative Law Judge  incorporates that memorandum into these Conclusions.

14.          The Administrative Law Judge adopts as Conclusions any Findings that are more appropriately described as Conclusions.

          Based upon the foregoing Conclusions, the Administrative Law Judge makes the following:

RECOMMENDATION

IT IS HEREBY RECOMMENDED:  that the Commissioner of the Minnesota Department of Commerce find that the rate increases for the homeowners policies of Glens Falls Insurance Company and Kansas City Fire and Marine Insurance Company and the rate increase for the automobile policies of Kansas City Fire and Marine Insurance Company filed in December of 2001 are excessive. 

Dated:  November 27, 2002

Reported:  Transcript Prepared by Barbara F. Schwegman

       and Jane E. Schollmeier, Court Reporters,

       Kirby A. Kennedy & Associates

NOTICE

Under Minn. Stat. § 14.62, subd. 1, the agency is required to serve its final decision upon each party and the Administrative Law Judge by first class mail or as otherwise provided by law.

MEMORANDUM

Relationship between Minn. Stat. § 70A.04, subd. 2, and 70A.06, subd. 1a

As a threshold matter, it is necessary to address an issue raisedby the parties concerning the interplay between two statutory provisions contained in Chapter 70A.  Minn. Stat. § 70A.04, which was first enacted in 1969 and amended in 1986,[242] provides that “[r]ates shall not be excessive, inadequate or unfairly discriminatory, nor shall an insurer use rates to engage in unfair price competition.”  The statute goes on to state in subdivision 2 that “[r]ates are presumed not to be excessive if a reasonable degree of price competition exists at the consumer level with respect to the class of business to which they apply.  In determining whether a reasonable degree of price competition exists the commissioner shall consider all relevant tests.”  The statute further specifies that, “[i]n addition to any other manner of determining whether a reasonable degree of price competition exists with respect to any class of insurance, it is presumed that a reasonable degree of competition does not exist if less than five insurers write more than 75 percent of the direct written premiums.”  This hearingwas initiated under Minn. Stat. § 70A.06, subd. 1a, which was enacted in 1987.[243]  That provision states that, “[w]henever an insurer files a change in a rate that will result in a 25 percent or more increase in a 12-month period over existing rates, the commissioner may hold a hearing to determine if the change is excessive” and specifies that “[i]t shall be the responsibility of the insurer to show the rate is not excessive.”[244] 

The Department contends that the Commissioner can challenge a rate increase as excessive if it exceeds 25 percent under Minn. Stat. § 70A.06, subd. 1a, and that the Commissioner can also challenge a rate increase as excessive where there is not a reasonable degree of price competition under Minn. Stat. § 70A.04, subd. 2, regardless of whether the increase exceeds 25 percent.  The Department thus asserts that these statutory provisions provide two separate standards by which the Commissioner can challenge a rate increase.  Under section 70A.04, subd. 2, a rate increase is presumed not to be excessive where there is a reasonable degree of competition.  If, however, the rate increase exceeds 25 percent, the Department contends that the burden is on the insurer under Minn. Stat. § 70A.06, subd. 1a, to provide that the increase is not excessive.  Thus, even if it is determined that a reasonable degree of competition exists, the Department asserts that the standard set forth in the plain language of Minn. Stat. §  70A.06, subd. 1a, still applies and the burden remains on Encompass to affirmatively prove by a preponderance of the evidence that its three increases, all of which exceeded 25 percent, are not excessive.  The Department argues that the Legislature clearly contemplated situations in which a reasonable degree of competition exists but an insurer still files for a greater than 25 percent rate increase, which may be excessive, and must bear the burden of proving that the increase is not excessive. 

Encompass contends that the 25 percent threshold set forth in Minn. Stat. § 70A.06, subd. 1a, is simply a procedural trigger that sets the level at which the Department can challenge a rate increase, and has nothing whatsoever to do with the substantive determination of whether a rate is in fact excessive.  Encompass asserts that the Department’s interpretation of Chapter 70A would fail to give any effect at all to the presumption of reasonableness set forth in section 70A.04, subd. 2, and would lead to an absurd result.  Encompass argues that the only reasonable interpretation is that the presumption that a rate increase is not excessive in a competitive market applies in all cases, including those that go to hearing because the increase exceeds the procedural threshold of 25 percent. 

