For affirmance -- Chief Justice Weintraub, Justices Jacobs and Proctor, and Judges Lewis and Collester. For reversal -- None.
This matter was before us in In re Insurance Rating Board, 55 N.J. 19 (1969). The then Commissioner of Banking and Insurance denied approval of rate filings for increases (1) for automobile liability insurance and (2) for collision and other physical damage coverage. We remanded the matter to the department for further consideration but retained jurisdiction. Further hearings were held by the Commissioner of Insurance (successor to the Commissioner of Banking and Insurance) and a new determination made. Both the Insurance Rating Board (herein IRB) and Special Counsel appointed by the Attorney General to represent the Public seek a review of that determination.
The parties had started with the premise that the insurer should receive 5% of premiums for underwriting profit and contingencies but disagreed as to whether there should be deducted from that sum the income received by the insurer from investment of funds supplied by policyholders, i.e.,
the reserve for unearned premiums and the reserve for losses. We concluded tentatively that such earnings could not be disregarded in fixing a reasonable profit for the insurers mandated by N.J.S.A. 17:29A-11, but we wanted to know the basis for the premise that 5% of premiums was the proper rate. On the remand the Commissioner found "there is no substantive basis for the 5% provision for underwriting profit and contingency other than its historical acceptance in this State in connection with prior rate filings."
Indeed upon the remand, IRB abandoned the proposition that 5% of premiums constituted a fair profit for the risk the insurers took. Instead, by analogy to rate-making in the case of a public utility, IRB sought a fair return upon the funds supplied by stockholders. Upon that approach, the earnings from the funds supplied by policyholders (the two reserve accounts mentioned above) were taken into account as we had tentatively said they must be, but so also were the total gains from the investment of the funds supplied by stockholders. Stock analysts for IRB testified that a return of at least 12% after federal income taxes on stockholders' investment was needed to attract and retain capital in the insurance business. IRB sought a provision in the rates for a 9% underwriting profit on stockholder-supplied funds, which, after federal income tax, would leave an underwriting profit of 4.7%, which, added to "banking profit" of 7% (after federal income tax) would approximate the 12% yield IRB maintained was necessary. Special Counsel maintained that with respect to the lines of insurance here involved, no underwriting profit whatever was needed since the income from the investment of the policyholder-supplied funds was adequate compensation for the underwriting risk.
The public-utility analogue was of course imperfect. The stockholders' investment in an insurance company is not embedded in plant or equipment committed to the supplying of the service or product involved. The funds thus supplied, which are invested in securities selected by the insurer, are not directly used to furnish the service, but rather constitute
a fund to which the policyholders will have recourse if the insurer's underwriting experience involves a loss. The Commissioner concluded that the policyholders should not be concerned with the income, gains or losses from the investment of stockholder-supplied funds. That risk, the Commissioner held, is the stockholders'. And he concluded as well that the risk of capital gain or loss in the investment of policyholder-supplied funds should be the insurer's. Hence the Commissioner held that in fixing a reasonable profit for the insurer, account would be taken only of the income from interest, dividends and rents earned on the funds the policyholders supplied.
But since compensation for the underwriting risk was being sought in terms of a fair return upon the stockholders' investment which must be translated into a percentage of premiums for rate-making purposes, the critical question became what was the needed stockholders' investment to support the total premiums written. IRB relied upon the fact that historically the industry-wide ratio between premiums and net worth was 1 to 1. Special Counsel countered with proof that net worth nonetheless included "surplus-surplus," i.e., assets which exceeded the funds needed to support the insurance business done, and that such "surplus-surplus" was not subject to any real risk. The thrust of his proof was that the appropriate ration of premiums to net worth was 3.5 to 1. The record shows that some substantial insurers operated at or near that ratio. The Commissioner concluded that for rate-making purposes the appropriate ratio of premiums to net worth was 2 to 1, but finding that "surplus-surplus" remained subject to some remote risk, the Commissioner allowed a return upon "surplus-surplus" at a lesser rate.
As we noted above, IRB's stock analysts said a total return of 12% after federal income taxes was needed to attract and retain capital. In reaching that result, they assumed the risk of underwriting loss was high. The Commissioner, however, rejected that premise. He found the fluctuations in the total return upon net worth to which those experts referred
were the result of stock market fluctuations rather than underwriting experience. He pointed out that automobile rates were normally reviewed each year and that automobile loss experience does not change so drastically from year to year. He noted that in New Jersey rating organizations and large independent filers are required to submit rate reviews for private passenger cars at six-month intervals, in each case using experience six months more ...