It is a fundamental canon of statutory construction that “[e]very law shall be construed, if possible, to give effect to all its provisions.”[245]  Even though the present contested case proceeding was initiated under section 70A.06 due to the Respondents’ greater-than-25-percent rate hike, the underlying basis of this case is the general prohibition against excessive rates set forth in section 70A.04, subd. 1.  It would not make sense to recognize that the prohibition against excessive rates set forth in section 70A.04, subd. 1, applies in proceedings under 70A.06, but preclude the insurer from obtaining the benefit of the presumption set forth in 70A.04, subd. 2, if the underlying facts supporting the presumption are established.  There is nothing in either statutory provision that supports the Department’s view that they were each meant to stand alone.  Rather, both provisions address excessive rates and are substantively intertwined.  Therefore, the Administrative Law Judge agrees that, even where the insurer’s rate increase exceeds 25 percent, the rate must be presumed not to be excessive if a reasonable degree of price competition exists at the consumer level with respect to the class of business to which it applies.  This interpretation gives effect to both Minn. Stat. § 70A.04, subd. 2, and 70A.06, subd. 1a.  To conclude that the presumption only applies in cases that are not brought under section 70.06 would render the statute internally inconsistent and lead to the illogical result of precluding insurers from obtaining the benefit of the presumption simply because they imposed a rate increase in excess of 25 percent.

          Rule 301 of the Minnesota Rules of Evidence provides guidance concerning the manner in which the presumption should be applied in this proceeding.  Rule 301 states that, “[i]n all civil actions and proceedings not otherwise provided for by statute or by these rules, a presumption imposes on the party against whom it is directed the burden of going forward with evidence to rebut or meet the presumption, but does not shift to such party the burden of proof in the sense of the risk of nonpersuasion, which remains throughout the trial upon the party on whom it was originally cast.”  As explained in the Advisory Committee Comment, “[o]nce the basic facts that give rise to the presumption are established the opponent must produce evidence to rebut the assumed fact or a verdict will be directed on the issue.  If sufficient evidence is introduced that would justify a finding of fact contrary to the assumed fact the presumption is rebutted and has no further function at the trial.”  The Comment also indicates that Rule 301 “applies to both common law presumptions and statutory presumptions with the exception of those statutory presumptions in which the legislature has specifically provided that the presumption shall have some other effect.”[246]  There is nothing in Minn. Stat. § 70A.04, subd. 2, that specifies that the presumption must have some other effect.  In explaining the operation of Rule 301, Professor Peter N. Thompson states that, “A presumption is an assumption of fact required by law once certain underlying or basic facts are established. . . .  The Minnesota Supreme Court has followed the federal rule of evidence in promulgating the Thayer or ‘bursting bubble’ view of presumptions in Rule 301.  According to the rule, presumptions are procedural devices that govern only the burden of going forward with the evidence.  If unrebutted, a presumption requires a directed verdict in favor of the beneficiary of the presumption.  Once rebutted, the presumption disappears, or bursts, and has no more effect on the trial process.”[247]  Thus, as emphasized by Professor Thompson, “Rule 301 presumptions relate to the burden of producing evidence and have no effect on the burden of persuasion.”[248] 

In the context of the present proceeding, this means that, if the Respondents established that a reasonable degree of price competition exists at the consumer level with respect to the class of business to which their rate increases apply and are therefore entitled to the presumption that their rates are not excessive, the Department has the burden of going forward with evidence to rebut or meet the presumption.  The overall burden of proving that the rates are not excessive remains on the Respondents throughout the proceeding.

Competitiveness of the Market

As noted in the Findings, the Department conceded that the market in Minnesota for automobile insurance is competitive, but contends that the market for homeowners insurance is not competitive.  Encompass presented detailed testimony through its expert, Dr. Andrew Whitman, concerning the homeowners insurance markets in Minnesota in 2001.  This evidence showed that, while the four largest companies in Minnesota wrote approximately 55 percent of the direct written homeowners premiums, seventeen companies made up the top 75 percent of the homeowners market.  Under Minn. Stat. § 70A.04, subd. 2, the market is presumed not to be competitive if less than five insurers write more than 75 percent of the direct written premiums.  The evidence for 2001 obviously did not show this level of lack of competition.  Encompass also showed that, while the 2001 Minnesota homeowners market approached a level that would be deemed moderately concentrated under the Herfindahl-Hirschman Index, it did not actually reach or exceed that level and thus would be labeled not concentrated.  The Respondents also showed that 151 companies wrote at least $1,000 worth of homeowners policies in 2001, 28,000 agents (6,000 of whom are independent agents) are licensed to sell either homeowners or auto insurance in Minnesota, a number of marketing channels facilitate price-shopping by consumers, and some companies are pursuing new homeowners business in Minnesota and increasing the amount of business they are writing.  Dr. Whitman also testified about his personal experience in shopping for homeowners insurance and his ability to obtain quotes from independent agents representing Farmers and other companies despite the fact that he has had three claims on his homeowners insurance during the past three years. 

The Department did not present any evidence challenging Dr. Whitman’s testimony regarding the market share, the Herfindahl-Hirschman Index, the number of companies and agents selling insurance in Minnesota, or the existence of multiple marketing channels.  The Department does, however, argue that Encompass failed to establish that a reasonable degree of competition exists in Minnesota.  The Department emphasizes that, in the years 1996-2000, the market share of the top five insurers in Minnesota actually increased, and points out that, in 2001, the top four insurers had over 54% of the market share.[249]  Although this share does not reach the level required for a presumption of a lack of competition under Minn. Stat. § 70A.04, subd. 2(a), the Department contends that the fact that only four insurance companies out of the 151 companies that write homeowners insurance in Minnesota share well over 50% of the market is evidence that the market is not competitive.  The Department emphasizes that the top 50 insurers control 93.96% of the business, and the remaining 100 insurers share less than seven percent of the business in Minnesota.  The Department asserts that Dr. Whitman based his opinion solely on historical statistics and failed to support his opinion with any concrete evidence or any reference to the real-world experience of the agents.  The Department also asserts that its view that the market is currently not competitive was supported by Mr. Baker (the Department’s Director of Property Casualty Insurance and Self-Insurance), Ms. Myers (the Department’s actuary), and the three independent insurance agents who testified in this case. 

After careful consideration of all of the evidence presented, the Administrative Law Judge is persuaded that it is appropriate to find that a reasonable degree of price competition exists in the homeowners insurance market in Minnesota.  The total market share of the top five companies only increased by approximately one percent during the time period of 1996 to 2000.  During this same time period, State Farm, the industry leader, lost market share to smaller companies.  Mr. Srenaski testified that he has been able to place approximately half of the approximately 15 percent of his Encompass customers who have asked to switch companies with other companies, and lost the remaining six or seven percent to companies he does not represent.  He has not had to place anyone with the FAIR Plan.  In addition, Michael Reid, Encompass’ Vice President and Chief Operating Officer, testified that none of the Encompass agents to whom he had spoken had placed any customers with the FAIR plan.  The Department did not offer any evidence that any Encompass customers have had to be placed with the FAIR Plan or that the FAIR Plan has experienced an increase in subscribers.  Dr. Whitman testified about his own personal experience in shopping for insurance and his ability to obtain quotes despite the fact that he had filed claims. 

Although the Department and the independent agents supplied some anecdotal evidence that the homeowners market in Minnesota is currently becoming more restrictive or “tighter” in the sense that some insurance companies are unwilling or less willing to write new business, have tightened their underwriting standards, are looking more carefully at underwriting their existing book of business, and will only issue package policies, and that some customers, particularly those with poor credit ratings or recent losses, are having difficulty finding policies, this evidence did not demonstrate that the homeowners market in Minnesota has reached the point where a reasonable degree of competition does not exist.  There was no evidence that the responsibilities of either Mr. Baker or Ms. Myers include review or evaluation of the competitiveness of the Minnesota market for homeowners insurance.  It appeared that they merely relied upon television and newspaper coverage of State Farm’s decision to limit its new business in Minnesota and scattered casual remarks as a basis for their testimony that the current market is not competitive.  The Department did not provide any objective evidence to support its allegation that there is a lack of competition in the current market.  Moreover, the testimony of the three independent insurance agents is undermined by the fact that the companies they represent have a comparatively small portion of the market in Minnesota, thereby limiting the breadth of their experience in the Minnesota market and undermining their ability to be in a position to assess the competitiveness of that market as a whole.[250]  Finally, there was evidence by both Encompass and Department witnesses that some insurers, including American Family (the second largest insurer in the state in 2001), are pursuing new homeowners business in Minnesota. 

As a consequence, the evidence put forward by the Department was not sufficient to overcome the more objective evidence of the competitiveness of the market and the expert testimony that was provided by Encompass concerning the number of companies writing policies, the number of insurance agents, the existence of multiple marketing channels, and the ease with which customers may shop among different companies.  Thus, because the preponderance of the evidence supports the conclusion that a reasonable degree of price competition exists at the consumer level with respect to homeowners insurance, Encompass is entitled to a presumption under Minn. Stat. § 70A.04, subd. 2, that its rates are not excessive.  Because the Department did not take the position that the Minnesota auto insurance is not competitive, Encompass is also entitled to the statutory presumption that the Kansas City auto rate increase is not excessive. 

Rate Increase Filings

The Department took issue with four aspects of Encompass’ homeowners rate filings:  (1)  the selection of an “excluding-catastrophe” (“ex-cat”) loss ratio of 95 percent, which the Department contends is excessively high; (2)  the selection of a catastrophe factor (“cat factor”) of 35 percent, which the Department also contends is excessively high; (3)  the allocation of the base loss ratio between Glens Falls and Kansas City, which the Department contends lacks sufficient actuarial support; and (4)  a 15 percent upward adjustment to the rate indication for each company to incorporate data for the first nine months of 2001, which the Department contends lacks actuarial support.  As noted in the Findings, the Department has no disagreement with the profit margin allowed in the rate filings at issue.  The Department’s only disagreement with Encompass’ automobile filing has to do with the allocation of the rate increase between the two companies. 

A.  Selection of Ex-Cat Loss Ratio

Encompass contends that its selection of an ex-cat loss ratio of 95 percent was reasonable and supported by actuarial data.  As summarized in the Findings, Encompass selected, through an exercise of actuarial judgment, an ex-cat loss ratio of 95 percent based on what it viewed as a consistent upward trend in the loss ratios.  Although the use of selections is a generally accepted methodology within the actuarial profession,[251] the Department contends that the selection in this instance is problematic because Encompass failed to account for the previous five years of ex-cat loss experience and inappropriately attempted to account for trend in its selection of the ex-cat loss ratio, resulting in the selection of an excessively high ex-cat loss ratio. 

The Department provided persuasive evidence that Encompass’ method of selecting the ex-cat ratio was unreasonable and resulted in an excessively high ratio.  In particular, Encompass adjusted the ex-cat loss ratios of the previous five years to the 2000 level and then simply selected 95 percent, which matched the most recent loss ratio, as the most likely predictor of losses during the next experience period.  Encompass’ approach is contrary to the standard method of using a five-year weighted average method, giving the most weight to recent years.  As expressed in Homeowners Insurance Pricing by Mark Homan:[252]

Many of the property causes of loss are weather related.  Since weather varies greatly from one year to the next, the losses also show significant variation.  In addition, fire, which contributes a major portion of the losses, is a relatively low frequency, high severity occurrence.  To compensate for this variation in property coverages, a longer time period, here a five year period, is needed for stability. 

The use of a five-year weighted average is fairly standard among insurers.  The most recent homeowners filings by ISO and Allstate Insurance Company (Encompass’ parent company) used the five-year weighted average method.  Encompass itself used this method in its July 2001 homeowners filing with the Department and in a recalculation of its December 2001 rate increase produced to the Department.  Had the five-year weighted average method been used, a more reasonable ex-cat loss ratio would have been derived.  As Ms. Myers testified, Encompass’ approach here is troublesome because it appears that it merely picked a number that gave the desired result, rather than calculating the ex-cat loss ratio in a more disciplined fashion.  The fact that Mr. Carlton selected the same 95 percent figure in his recalculation does not provide persuasive evidence of the reasonableness of this ratio, primarily because he, like Encompass, made a selection rather than a calculation and chose to give greater impact to the more current years that were showing worse experience rather than relying upon a five-year weighted loss approach.  His testimony did, however, provide additional support for the use of a five-year weighted average, since he did perform that calculation as part of his approach.[253]

The Department also demonstrated convincingly that Encompass inappropriately attempted to account for trend in its selection of the ex-cat loss ratio.  Encompass developed a separate loss trend factor based upon information provided by ISO.  Because Encompass accounted for increases in frequency of accidents and the severity of accidents in its trend factor, it is unreasonable for Encompass to also take trend into account in its selection of the 95 percent ex-cat loss ratio.  In addition, the use of the weighted average method giving the most weight to the most recent years appropriately takes any upward trend into account.  Moreover, even though the ex-cat loss ratios for the previous five years seem to be increasing, that merely may be due to random variations rather than an upward trend.  Accordingly, for both of the reasons asserted by the Department, Encompass’ selection of the 95 percent ex-cat loss ratio was unreasonable and excessive. 

B.  Selection of Cat Factor

As summarized in the Findings, Encompass selected 35 percent as the cat factor for the future period when the proposed rates would be in effect.  Encompass contends that it tempered the 1998 year by selecting a ratio that was lower than the five-, ten-, and fifteen-year averages.  Encompass points out that it selected a 30 percent cat factor in its previous filing of July 27, 2001, which has not been challenged by the Department.[254]  Starting in 1996, the cat factors increased significantly over the previous ten years.  There were an unusually high number of storms in 1998, and the cat factor for that year was 474 percent.   The 1996-2000 five-year arithmetic average of the cat factors was 128 percent, the 1991-2000 ten-year average was 67 percent, and the 1986-2000 fifteen-year average was 46 percent.[255]  Encompass’ expert actuarial witnesses, Kenneth Carlton, testified that he would have selected an even higher cat factor of 50 percent using a weighted average methodology and tempering the impact of theunusual 1998 year, and felt that the selection by Encompass of a 35 percent cat factor was conservative.[256] 

The Department contends that Encompass’ selection of a cat factor of 35 percent is excessively high and unreasonable because (1)  Encompass only analyzed fifteen years of catastrophe loss data, which is inadequate; (2)  Encompass’ treatment of the 1998 storm losses was unreasonable because it failed to properly take into account the extremely unusual nature of those losses; and (3)  Encompass’ selection of 35 percent is not supported by a calculation or rational analysis.[257]  Encompass disagrees with the Department’s contention that it selected the cat factor “randomly” and without analysis, and contends that the evidence adduced at the hearing supports its position that the 35 percent figure was selected based on a significant increase in cat factors over the most recent five years, plus 2001.  It also contends that there was adequate and sufficient data to support the selection and that the figure it selected was lower than the five, ten, and fifteen year averages.

Based upon a consideration of the competing arguments and evidence, the Administrative Law Judge concludes that the Department has shown that the cat factor selected by Encompass was excessive.  Encompass only compared its catastrophic and non-catastrophic losses for the most recent 15 years of experience.  In arriving at the cat factor, Encompass derived the 15-year straight average of its catastrophe losses, thereby giving each year the same weight without any adjustment to account for the highly unusual nature of the 1998 losses.  In fact, Encompass did not perform any analysis or calculation to adjust for the unusual nature of the 1998 storms.  Encompass merely selected 35 percent as its catastrophe loss ratio, without providing a supporting calculation. 

While it is evident that “there is no one methodology for analyzing catastrophic losses,”[258] the Department provided persuasive evidence that 15 years of experience in Minnesota is not a long enough period of time for a proper analysis, particularly where no effort is taken to account for the highly unusual nature of the 1998 storm losses, and that the Company’s failure to adequately temper the 1998 losses led to the selection of an excessive cat factor.  The ISO maintains 40 years of catastrophic loss data that is available to all insurers.  A graph prepared by Ms. Myers comparing the ratios of wind losses to non-wind/water losses over 40 years for the insurance companies reporting to ISO dramatically illustrated the extraordinary nature of the 1998 losses.[259]  The reasonableness of making adjustments to account for the extremely unusual nature of the 1998 storms is illustrated by the fact that ISO modified the excess calculations to reflect the assumption that storm such as the one that occurred in 1998 occurs once in 100 years,[260] and Allstate spread its losses over twenty years, incorporated countrywide data into its adjustment for unusual losses, and also capped state numbers in order to account for the unusual nature of the 1998 losses.[261]  The evidence demonstrated that it also was unreasonable for the Company to rely on a perceived trend in the most recent five years of cat loss ratios, since five years simply does not supply enough data to show a trend and, in any event, trend is accounted for elsewhere in the filing.  Finally, Mr. Carlton’s selection was not reasonable due to his dependence upon actual dollar amounts in calculating what he thought the load for catastrophe should be.  As Ms. Myers pointed out, the use of dollars in place of ratio is problematic because dollars are not comparable over time, demographics have changed, and the use of dollars places more weight on the years involving large amounts, rather than analyzing catastrophes over a long period of time.[262] 

C.    Allocation of Base Loss Ratio between Glens Falls and

      Kansas City

As set forth in the findings, Encompass decided to place customers with a higher loss experience in Kansas City in 2001.  Once Encompass arrived at a preliminary OTA rate level indication of 71.2 percent, it allocated the rate indication between the two companies.  After considering the historical loss ratios of the two companies based upon nine months in 2001 for which data was available (from the time Encompass first segmented its Minnesota business into the Glens Falls and Kansas City companies), the Respondents arrived at preliminary OTA rate indications of 61.9 percent for Glens Falls and 83.9 percent for Kansas City.  According to Mr. Carlton, the allocation between companies was reasonable given that this was all the data available.  He pointed out that the loss ratio for Glens Falls (106.2 percent) was better than that for Kansas City (143 percent) and that, if Encompass had reduced the rate level indication for Kansas City, it would have had to increase the indication for Glens Falls, resulting in those policyholders paying more even though their experience was better.  Encompass asserts that, contrary to the Department’s arguments, the purpose of insurance is not subsidization but the spreading of risk after the product is priced so that those with similar risks pay similar premiums, and that the goal is to remove as much subsidy as possible from the premium, so that better-performing clients aren’t charged a higher rate to cover the losses for under-performing clients. 

The Department argues that Encompass failed to prove that its allocation of the rate increase between Glens Falls and Kansas City was reasonable and supported by the actuarial data.  The Department asserts that the allocation is unreasonable, unsupported, and leads to an even more excessive rate increase for its Kansas City customers.  The Department primarily contends that Encompass failed to account for the limited credibility of the data used to make the allocation.  In this regard, the Department asserts that the data is far short of the 60,000 earned house years that are required for credibility.  The Department also asserts that it is unclear whether the Company took into account the July 2001 rate increases that applied to Glens Falls and Kansas City.  The Glens Falls July 2001 increase was 3.7 percent, while the Kansas City increase was 11.7 percent.

The Administrative Law Judge concludes that the allocation was not shown to be reasonable.  Encompass did not dispute the Department’s assertion that it uses a credibility standard of 60,000 earned house years or the propriety of using that credibility standard in the context of the allocation.  As of January of 2002, Glens Falls had 14,753 policies in force, while Kansas City had 6,532.  Assuming that all of the policies in force in January of 2002 included homeowners’ coverage and were in force for the entire first nine months of 2001, the Department argued that the total number of earned house years was only 11,065 for Glens Falls and 4,899 for Kansas City (representing the number of policies multiplied by .75, to reflect the nine-month period).  This is far short of the 60,000 earned house years required for full credibility.  Even Encompass’ own consulting actuary, Mr. Carlton, acknowledged that he would have been more comfortable if the Respondents had had five years of data and agreed that Encompass could have accounted for the limited credibility of the nine months’ of data in some way.[263] 

Encompass should, at a minimum, have taken steps to account for the limited credibility of its data.  As the Department pointed out, one way to do this would be for Encompass to have calculated an adjusted loss ratio by assigning the residual credibility to the statewide loss ratio of 129 percent.  In the alternative, Encompass could have filed for the same increase for both companies or waited until it had additional data and the requisite 60,000 earned house years to file a new rate increase.  Encompass did not take any of these approaches.  In addition, there is no evidence that Encompass took into account the fact that the Kansas City rates were already significantly higher than the Glens Falls rates prior to its December 2001 filing.  This obviously should have been done.  Accordingly, the limited data offered by Encompass simply does not support the reasonableness of the higher increase to Kansas City customers. 

D.  Adjustment to Rate Indication to Incorporate Available 2001 Data

Because the available data for the first nine months of 2001 showed a continuing deterioration in the loss ratios, the Respondents added an adjustment of 15 percent to the preliminary rate indications to arrive at final OTA indications of 76.9 percent for Glens Falls and 98.9 percent for Kansas City.  The data for the first nine months of 2001 showed losses that were approximately 30 percent worse than the same period in 2000.  At the time of the filings, Encompass was unable to incorporate fiscal year data into its ratemaking methodology.  Encompass incorporated the partial calendar year data for 2001 separately through the 15 percent adjustment.  Encompass later changed its computer programs so that it could incorporate fiscal year data, and ran a fiscal year indication through September of 2001.  That fiscal year data resulted in an indication that was even higher than the indications in the filings which incorporated the 15 percent adjustment. 

Encompass argues that the 15 percent adjustment for 2001 data was reasonable and justified by the available actuarial data.  Mr. Carlton supported the reasonableness of the 15 percent adjustment based upon the fiscal year data that subsequently became available and the application of his own re-selections of the ex-cat loss ratio and the cat factor.  Based upon fiscal year data through September 2001 incorporating his re-selections, Mr. Carlton derived an overall indication for the combined companies of 121.3 percent, compared to the 86 percent indication derived by Encompass in the original filings. 

The Department contends that Encompass did not perform any analysis of the nine months of 2001 data it possessed when making its rate increase filings, and thus has failed to provide any of the requisite actuarial support for the 15 percent upward adjustment.  The Department points out that Encompass made a 15 percent upward adjustment of its preliminary rate indication based upon the sole justification that “an adjustment was made for emerging accident year 2001 data, which shows significant deterioration.”[264]  Based upon this statement alone, Encompass increased its final overall rate indication from 71.2 percent to 86.2 percent.[265]  The Department argues that Encompass could have analyzed the 2001 data manually, without the software program it contends it lacked; could have put a high priority on upgrading the system prior to its filing, as it now has done; or could have waited to seek a second increase based upon 2001 data once it had the appropriate software.  The Department thus asserts that Encompass has failed to prove that the 15 percent upward adjustment is reasonable and not excessive.

In its reply brief, Encompass contends that it is not true that it did not analyze the nine months of 2001 data when it made the December 13, 2001, filings, and points out that Mr. Lew testified about the Company’s review and analysis of loss ratio development triangles showing the 2001 loss data.  These loss ratio development triangles were included in the rate filings.  Mr. Lew testified that the Company determined that there was a 30 percent worsening of the loss ratio for 2001 when compared to the same point of time in accident year 2000.[266]  However, this does not answer Ms. Myers’ testimony that Encompass failed to put the nine months of 2001 data used to support the 15 percent adjustment through the same adjustments and calculations as it did the data for 1996 through 2000, which was adjusted in various ways to determine the loss ratios at the 2000 level.[267]  Mr. Carlton acknowledged in his testimony that the 2001 data had not been analyzed by Encompass in the rate filing in the same fashion as the data from previous years was analyzed.[268]  The fact that later recalculations using fiscal year data may have resulted in higher indications does not serve to justify the 15 percent upward adjustment contained in the December 2001 rate increase.  Encompass has not borne its burden to show that this adjustment was reasonable and not excessive. 

E.  Allocation of Automobile Rate Increases between the Two

     Companies

The Department’s only disagreement with respect to the automobile filing was with the allocation of the rate increase between the two companies.[269]  Encompass reviewed the loss data for the first nine months of 2001, which was once again the only data available, and made the allocation on that basis.[270]  The Company argues that a decrease in the Kansas City rate would cause a corresponding increase in the Glens Falls rate, resulting in an unfair subsidy.  The Respondents used the same methodology for this allocation as they used with respect to the allocation of the homeowners rate increase,[271] and the Department relies on the same reasons discussed above with respect to the homeowners allocation as a basis for its argument that the allocation was unreasonable and unsupported by the data. 

In her written report concerning the Encompass filings, Ms. Myers indicated that Encompass uses 72,000 earned car-years as a credibility standard for full credibility of data.  A car-year is one car insured for one year.  Ms. Myers referred to the number of policies she believed were in place as of January 2002 and asserted that the Company had significantly less earned car-years than required by the full credibility standard.  Ms. Myers contended that Encompass should have accounted for the limited credibility of its data when it calculated an adjusted loss ratio by assigning the residual credibility to the statewide loss ratio of 78% or should have increased the rates in both companies by the same amount.[272]  In her testimony at the hearing, Ms. Myers admitted that the numbers she had included in Ex. 39 concerning the auto policy were incorrect because they relate to the number of Encompass property policies, not auto policies,[273] and that, in any case, the number of policies does not necessarily correspond to the number of automobiles because often more than one automobile is covered by a policy.[274]  Ms. Myers did, however, continue to assert that the data used by the Company as a basis for the allocation of the automobile rate change to Glens Falls and Kansas City lacked sufficient credibility, and argued that she has not seen any indication that Glens Falls or Kansas City had 72,000 earned car years.[275]  As a result, the Department continues to contend that Encompass should have used a partial credibility standard or increased the rates in both companies by the same amount.[276]  Encompass did not respond to this testimony by disputing the applicability or accuracy of the car-year standard or providing any assurance that the car-year standard was, in fact, met. 

While it is a close question, the Administrative Law Judge concludes that the Department satisfied its burden of going forward with evidence to meet the presumption that the automobile rate was not excessive, and the Respondents failed in their overall burden to show that the allocation was reasonable and not excessive.  Given the limited nature of the data, Encompass should either have changed the rates by the same amount in each company or accounted for the limited credibility of the data. 

Public Policy Issue

None of the top 26 insurers in Minnesota sought a rate increase in 2001 that approached the increase sought by Glens Falls and Kansas City.  The next highest single increase was 30.8 percent sought by Prudential.[277]  If the July 2001 increase is added to those at issue in the present proceeding, the cumulative 2001 increase for Kansas City is 110.3 percent and for Glens Falls is 75.9 percent.[278]  The next highest cumulative increase by another insurer in 2001 is 34.3 percent by Austin Mutual.[279] 

The Department asserts that Encompass’ homeowners rate increases are so excessive that it would violate public policy for the Commissioner to approve them.  The Department argues that the Commissioner may not properly defer to the free market or let the free market determine rates, due to the nature of insurance, the requirement of most auto and home lenders that customers obtain insurance, and the difficulty that many people have in acquiring insurance due to past claims or credit scoring.[280]  The Department emphasizes that it has received dozens of complaints from insureds and agents regarding the Encompass rate increases, and points out that the premiums of many have actually increased more than 100% due to surcharges and the Company’s July 2001 increases that took effect in October 2001.  The Department points out that Encompass admitted that it had made a mistake in seeking only a 4.3 percent increase in 1999 and a 10.9 percent increase in 2000, and contends that it is the Commissioner’s responsibility to prevent an insurer from attempting to pass on its losses due to poor management decisions by raising its rates excessively in a single year.  The Department argues that, even if a 100 percent rate increase were supported by actuarial data, it would find the increase excessive and decline to approve it since the Department would want the company to try to spread that increase out so that it would not have such an immediate negative impact on the policyholders.[281] 

Encompass points out that its losses in Minnesota exceeded premiums by approximately $48 million for the period 1991-2001, and argues that the Department should only disapprove rates if they are outside a “range of reasonableness.”[282]  The Company asserts that the Department should not be permitted to impose rates that require it to operate at a loss.  Encompass contends that the public will not be served if the Department is successful in forcing rates on Encompass that do not allow the company to break even financially in Minnesota.  The Company argues that such a policy will ultimately force Encompass to further restrict its business in Minnesota or leave the state altogether, thereby reducing the overall availability of homeowners insurance in Minnesota.  Encompass denies that it is trying to recoup losses from prior years. In addition, Encompass contends that it has taken significant steps to mitigate the effects of the increase on policyholders and agents, a majority of Encompass insureds are choosing to remain with Encompass, and there is no evidence that any policyholder has been unable to obtain insurance on the voluntary market as a result of these rate increases.  Encompass thus argues that the rate increase is not in conflict with public policy. 

The stated purposes of Chapter 70A of the Minnesota Statutes include “protect[ing] policyholders and the public against the adverse effects of excessive, inadequate or unfairly discriminatory rates,” “encourag[ing] . . . independent action by and reasonable price competition among insurers,” “provid[ing] formal regulatory controls for use if independent action and price competition fail,” and “encourag[ing] efficient and economic practices.”[283]  This reflects Legislative intent that the statute is not intended solely to protect consumers from excessive rates or solely to require that a free market be allowed to dictate the rates.  It would not be warranted in the context of this case to find that a particular level of rate increase is barred as a matter of public policy, nor would it be warranted to find that companies must be permitted to impose whatever increase they deem necessary to avoid unacceptable losses.  A variety of facts and circumstances must be taken into account in determining whether a specific rate increase is excessive, and the outcome of each situation must be dependent upon the particular facts and circumstances involved.  The rate increases involved in this proceeding have been found to be excessive primarily based on flaws in analysis or a lack of reasonable data or actuarial support for the approach taken by the Company.  This determination is consistent with the purpose of Chapter 70A to protect policyholders and the public.  In the view of the Administrative Law Judge, it is not necessary under the circumstances of this case, nor would it be appropriate, to issue a general ruling that insurers must never be allowed to seek the level of increase involved here.

Constitutional Argument

Encompass contends that,if a rate is imposed upon it which precludes a reasonable rate of return, the order imposing the rate will amount to an unconstitutional confiscatory taking, in violation the Respondents’ rights under the Fifth Amendment of the U.S. Constitution and Article I, Section 13 of the Minnesota Constitution.  Encompass argues that, as noted in Hibbing Taconite Co. v. Minnesota Public Service Commission,[284] and other cases, the state cannot impose confiscatory rates “which are not sufficient to yield a reasonable return on the value of the property used, at the time it is being used to render the service.”  The Department opposes this argument on the merits, distinguishing the regulation of insurance rates from the types of regulation involved in the cases cited by Encompass and disputing that a proper showing of a confiscatory taking had been made by the Company.

In order to determine whether there has been an unlawful taking, it is necessary to review “1)  the economic impact of the regulation on the person(s) suffering the loss, 2)  the extent to which the regulation interferes with distinct investment backed expectations, and (3)  the character of the government action to assess whether the complained of action effected a taking of private property for public use.”[285]  Although Encompass will sustain an economic loss if the Commissioner finds its proposed rate to be excessive, the evidence presented in this case did not provide an adequate basis on which to assess the effect of the loss on the Company’s entire financial position.  The takings argument thus is not persuasive.[286] 

In conclusion, the Department satisfied its burden of going forward with evidence to support its position that the homeowners and automobile rate increases sought by Encompass were excessive, and Encompass did not establish by a preponderance of the evidence that the rate increases were not excessive.  Accordingly, it is recommended that the Commissioner find that the increases are excessive.

B.L.N.